As the markets now enter a period of high volatility, I ponder whether they are sensing the onset of the next recession. It's almost certain that we will see a global recession within the next two years. The history of U.S. recessions shows the range of expansions between two and 10 years since the Second World War. The longest was 120 months that ended officially in the first quarter of 2001. That 10-year expansion was driven by the Internet boom and the technology revolution. Free money and massive debt is the current tailwind, so the quality of this cycle is fundamentally weak.
Last week, on Sept. 15, we remembered the eighth anniversary of the Lehman Brothers bankruptcy: the day the world better understood how derivatives of mass destruction makes the financial markets so integrated. The current recovery is now in its eighth year and it could, but likely will not, run another two years before being the longest expansion in modern history without a recession. To say we are not in the latter innings of the economic cycle would be naive. To say the global economy is in good shape is laughable if we were not so depressed about it.
At the recent U.S. Federal Reserve conference at Jackson Hole, Wyo., we heard what policy tools the central bank has left to deal with the next recession. The Fed told us that it could use negative rates to fight the next recession. It also suggested that governments should kick up fiscal policy. So we reviewed the world's efforts on fiscal policy since the Lehman moment. We looked at the four largest economies in the world accounting for more than 90 per cent of world GDP.
- The United States government has borrowed about $9-trillion (U.S.). That is an average of about 6 per cent of GDP a year. Since the Lehman moment, with zero interest rates and $3.5-trillion of quantitative easing, the U.S. economy has grown at about 1.6 per cent a year. So in reality, without all that fiscal stimulus, the economy is shrinking about 4 per cent a year. There is no recovery and more of the same probably is useless given the increasing mountain of debt.
- China is currently borrowing more than 100 per cent of GDP to manufacture its (so called) 6.7-per-cent GDP. Without government fiscal policy, China is not growing. Its demographic headwinds are worse than in the United States.
- Japan has been performing quantitative easing and has had zero rate (now negative) policies since 1998, and its economy is no stronger today. Its equity market is still more than 60 per cent below its 1989 high. Japan is not growing without debt monetization. The central bank currently owns 50 per cent of the outstanding ETFs and is one of the largest equity investors in world. Where will the intervention end?
- Europe is about to blow apart from the Italian banking crisis, and when compounded by the escalating refugee crisis, odds the European Union fractures are higher than 50 per cent in the coming two years. We likely will see Italy leave and go back to using the Italian lira in 2018. The European Central Bank is out of bullets despite President Mario Draghi’s insistence that he will do anything required. Negative rates are killing European banks. And we still have to deal with Brexit implications in 2017.
The U.S. Congressional Budget Office forecasts budgets for the next decade and it anticipates at least another $8.5-trillion in deficit building (current debt stands at about $20-trillion), taking the total to about $30-trillion. Just spending more is not the solution – it's the problem. Currently that debt is costing about 2 per cent annually. Normalizing it to 4 per cent would make the total cost to $1.2-trillion a year or about $3,600 annually for every man, woman and child in the United States.
The U.S. government just can't keep spending its way out – it will not work and nor will negative interest rates. And it's pretty clear the Fed cannot afford to raise rates, either, without destroying the economy.
I spoke last week at a financial planning conference in Kelowna, B.C., a great place for retirement in Canada. Those that paid their taxes, saved for retirement and now need that money to last 25 years on average have had the biggest tax hike in history. Yes, tax hike. This world of zero and negative interest rates is stealing the traditional low-risk retirement dreams of hard-working Canadians at the expense of current consumption. The madness must end, but I do not see an ending without a more severe economic contraction.
Investors should contemplate a decade of poor returns for equities and bonds, due in part to high valuations and a poor outlook for global growth, but more importantly due to the massive accumulation of debt that has forced interest rates to near zero.
Learning how to use inverse ETFs (they move up when the markets move down) so that you can try to make some money or hedge your portfolio during difficult times is something I will discuss in this space and on my weekly Berman's Call show on BNN over the coming weeks. Loading up on high dividend ETFs (or stocks) with 50 per cent to 70 per cent of your portfolio and learning how to hedge the rest with inverse ETFs or options for a lower risk yield of about 3 per cent could help smooth what looks to be a challenging few years ahead.
Larry Berman is co-founder of ETF Capital Management. He is a Chartered Market Technician, a Chartered Financial Analyst charterholder, and is a U.S.-registered Commodity Trading Advisor.