Economic Depression and Other Plagues

Yesterday there was an article from Paul Krugman predicting a depression, the weekly post from John Hussman had a more strenuous warning about trouble coming and both got a lot of play around the interweb.

As opposed to trying to prove this line of thought right or wrong I think it is more instructive to try to figure out what to do in case Krugman and Hussman are correct. Making a compelling argument as to why they are wrong only for them to turn out to be right would be disastrous but going the other way, mentally preparing for bad times that don’t come strikes me as the more conservative route.

First I should say that if Krugman turns out to be correct and we go into something “officially” labeled as a depression it will turn out that the depression started years ago. Anyone capable of even a little rational thought should not be surprised or freak out if they are told a depression started in 2000 (ten years ago) and might last another six or seven. Stocks are where they were in the 1990s, housing prices have imploded, job growth has stunk for many years and US debt loads have been increased massively only to get us to lousy. I’m not real keen on labels but if someone says depression just remember that realistically and with the understanding that it will not be exactly like the Great Depression it already started. The depression Krugman is calling for would linger for quite a while without being as bad as the Great Depression.

If you can accept the idea that if this turns out to get the depression label that it would be dated several years back then the info on global equity market returns for the last decade from Bespoke Investment Group becomes very important. I’m not sure where on their site it is but I kept a copy as a PDF.

No matter when the so called depression will be dated to there are plenty of equity markets globally that thrived in that period. The point is not to look back and buy some country that is now up a lot but to realize that there are countries that can do well as the US does poorly. Not that these other countries would not go down if the US retested its March 2009 low but look at how some countries went down a lot less and are already back to where they were before the financial crisis began.

A comment I have made many times in the last two and half years has been that for many other countries the worst crisis in 80 years would look a lot more like a normal cyclical event than the possibly secular or structural event taking place in the US or Big Western Europe.

A reader pointed out an article from Bill Hester, also from Hussman funds, talking about the importance of country selection. This has been a crucial theme here and will continue to be crucial. I realize I’ve been saying the same thing here for years now but to the extent you care about my opinion on anything (why would you be reading this otherwise?) that should tell you the value I place on country selection.

If you are not able to buy big cap stocks from the countries you favor in order to capture the effect (either due to comfort level or access) there are plenty of ETFs with more on the way to make it easier for you.

While I’m repeating myself from past posts; as important as I believe country selection is I’ll say that saving more money and living below your means are even more important.

14 Comments

  1. I am extremely disappointed with your post today. While I know there are other definitions, the most common definition for a depression is a 10% reduction in GDP.

    We have not had this large a decline in GDP yet and there is no way you could argue a depression starting a decade ago. Your lack of understanding and fear mongering post will only help to confuse people.

    Are times good – no

    I use to post that we are turning Japanese from time to time. Now it is clear we have turned into Japan all over again for some time now.

    We have not had a depression and will likely not get a depression, but the future is always difficult to predict. The most likely outcome is for us to go in and out of recessions with low inflation or low deflation for many years to come. Why do you think I have been advocating retirees learn to live on 2% or less as opposed to the normal 4% for a few years now?

    I do not have rose colored glasses about the future. Still in the short run I still see are current market conditions as a correction with a lot of fear out there even if I am not thrilled with the market action.

    Most of your posts are good. Please do not succumb to writing things like there is a depression and it started years ago. I strongly suggest you take a closer look at Japan because we are going down the same road. Japan has had a debt/deflation problem for a couple of decades and we have had the same for about a decade. There has not been a depression in either country. To write otherwise will only mislead your readers and possibly yourself.

    It would be much better for all of us to understand our current condition.

    SEG

    Reply
  2. BTW, our fate was sealed when Clinton repealed the Glass-Steagall Act. The proposed legislation to fix these problems has whole large enough to pass a heard of elephants through the loop holes.

    So we will pass something our economic problems will persist and we will eventually pass real reform in about a decade (I hope).

    SEG

    Reply
  3. SEG–I think you’re misreading Roger’s post.

    I believe his point is that whether we’re in a depression or not, things aren’t good here and it’s prudent to think a little differently. One way to pick up some investing tailwind is to consider markets where things are less correlated with the US, financially speaking.

    That’s been a pretty consistent theme of his.

    Reply
  4. based on how I read SEG’s comment he is misreading my post

    Reply
  5. Big difference between the U.S. and Japan, at the outset of their slowdown they had a nation of savers to buy their debt instruments, now they are demographically aging so the BoJ will need to monetize. Likewise the U.S. population is aging and needs to fund their lifestyle, retirement, etc. So we now are Japan in a way.

    As far as a depression, the “recovery” was funded by various gummint stim programs, if they are not renewed then it is unclear from where the growth will emanate in a delevering world. It will just be semantics on whether we have depression, or just recession.

    Not trying to start a debate here but I agree with Roger that it is wise to be objective and consider all the likely possibilities no matter how unpleasant…

    Mark from L-Ville

    Reply
  6. I thought today’s post was an excellent reminder to be prepared as a responsible individual for whatever lies ahead. We all hope for prosperity. We also know that prosperity is defined in radically different ways, depending upon your viewpoint.

    As Harry Browne often stated, one cannot predict the future and investors should prepare for an assortment of surprises through a basic portfolio that will preserve capital whatever occurs, short of war.

    Cuggino’s Permanent Portfolio (originated by Browne) is a good example of this mode of preparation.

    T

    Reply
  7. Comparing Japan to the States is like comparing a glass of Château Lafite Rothschild to a glass of cola; they look a bit similar but that’s where the correlation ends. Causation and ongoing structural problems are extremely different.

    Yes, Japan’s population is aging, also it has no commodity reserves except rice (!), foreigners find it very, very difficult to get work there (apart from English teachers), there is little room for infrastructure development or population growth, its cottage industries are well developed, its population is very well-educated and trained (generally, where as there are whole neighborhoods in the States without a good school) and the ethos of individuality plays no a part in many areas of society.

    In short, investment-wise it’s a basket case, unlike many sectors in the US (ironically tech is one of them). Japan had one enormous bubble in the 80s and never recovered, whereas States has made a complete mess of itself many, many times and always somehow come back.
    (humour attempt)

    Reply
  8. Roger,

    If I misread your post I apologize. I would reread it now but I just got done with my hour of exercise in the FL heat so I will wait until later.

    The problem was my reading your giving credence to this being a depression as opposed to what it is.

    SEG

    Reply
  9. Question for you Roger, and I apologize if you’ve answered it already before or blogged on it, but I must have missed it or don’t recall.

    Regarding your use of inverse market ETFs for hedging, what is the position size of the hedge versus the overall equity allocation? 5% of equity? 10%? 25%?

    Is that a static number, or are there are factors (either quantitative or qualitative) besides the 200 DMA that would lead you to increase the size of the hedge from whatever the initial position size was.

    Lastly, would you view fully hedging equity exposure ala Hussman (say a portfolio with 50% equity would have a 25% SDS position) as too extreme or too much of a “big bet”? If so, what would you consider as the maximum position size in a inverse ETF for hedging?

    Thanks in advance for any answers!

    Looks like more fun and games today at that 1040-1044 level. Just instinctually, it feels like this market wants to go much lower. I think the fact that we are now testing this level for the fourth or fifth time is indicative of that.

    Jeff, what do you think? Still thinking 870 correction? Maybe with the seasonal factors we get an 870 bottom into the Sep-Oct time frame, and then move back up from there.

    Reply
  10. Man, heckuva day in the market. Here’s where planning comes into play!

    Reply
  11. Mike none of this can be the same answer for all times. the DXD has grown some since I bought it as the market has dropped and DXD has gone up but still mid single digit weight so it neutralized twice that amount and we have some cash that also neutralizes some of the exposure. from here my choice are do nothing more and DXD would hedge progressively more if the market went down, I could buy more DXD or sell some stock or ETF exposure.

    My inclination is to be less aggressive with any defensive action as the event is now several years old but that may change.

    Reply
  12. Mike C.,
    my opinion from 27/5/2010 has not changed. I can look at this stuff over the weekend and try to find out something. We are now at a oversold mrkt. Might go up from here to then accelerate to the points I had stated. However my work is telling me that we might hit a low in 2011. So I am not sure about sept oct.
    Hope for the best for you. I would give a good ear what Roger is saying since I think that he is one of the best. I am doing some cycle work and can post it over the weekend. However since the prev cycle was 4 years from 2003 to 2007, it does not mean that the next one is going to be 4 years. If we are in a correcting cycle (from bot – to bot) the cycle can accelerate in time as we go down. So we might have a cycle of 2 years. As we go into a bull market the cycle (from bot to bot ) can expand and be 8 years. So in my opinion this is one of these cases that the time frame can cal laps. However, to put in a hedge is asap and then as we come up.
    Not too long ago you where the one that you were telling me that the market was going up valuations where high and things sucked but hec we are making money. Mike must listen to your self a bit more.
    Best,
    Jeff from Milan, Italy
    30/6/2010

    Reply

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Economic Depression and Other Plagues

Yesterday there was an article from Paul Krugman predicting a depression, the weekly post from John Hussman had a more strenuous warning about trouble coming and both got a lot of play around the interweb.

As opposed to trying to prove this line of thought right or wrong I think it is more instructive to try to figure out what to do in case Krugman and Hussman are correct. Making a compelling argument as to why they are wrong only for them to turn out to be right would be disastrous but going the other way, mentally preparing for bad times that don’t come strikes me as the more conservative route.

First I should say that if Krugman turns out to be correct and we go into something “officially” labeled as a depression it will turn out that the depression started years ago. Anyone capable of even a little rational thought should not be surprised or freak out if they are told a depression started in 2000 (ten years ago) and might last another six or seven. Stocks are where they were in the 1990s, housing prices have imploded, job growth has stunk for many years and US debt loads have been increased massively only to get us to lousy. I’m not real keen on labels but if someone says depression just remember that realistically and with the understanding that it will not be exactly like the Great Depression it already started. The depression Krugman is calling for would linger for quite a while without being as bad as the Great Depression.

If you can accept the idea that if this turns out to get the depression label that it would be dated several years back then the info on global equity market returns for the last decade from Bespoke Investment Group becomes very important. I’m not sure where on their site it is but I kept a copy as a PDF.

No matter when the so called depression will be dated to there are plenty of equity markets globally that thrived in that period. The point is not to look back and buy some country that is now up a lot but to realize that there are countries that can do well as the US does poorly. Not that these other countries would not go down if the US retested its March 2009 low but look at how some countries went down a lot less and are already back to where they were before the financial crisis began.

A comment I have made many times in the last two and half years has been that for many other countries the worst crisis in 80 years would look a lot more like a normal cyclical event than the possibly secular or structural event taking place in the US or Big Western Europe.

A reader pointed out an article from Bill Hester, also from Hussman funds, talking about the importance of country selection. This has been a crucial theme here and will continue to be crucial. I realize I’ve been saying the same thing here for years now but to the extent you care about my opinion on anything (why would you be reading this otherwise?) that should tell you the value I place on country selection.

If you are not able to buy big cap stocks from the countries you favor in order to capture the effect (either due to comfort level or access) there are plenty of ETFs with more on the way to make it easier for you.

While I’m repeating myself from past posts; as important as I believe country selection is I’ll say that saving more money and living below your means are even more important.

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