Bull Market Complacency After the Great Depression

In my last post, I offered the following chart showing S&P 500 bull market complacency after epic economic disasters.


Click to enlarge.

The following chart shows the period after the Great Depression (using the DJIA in place of the S&P 500).


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Note that there was no calm period immediately following the Great Depression. Other than that, the charts are pretty much the same. Few could see the crash of 1937 coming (or World War II shortly thereafter). As seen in the chart, complacency had fully set in (just like it has now).

In summary, it would seem that the 3rd and 4th years after epic investment disasters are periods of great complacency. Perhaps investors assume that the worst is behind us and a whole new era of economic prosperity will soon unfold? If history is a guide, that could not be further from the truth. Serious "unexpected" risks lurk in the 5th year. I would even be so bold to argue that serious "unexpected" risks lurk every time complacency sets in. The popular saying is not, "Hope for the best, plan for the best." That's got optimistic disaster written all over it. (No sarcasm intended.)

For what it is worth:

1. The Great Recession was an epic economic disaster.
2. In its aftermath, we have just experienced two years of great complacency.
3. We're just about to enter the 5th year yet again.

Can we make it a full year without any further economic pain? I have serious doubts. I continue to stand by my prediction that the next recession will hit by October of 2014 (made in 2012). I just don't see much reason to change my mind, especially now that job growth is slowing again and few seem to notice. Sigh.

This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart

Theory: The Four Phases of Extreme Bull Market Complacency

Phase One: The Calm After the Storm

Start with an epic disaster. Enjoy the first stage of the recovery. You don't even need to see much improvement, just the lack of additional disasters would suffice. This is nearly a sure thing. There's almost no volatility. The stock market only goes up. It won't feel like it at the time though, since most investors are still so shell-shocked. This phase lasts one year.

Phase Two: A Return to Normal

There is a wall of worry to climb. Investors can still remember the epic disaster. Volatility is back as investors aren't quite sure what will happen next. It pays to be an investor for those with the stomach for it though. This phase lasts two years.

Phase Three: The Calm Before the Storm

The market's been rising and all risk is seemingly gone. All thoughts of the previous epic disaster are forgotten in the name of greed. Since the market only goes up over time again (and everyone knows it), volatility disappears as investors buy all dips and congratulate each other profusely on the easiest money they've ever made (while chastising the bears for being so incredibly stupid, who in turn begin to capitulate in droves). This phase lasts two years.

Phase Four: The Storm

25-sigma event! WTF! Nobody could have seen this coming! The very foundations of our economic society are called into question. Mechanisms are put into place so that "the unexpected" never happens again!

Hey, it's just a theory. Perhaps I can present some evidence that backs the theory though. (I actually used the evidence to help create the theory.)

The following chart shows the complacency in the stock market in the 6 years following recent epic stock market disasters (the 1970s, the dotcom bust, and the housing bust).


Click to enlarge.

Each data series shows the amount the inflation adjusted S&P 500 index monthly average is below the bull market monthly average peak.

As seen in the green data line (starting in July of 1982), investors were way too complacent heading into the crash of 1987 (and the early 1990s recession that followed).

As seen in the blue data line (starting in February of 2003), investors were way too complacent heading into the Great Recession.

As seen in the red data line (starting in March of 2009), investors may be way too complacent right now. Just look at that lack of volatility (and the downward trend in it).

"History doesn't repeat itself, but it does rhyme." - Mark Twain

Other than to strongly suggest that there are no sure things (especially at this stage of the recovery), this is not investment advice.

Source Data:
St. Louis Fed: Custom Chart

Employment Growth Is Slowing Again

The following chart shows the 12 month moving average of the average annual growth rate in nonfarm payrolls (establishment survey), civilian employment (household survey), and aggregate weekly hours of private production and nonsupervisory employees (establishment survey).


Click to enlarge.

This chart is basically a smoothed summary of 3 different ways to look at the overall employment trend.

1. We failed to leave the channel to the upside. In fact, we turned downward right on schedule (bouncing right off the channel's ceiling).

2. Employment growth has been slowing in a fairly predictable way since December of 2012. Contrary to popular expert financial opinion, this downtrend cannot be blamed on this winter's weather. It's been going on for more than a year.

As a side note, aggregate weekly hours are important. If more people are working but each one works less, then the headline employment numbers are actually weaker than they appear. This chart factors that in to some degree. Some might argue that I should be factoring it in even more than I am. A mere one third of the smoothed summary may not do it justice.

In any event, I firmly believe that we are in the late stages of this business cycle and I'm fairly comfortable with my recession by October of 2014 prediction. For what it is worth (not much), I do not see enough evidence here to change my estimate.

Keep in mind that my estimate started as a "fool's game" prediction and it still is. I have made no investment decisions based on attempting to time the next recession. As a permabear since 2004, my decisions were primarily focused on locking in long-term real yields over the long-term (TIPS and I-Bonds). To date, I have no complaints.

Please don't read too much into the chart. Yes, there is plenty of downside risk here. Yes, we are near the top of the channel and falling again. However, there are no sure things. As Warren Buffett once said, "If past history was all there was to the game, the richest people would be librarians."

This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart

The Four Horsemen of the Jobpocalypse

The following chart shows the total number of manufacturing, information services, construction, and financial activities employees (thousands).


Click to enlarge.

Within these industries, we're about 6.6 million employees below the peak. Call me crazy if you must, but I predict that we will never make it back to the trend channel.

The next chart shows the same employment data per capita (as a fraction of total population).


Click to enlarge.

I predict that we will never make it back to the historical norm. I know. I'm certifiable. Lock me up. Put a straight-jacket on me. It's just the crazy rantings of a lunatic!

I'm not done yet though. I suspect, thanks to the rise of Amazon.com and other online retailers, that we will be adding even more horsemen during the next recession. In fact, we may need to swap party hats. Something made of tin foil? Or perhaps a hat with a rodeo theme would be more appropriate? We will certainly want something to blend in with all those horsemen.


File:Strawhat.jpg (Ealdgyth)

This is not investment advice. Sigh.

Source Data:
St. Louis Fed: Custom Chart #1
St. Louis Fed: Custom Chart #2

Pivotal Moment for Initial Claims (Musical Tribute)

The following chart shows the 26 week moving average of initial claims.


Click to enlarge.

I have added a trend line in red that coincides with my belief that the economy will get worse over time.

Let's zoom in for a closer look.


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I made a prediction in May 2012 that the next recession would hit by October 2014. In order for that prediction to be accurate, the data pretty much has to bounce off that red trend line in a meaningful way soon. It's certainly attempting to bounce but will it actually do it?

Terri Nunn - Moment of Truth

My confidence is leaving me
And I don't have a parachute

For the record, I hope that we do not bounce.

1. As I stated earlier, the slope of the red trend line coincides with my belief that the economy will get worse over time. I hope that I'm wrong to think this way. As Lee Child once said, "Hope for the best, plan for the worst."

2. My girlfriend has worked a grand total of 2 hours part-time in 2014 so far. That's just one of many reasons I would not complain if my recession prediction timing was in error.

This is not investment advice.

Source Data:
St. Louis Fed: Initial Claims

Exponential Trend Failure of the Day: "Get Rich Never"

The following chart shows real personal dividend income per capita plus real personal interest income per capita (December 2013 dollars).


Click to enlarge.

Fantastic.



Source Data:
St. Louis Fed: Custom Chart

Pent-Down Retail Trade Employment (Musical Tribute)

The following chart shows retail trade employment per capita.


Click to enlarge.

Would you believe that there was a time when there was only 1 person working in retail trade for every 33 men, women, and children in this country? Oh the humanity. How did we ever survive?

Why has it taken so long for the retail trade productivity miracle to finally appear?

Let's look at retail trade employment as a fraction of nonfarm payrolls.


Click to enlarge.

The ratio has mostly been trending flat since the Great Recession. That said, I don't believe for a minute that the Fed has permanently prevented the long-term trend seen in blue. Time will tell.



This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart #1
St. Louis Fed: Custom Chart #2

West Coast Initial Claims

The following chart shows the 52 week moving average of initial claims in California, Oregon, and Washington.


Click to enlarge.

Good luck convincing me that:

1. October's weather explains the trend failure on the west coast.
2. The business cycle is dead.
3. I should embrace risk assets right now.

See Also:
The Business Cycle Is Not Dead

Source Data:
St. Louis Fed: Custom Chart