My Last Financial Forecasting Post

Two posts ago I mentioned that I do not want to create disposable content. One form of disposable content is financial forecasting. Years ago I did it. Sometimes I got things right and sometimes I got things wrong. In the end, the lesson I learned for myself personally is that although I was obsessed with finance for a few years, I no longer am. I discovered that I enjoy learning more about economics than the day to day market moves.

With that said, I did promise I would provide my thoughts on the stock market and where things might be heading. But this will be my last post on finance. I’m more interested in economics.

I currently have zero positions in the stock market. I did that for my own sanity, as I was spending too much time obsessing over things outside my control. I also don’t feel comfortable with the idea that people might lose money following my investment advice. Although my investment philosophy is far more conservative than most. When times are good, I under perform. When times are bad, I do quite well.

To do well when times are bad requires timing skills. These are skills I got right during the housing crisis and the stock market crash that followed. To think I will catch the next major move down and profit from it while focused on other interests, is not likely to happen. And since timing down legs comes with a cost of both time and money, I decided a few years ago to step away and pursue other hobbies.

With that long disclaimer behind me, here is my last financial forecast post.

wall-street

Photo by Alex Proimos

Two Tidal Waves

When I think of what might happen in the next few years, I imagine two tidal waves. One wave is debt. One wave is technology. Each of these waves will strike. Which hits first will determine everything.

Debt Wave

Since the Great Recession, debt at every level has gone parabolic. Global debt is now over $100 Trillion. By suppressing interest rates, governments and central bankers have created an environment where lower financing costs, which could have been used to pay down debt, have instead been used to become even more indebted. Interest rates have been rock bottom for years now and the debt levels continue to climb. Even at a low interest rate, financing costs to debt will at some point get to the levels where defaults are inevitable.

Central bankers have tried and continue to try to inflate their way out the debt. It hasn’t been working. Explaining their failure would be a post in itself. The short version is the more money printed, the more debt in the system, the more of that money is directed towards financing costs, malinvestment and speculation. This decreases monetary velocity and the result instead of being inflationary becomes deflationary. If this topic is of interest, seek out Irving Fisher’s Debt Deflation Theory.

We are now past the point of getting benefits from lower interest rates. Now comes the currency wars. Japan and European Union are working hard to devalue their currency against the US Dollar. OPEC is slashing the price of oil. The US Dollar is getting stronger. Besides cheaper gas, I see this having two major effects globally.

  1. All those emerging markets that borrowed US Dollars at low interest rates to fuel their expansion will now have to pay back those debts at a much higher rate since those debts are denominated in USD and the USD has gotten much stronger. This will be Japan’s carry trade story playing out all over again. Defaults are coming.
  2. Capital flight. Europe now has a negative interest rate. The misguided fools think this will encourage depositors to either spend or invest that money to spur the economy. Nope! What will happen is capital flight. Those deposits will start flowing towards higher and safer yields outside the continent.

Predicting which way the market goes is a guess. If the rest of the world goes into recession, we are likely to start seeing sovereign debt defaults. Interest rates can’t go lower. This could set off a global recession which leads our stock market lower. However, it is possible that investors around the globe looking to move capital to a safe haven decide to buy US equities. Not because they are a good value, but because a belief that the global corporations on the NYSE are the safest investment on the planet. Even more safe than US Treasuries. If that happens, the stock market could explode upwards, even as the world slips into recession.

I need to mention there is a risk that currency wars could lead to shooting wars. That would be a most pessimistic case. I’m not saying that will happen, but there are numerous parallels between the 1930s and today.

Technology Wave

The second half of the equation is technology. It is making our lives richer and safer and doing so at an ever increasing pace. I get lots of push back about my optimism and frankly I’m tired of debating it. The future is going to be awesome.

The fact that we are humans have never been able to imagine what that future will be, never stops the fact that we are constantly standing on the shoulders of giants and will continue to do so. We are progressing and at an accelerated rate. That doesn’t mean there wont be any problems. It means I am confident we will solve the problems of today with the technology of tomorrow. That is the way it has always been.

Here are a few of the sources that have provided me with the conviction that technology has and will continue to improve our lives at an even faster pace.

  1. Abundance: The Future Is Better Than You Think by Peter H. Diamandis
  2. The Rational Optimist: How Prosperity Evolves by Matt Ridley
  3. The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies by Erik Brynjolfsson

Back to finance. If the gains from technology accelerate faster or at the same pace as the debt expansion, we could minimize, spread out or avoid the damage caused by the excessive debt discussed above. We tend to think of technology moving slowly and financial markets moving quickly. But Japan has been at near zero interest rates running massive deficits for 20+ years now. The US is at 6 years. How long can this go on? Beats me.

Last Words

I see two tidal waves coming. I just don’t know the speed. If I had to guess, I would say the debt wave will hit first. It could hit as soon as next year. Whether that causes the stock market to go straight down or straight up is something I don’t know. If it does go straight up, I don’t see it as sustainable. The reason being the debt defaults would be deflationary, which will cause asset prices to fall.

If my financial prediction happens to come true, it is not because I am a visionary. It is because I guessed right. I have no money on the line. If the market explodes up during a global recession, I will short it when it looks like it is losing steam. If the market tanks, I will go long and catch a bounce at the bottom. If those two low risk scenarios don’t present themselves, then I’ll continue to sit on the sidelines living a stress free life not glued to stock tickers. Win. Win. Win.

Published by

MAS

Critical MAS is the blog for Michael Allen Smith of Seattle, Washington. My interests include traditional food, fitness, economics, and web development.

10 thoughts on “My Last Financial Forecasting Post”

  1. Nice write up. Thanks for sharing.

    “We will solve the problems of today with the technology of tomorrow”

    That is a game of musical chairs on a global scale. I’ve listened to Diamandis before and I can’t get behind his theory.

    Humans have shown the propensity to avoid difficult choices until it is too late. Easter Island is either a one time event or a precursor to us exhausting resources on a global scale.

    I believe in our lifetime we’ll have wars over basic resources. I expect your blog will still be in production and we can come back here to see who was right. 🙂

  2. Thanks for the post!

    “By suppressing interest rates, governments and central bankers have created an environment where lower financing costs, which could have been used to pay down debt, have instead been used to become even more indebted.”

    How do you suppose we could change the way these lowered financing costs are used? It is a cultural issue for me. I agree with you that the debt wave will probably be catastrophic, but if there was a way to restructure the way these lowered financing costs are being used, we may be able to avoid the massive wave of defaults you described.

    Much easier said then done!

    Thanks!

  3. @Will – On the private side, I suspect that when large borrowers saw very low interest rates were a guaranteed certainty for the next several years, they decided to leverage up to become even larger. It was a competitive move.

    On the public side, politicians are motivated to stay in office. Save the tough decisions for the future and if there is any pain it will be on that politician and not them. So the lower interest rates provide the illusion that times are better than they are. Once interest rates rise, that illusion will come undone.

    Losses are coming. The only question is who pays for them.

  4. Do you not subscribe to the Peak Oil narrative that Thomas Homer-Dixon and his ilk put forth? I’m a bit worried that Peak Oil and the debt crisis will both come to a head at the same time.

  5. Great road map! Just the markets to move (whether up or down) so we can put our plans in action!

  6. A few comments:

    “Central bankers have tried and continue to try to inflate their way out the debt. It hasn’t been working. Explaining their failure would be a post in itself.”

    I’d say it depends on how you measure failure. Taking US as an example it has steadily increased its major economic figures since the bottom 2009.

    “The short version is the more money printed, the more debt in the system, the more of that money is directed towards financing costs, malinvestment and speculation. This decreases monetary velocity and the result instead of being inflationary becomes deflationary. If this topic is of interest, seek out Irving Fisher’s Debt Deflation Theory.”

    The “money” printed is only to keep the central banks balance sheets inflated to minimize system risk. That’s why all this money printing isn’t increasing CPI. It’s not out on the open market, it’s on figures on central banks computers. The bonds the FED was buying were with relatively small amounts.

    The Debt Deflation Theory is just a theory. If you are a Keynesian you might buy that story, but the evidence is just speculative. One thing is sure though, malinvestments should occur when interest rates are artificially low. By artificially I mean set by politicians instead of markets. Prices set by politicians instead of markets has been tried a few times around the world but has never been successfully. Usually it’s called planned economy vs. the free market economy.

    “I need to mention there is a risk that currency wars could lead to shooting wars. That would be a most pessimistic case. I’m not saying that will happen, but there are numerous parallels between the 1930s and today.”

    I often hear arguments of “currency wars” so I’m glad you mention the 30’s. The enormous difference between now and then is that the countries that are supposed to fight each other or the ones creating business with each other. So it would be like shooting your customer in the foot if you create currency wars. So that argument is in itself weak.

    However, one thing that opens up the risk is the fact about politicians that you mention. The ruling politicians of today primarily care about their being in office. With might open up for shooting the customer in the foot if that is the headache for tomorrow’s politicians.

    One last note, I don’t see how US stocks could be a better investment in a financial crises than US bonds. Has that happened any time in history? I think just the opposite always happened.

    If the stocks go fine, means business goes fine, and that will mean that the US and its bond market will be fine.

    Sorry to drag you into the Finance section again MAS 😉

  7. @Johan – True I do not want to get dragged into Finance again. I just want to say that The Keynesians believe that an increase in spending increases monetary velocity. The opposite of what Irving suggested. Monetary velocity has dropped.

    As for how US Stocks could go up in a crisis more than US bonds, it is less about historical examples and more about where we are now. Money from outside the United States is being subjected to near zero or negative yields (Europe). Japan’s central bankers are actively devaluing the Yen. And with a few keystrokes that money can be pushed anywhere on the planet. If there is a major currency crisis having your money in a global corporation might be a safe haven, especially with US Bond yields at a rock bottom while running massive deficits. Again I say *might*. It could go the other way.

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