The return of the bear

Figure 7: Accelerating debt drives rising share prices–and decelerating debt causes crashes

The stock market could easily bounce again from its current levels if, once again, the rate of decline of debt slows down. But in an environment where deleveraging dominates, deceleration will be the dominant trend in debt, and the unwinding of asset prices back towards consumer prices will continue.

How far could it go? Take another look at Figure 1. The CPI-deflated share market index averaged 113 from 1890 till 1950, with no trend at all: by 1950 it was back to the level of 1890. But from 1950 on, it rose till a peak of 438 in 1966-which is the year that Hyman Minsky identified as the point at which the US passed from a financially robust to a financially fragile system. Writing in 1982, he observed that:

A close examination of experience since World War II shows that the era quite naturally falls into two parts. The first part, which ran for almost twenty years (1948-1966), was an era of largely tranquil progress. This was followed by an era of increasing turbulence, which has continued until today. (Hyman P. Minsky, 1982, p. 6). (Note #)

From then, it slid back towards the long term norm, under the influence of the economic chaos of the late 60s to early 80s, only to take off in 1984 when debt began to accelerate markedly once more (See the inflexion point in 1984 in Figure 4). From its post-1966 low of 157 in mid-1982, the CPI-deflated S&P500 index rose to 471 in 1994 as the 1990s recession ended, and then took off towards the stratosphere during the Telecommunications and DotCom bubbles of the 1990s. Its peak of 1256 in mid-2000 was more than ten times the pre-1950 average.

Even after the falls of the past week, it is still at 709, while private debt, even after falling by 40% of GDP since 2009, is still 90 per cent of GDP above the level that precipitated the Great Depression-leaving plenty of energy in the debt-deleveraging process to take asset prices further down.

There CPI-deflated share index doesn't have to return to the level of 1890-1950-especially since companies like Berkshire-Hathaway that don't pay dividends give a legitimate reason for share prices to rise relative to consumer prices over time (Note ##). But a fall of at least another 50 per cent is needed simply to bring the ratio back to its 1960s level.

Welcome to the Bear Market and the Second Great Contraction.