I found a chart that is titled Global Stock Market Cap. It is the market capitalization of all stock markets in the world. You add up the United States’ stock market, the Chinese, the European, the Japanese, and numerous other stock markets around the globe. It is an assembly of all the prices for all the different stocks combined in a single, solitary chart. What you can see is a massive credit cycle in action. And here is how it looks like:
When you look at this chart, you can see how valuations grew by around $30 trillion from 2011 to the summer of 2015. $30 trillion. In four years.
We have already lost half of that in the past 6 to 9 months. One of the key things of credit cycles is that they are self-reinforcing. I find it important for regular market participants to understand. Whenever markets are going up, it is self-reinforcing because the general public will have more money to spend.
There can be good and bad examples of self-reinforcing processes. A bad one is the self-reinforcing cycle of debt. A person borrows in order to consume beyond his current income and is unable to pay the bill, so he borrows again to make the payment and gets deeper and deeper into debt. We usually call this a vicious cycle. A virtuous cycle (a good example) is a favorable self-reinforcing process. If a person spends less than his income, he can add the residual amount to savings or investments which collect interest. If he spends less than the income in the next period again, he can increase savings and thus collect even more interest.
It has been thoroughly explained in Ray Dalio’s video How The Economic Machine Works. A very educational watch.
These cycles tend to feed on themselves unless there is an outside factor such as a central bank that has the fire-power to change their direction. As the Global Stock Market Cap shows, we are already in a contracting stage on a global scale. The contraction is even faster than market participants in the United States may realize. As a matter of fact, the Federal Reserve added fuel to the fire last year and began increasing its interest rates.
Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 0.25-0.5%.
Although it plans to raise them four more times in 2016, it could barely bring itself to squeeze a 25-basis-point hike out of its tightly clenched loins after seven years. It is since in a wait-and-see stance and further rate hikes appear unlikely given the bleak economic conditions since the beginning of 2016.
The market may even be at the early stages of unwinding the largest credit bubble in history and is overdue for a recession. A painful stock correction is likely even if we avoid slipping into recession. In fact, it may have already started. Investors need to learn to ignore what they are told by the establishment and think for themselves. My expectation going forward is that it is going to get worse because you are seeing this contraction happening globally and there is not enough fire-power coming from central banks that could at least subside this downturn. Let alone help bring markets back to its highs.
We can consider ourselves lucky because as trend followers, there is little interest in what economists have to say. In the short term, it will be interesting to see how long the current bounce will last. The medium term may appear bleak but this will fade, and we will rise back to new highs after we have overcome the contemporary troubles and negativity. I continue to be excessively bullish in the long term perspective, so let me end on a positive note.
Even with all our economic and geopolitical troubles, the progress of humanity in overcoming problems has been persistent and impressive. Technology is advancing on dozens of different fronts. There is good reason to believe that we are living in the upswing of an exponential curve of progress unlike any that life has ever experienced.
Look no further than the revolution of sustainable energy and becoming independent from oil, scientific breakthroughs in decoding the human genome and reversing the cause of biological age, the excessive automation of everything under the sky up until we no longer need to own an automobile or stress about parking lots because we can simply call a driverless and battery-powered Uber anytime and anywhere, the rise of artificial intelligence after understanding how our minds work (something that could progress to artificial superintelligence entirely surpassing our human capabilities), space exploration and becoming an interplanetary species. After what happened during the Industrial Revolution since 1815, I believe that we are transitioning into a new phase of Technological Revolution (or whatever it will be called) while computers were merely the prequel to the unbelievable opportunities that lie in front of us. Extremely exciting times ahead.