Economic Scenarios

We believe the future of the U.S. and global economies will likely follow one of four different scenarios.

Four main scenarios

Economic scenarios

For each scenario, the position of the bubble shows the combination of growth and inflation that we expect to see in the next one to three years.

The size of the bubble illustrates our view on the likelihood of this scenario occurring – this is subjective, and is intended just to illustrate our thinking.

Growth is expressed in relation to the potential for each country. For example, a growth rate of 4 percent would be low for China but very high for Europe. Similarly, inflation relates to a country’s individual inflation target.

Economic scenarios text

Implications for investment returns

The tablebelow summarizes the expected returns of the major asset classes under each of our four main scenarios.

The circles in the boxes show the expected return over the next three years, relative to the long-term expected returns*. Light green means higher than long-term expected returns*, while light red means lower.

Economic scenarios returns

Conclusion

In most scenarios equities are the most attractive asset class. But valuation support is limited, exposing equities to a potentially sharp correction.

1. Favor equities

We continue to favor equities despite their demanding valuations:

  • Abundant liquidity and repressed interest rates in our “muddling through” and “new monetary world” scenarios continue to support equities.
  • Improved earnings prospects in our economic renaissance” scenario should also boost equity prices despite the prospect of higher interest rates.
  • This pattern applies particularly to the US market. It is the most overvalued region but prices could continue to rise if the “economic renaissance” scenario becomes increasingly likely.

2. Be cautious on bonds

  • We are avoiding long-maturity nominal bonds because they would be negatively affected by a normalisation of monetary policy in our “economic renaissance” scenario.
  • Within fixed income we continue to like shorter-maturity corporate bonds. This part of the market has two attractive features. First, there is still a decent yield advantage relative to government bonds. Second, the short maturity would offer some protection against rising interest rates, especially in our “economic renaissance” scenario.

3. Maintain exposure to real assets

  • The still sizeable probability of our “new monetary world” scenario lies behind our ongoing exposure to real assets such as gold, real estate and possibly inflation-linked bonds.
  • We are also confident that over an economic cycle equities continue to offer protection against inflation.
  • Additionally, we are focusing on hedge funds that have the flexibility to adjust to an unexpected increase in inflation.

4. Maintain hedges

Although we believe the “depression” scenario is the least likely, its impact would be so disruptive that it must be considered within our investment strategy. Notably, equities are not well supported by current valuations, while monetary policy is limited by high debt levels and interest rates that are already close to zero.

Therefore, we recommend hedging strategies that can limit the potential losses from your portfolios.

How To Hide a Depression

I’ve suggested for some time that the U.S. is in a depression. The primary reason we do not have visible evidence of widespread poverty and suffering is massive government intervention in the economy. Despite the multi-trillion dollar “extend and pretend” game being played today, I suspect that with a little historical perspective the past 12 years and the coming five (or more) will replace the 1930s Great Depression as the most significant downturn in modern U.S. history.

Following are a series of charts which highlight just how far the federal government has gone to hide the depression.

ss-and-disability-stats-2000-2012

The above chart shows those receiving benefits. Those who are not in the labor force claiming a disability is much higher.

Not in Labor Force – With a Disability, 16 Years and Older

disability-16-years-older-2008-2012

Those not in the labor force and receiving disability benefits are not considered unemployed and do not affect unemployment statistics. This is one means the federal government uses to understate unemployment.

Beneficiary Data

The following charts are from Social Security Online.

Social Security Beneficiaries By Type

ss-beneficiaries-1970-2012

Number of Beneficiaries as of December 2011

beneficiaries

A few more charts will put this in perspective.

Civilian Labor Force

civilian-labor-force-1940-2012

Private Employment

private-industries-employees-1930-2012

Quick Stats

  • As of June 2012 – the civilian labor force was 155,163,000
  • As of June 2012 – there were 111,145,000 in the private workforce
  • As of June 2012 – there were 56,174,538 collecting some form of SS or disability benefit
  • The ratio of SS beneficiaries to private employment just passed the 50 percent mark (50.54%)

Following is one final chart to consider.

Social Security Benefits in Dollars

social-security-1950-2012

As of May 2012, social security outlays are $756.9 billion annually. Fewer and fewer workers support more and more recipients. Social Security benefit payments are now growing exponentially. This is how you hide a depression.

Source: Global Economic Analysis

This is What Depression Looks Like; Real Corporate Earnings Collapse – Nearly 50 Percent Below 1973 Levels

In a recent article John Williams, publisher of ShadowStats writes:

“Temporary consumption gains could be fueled by debt expansion, but that option also is not available to most consumers.  With limited prospects for income growth and debt expansion in the near future, broad economic activity remains likely to bottom-bounce for the foreseeable future, while healthy, sustainable gains in real retail sales remain improbable.

Adjusting government-provided income and sales figures might seem unnecessary when reported inflation is running at 2.5 percent. But, in reality adjusting for inflation provides the only meaningful and accurate look behind the federal government’s “headline” numbers – whether they be for retail sails, income or the CPI. Government provided numbers are heavily massaged and manipulated. While it may be a stretch to outright call them a lie, they are in the least misleading.

Middle class income peaked in 1972

As shown in the preceding graph, the peak in real average weekly earnings was hit in October 1972.  The official accounting for March of 2012—almost 40 years later—still is 14.8 percent below that pre-1973 recession high.  The bounce higher in real earnings starting the mid-1990s was due to post-1990 changes made to the CPI-W and the CPI-U, which lowered official inflation reporting.  The blue line shows roughly what those numbers would have looked like today, as estimated by the SGS-Alternate CPI Inflation (1990-Base), had the changes not been made.

Structural Liquidity Problems Continue to Impair Economic Prospects.  Consumer income currently is in contraction, while consumer credit continues to show no net growth in areas that could buy short-lived expansion in consumption of consumer goods.  The issues here involve long-term structural problems with income and an ongoing systemic solvency crisis.

With consumer liquidity so impaired, and with the consumer confidence and sentiment measures still showing levels so low that they have not been seen outside of the deepest post-World War II recessions, the prospects of a near-term, sustainable economic recovery are nil.”  Not only is Shadow Government Statistics (SGS) unemployment in the US above 22 percent, only comparable to the Great Depression, but for those who are working, their real earnings have been collapsing for more than a decade.  Real earnings are nearly 50 percent below 1973. 

That chart is critical for readers around the world to understand the systematic destruction of the middle class in the United States.  This is what depressions look like.  Do not believe lies from the mainstream media.  There will be no recovery in the United States for the foreseeable future.

No More Risk of Recession?

imageIn the vein of classic contrary indicators, such as the ill fated Time magazine cover that marked the top of the housing bubble, Bloomberg reports that JPMorgan’s CEO Jamie Dimon see nothing but blue skies ahead for the U.S. economy. Please see JPMorgan’s Dimon Says U.S. No Longer Faces Risk of Recession for your reading enjoyment.

I’m a contrarian by nature. When the mainstream, whether it be government officials, the media or business executives such as Dimon spew their “insights”, my radar goes up – especially in light of the contradictory indications of economic performance that we are confronted with nearly every day. Take for example an interesting observation posted this morning by Mike “Mish” Shedlock highlighting the discrepancy between the major market averages and the commodity indexes.

I’m inclined to treat a statement like Dimon’s as evidence that just the opposite is near – a plunge back into recession or depression, a further fall in housing values and further erosion of jobs.

The initial evidence of a trend change in the markets is seldom obvious. If it were we’d all have plenty of time to get our money to safety. That’s why trend following is the preferred way to trade markets. Trend following eliminates emotion from the investment buying and selling process. Trend following provides the tools that enable an individual investor to catch and profit from long term trend changes in markets.

The United States Needs a Depression Now

Paul Farrell, writing on MarketWatch, pens an interesting article describing why we need a depression in order to fix America’s looming credit default, failing economy and our insolvent banking system. Everything the government  has done since September 2008 has just postponed and guaranteed a far worse depression than if we had let the insolvent Wall Street banks go bankrupt. It would have been bitter medicine, but the pain would have restructured our debts, removed corrupt bankers from positions of power and shown the American people that you can’t live above your means using debt.

Instead, the U.S. Treasury and Federal Reserve, doubled down with $7 trillion of additional debt to keep the Ponzi scheme going. Those at the top of the Ponzi scheme (Wall Street and the “elite”) have become wealthy off of government largesse and the orchestrated 100 percent “recovery” in the stock market.

Ferrell argues against raising the debt ceiling, which would initiate the depression he argues for. However, in my opinion it is a political impossibility that Congress and President Obama will allow that to happen.

No, do not raise the debt-ceiling. You heard me: Block the debt ceiling vote. Don’t raise it. America’s out-of-control. A debt addict. Time to detox. Deal with the collateral damage before it’s too late.

We need to fix America’s looming credit default, failing economy and our screwed-up banking system. Now, with a Good Depression. If we just kick the can down the road one more time, we’ll be trapped into repeating our 1930’s tragedy, a second Great Depression.

Barton Biggs: U.S. needs massive public works program

The U.S. needs to invest in a massive public works program, and rich people and corporations should pay more taxes. Barton Biggs, of Traxis Partners, shares his views with the Simon Constable.

Yes, depression. Spelled: d-e-p-r-e-s-s-i-o-n. Wake up America, recessions do not work. Won’t work in the future. Remember that 30-month recession after the dot-com crash? Didn’t work. Why? Because in the decade since that 2000 peak, Wall Street’s lost an inflation–adjusted 20% of America’s retirement money.

And what about the so-called Great Recession of the 2008 credit meltdown? Didn’t work either. In fact, made matters worse: Wall Street got richer by stealing from the other 98% of Americans, the middle class, the poor. And now their conservative puppets in Washington want to make matters worse, widening the wealth gap further to benefit the Super Rich.

Seems nobody really gives a damn about our great nation any more. America’s now a capitalists anarchy: “Every (rich) man for himself.” Proxy battles are fought by high-priced lobbyists in a broken political system. America needs a 21-gun wake-up call. Yes, that’s why America needs a Good Depression. The economy’s bad now. But kicking the can down the road again will make matters much worse later.

America’s leaders lost their moral compass, lack a public conscience

This is not our first call for a Good Depression. As early as 2005 we began reporting on excessive debt. In November 2007 we warned of a crash dead ahead. The subprime credit meltdown had been accelerating for many months, although for a year our leaders kept misleading Americans: Fed Chairman Ben Bernanke’s “it’s under control.” Treasury Secretary Henry Paulson’s delusional “best economy I’ve ever seen in my lifetime.”

In August 2008 came the original of our seven reasons why America needs a Good Depression. Yes August, just two months before Wall Street banks collapsed into de facto bankruptcy, after many warnings predicting a crisis. This was no Black Swan. In September 2008 we reported on Naomi Klein, author of “Shock Doctrine: The Rise of Disaster Capitalism,” warning of Wall Street’s insidious plan to take over America:

“Nobody should believe the overblown claims that the market crisis signals the death of ‘free market’ ideology.” Then as the meltdown went nuclear, Klein warned: “Free market ideology has always been a servant to the interests of capital, and its presence ebbs and flows depending on its usefulness to those interests. During boom times, it’s profitable to preach laissez faire, because an absentee government allows speculative bubbles to inflate.”

But “when those bubbles burst, the ideology becomes a hindrance, and it goes dormant while big government rides to the rescue. But rest assured,” she predicted, Reaganomics “ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis that will be the rationalization for deep cuts to social programs, and for a renewed push to privatize.”

Totally predictable: No Black Swans in 2000, 2008 … nor in 2012

Yes, all was predictable: The events of the past few years were well known in advance. In fact, the events of the entire decade were predictable. The rich got richer off the backs of the middle class and the poor. Why? “There’s class warfare all right,” warns Warren Buffett. “But it’s my class, the rich class, that’s making war, and we’re winning.”

And they are also blind and deaf to the havoc their free-market Reaganomics policies are creating, selfishly undermining America, the world’s greatest economic power.

Lessons learned? Zero. Why? Wall Street, Washington and Corporate America are focused on one narrow-minded short-term strategy: Economic g-r-o-w-t-h, bull markets, megabonuses, tax cuts. In good times they tout “free markets.” But when greed bombs, they throw free-market “principles” under the Reagan Revolution bus and unleash their mercenary lobbyists to go whining to Congress for huge taxpayer bailouts and access at the Fed discount window, to siphon off more taxpayer money. And they’ll do it again soon,

Wall Street and their cronies are doing such a miserable job, America needs a new strategy: First, stop “kicking the can down the road.” Let a good old-fashioned Good Depression do the job that our hapless, happy-talking leaders refuse to do. Take our medicine. Let a new depression clean house and reawaken Americans to core values.

Trust me folks, it’s either a Good Depression now … or a Great Depression 2. Here are seven reasons favoring the do-it-now strategy:

1: Capitalism’s now a lethal soul sickness, needs a reawakening

What’s the real problem? Not the economy, not markets, nor even politics. Yes, our economic pains are real. But they’re just symptoms. Something’s structural wrong. Since 2000 endless bad news: Greed, deceit, stupidity, corruption, unethical behavior, lack of moral conscience.

The real problem’s deep in our character, the “mutant capitalism” Jack Bogle warned of in “The Battle for the Soul of Capitalism.” Sadly, that battle was lost. With it we lost our soul, our moral compass. America’s character is measured by our net worth.

2. We’re already in the early stages of a Great Depression

Comparing today with the Great Depression is common sport. In a Newsweek special “Seeing Shades of the 1930s,” Dan Gross wrote: “Wall Street, after two terms of a business-friendly Republican president, self-immolated on a pyre of greed, incompetence and excessive optimism.” Today’s “new normal” economy means high unemployment for years, inflation driving prices, rising interest rates, more debt, chaos.

We are destroying ourselves from within. Former U.S. Comptroller General David Walker warns that “there are striking similarities between America’s current situation and that of another great power from the past: Rome.” Three reasons “worth remembering: declining moral values and political civility at home, an overconfident and overextended military in foreign lands, and fiscal irresponsibility by the central government.” We are becoming more vulnerable to external enemies.

3. Good Depression exposes our self-destruct bubble-thinking

Before the 2008 crash, “Irrational Exuberance” author Robert Shiller warned in the Atlantic magazine that “bubbles are primarily social phenomena. Until we understand and address the psychology that fuels them, they’re going to keep forming.” Housing inflated 85% in the decade: “Historically unprecedented … no rational basis for it.”

Bubble thinking is an toxic virus that infected everyone. Shiller warns of another coming: “We recently lived through two epidemics of excessive financial optimism … we are close to a third episode.”

4. Good Depression will stir outrage, force real reforms

Writing in the Wall Street Journal, Jim Grant, editor of the Interest Rate Observer, wrote: “Why No Outrage? Through history, outrageous financial behavior has been met with outrage. But today Wall Street’s damaging recklessness has been met with near-silence, from a too tolerant populace.” Grant worries that Wall Street will run “itself and the rest of the American financial system right over a cliff.”

But we only went to the edge in 2008. Today, a rebellious “throw the bums out” hostility is blowing a new kind of bubble: Three years ago we did not have Tea Party, union fights, the Arab Spring and Greek austerity riots, all signs of an dark angry future sweeping across America.

5. Good Depression forces Wall Street to think outside the box

In a powerful Bloomberg Markets feature, “No Easy Fix,” we’re told Wall Street’s “profit formula has hit a wall.” Their “money-making machine is broken and efforts to repair it after the biggest losses in history are likely to undermine profits.”

Even Mad Money’s Jim Cramer openly admits hedge fund managers are pocketing megaprofits at capital gains rates while laughing at the stupidity of a broken political system that gives hundreds of billions in tax breaks to the richest, then takes taxes off the table as our middle class is dying under massive unsustainable deficits. Soon angry mobs will “fix” Wall Street.

6. Good Depression will deflate America’s warring soul

The American economy is a “war economy” driven by a egomaniac. I saw it firsthand as a U.S. Marine. Americans love being king of the hill, world’s cop, the global superpower. Why else spend 54% of our tax dollars on a war machine, 47% of the world’s total military budgets.

Why? Our war machine generates such “spectacular profits that many people around the world” are convinced America’s “rich and powerful must be deliberately causing catastrophes so that they can exploit them,” warns Klein in “Shock Doctrine.” No wonder the GOP takes military spending, like tax cuts for the rich, off-the-table: The war industry is a major political donor.

7. Good Depression now … avoids a far bigger depression later

In “The Price of Liberty: Paying for America’s Wars,” Robert Hormats, undersecretary of state and a former Goldman Sachs vice chairman, traces America’s wartime financing from the Revolutionary War to present wars. He warns that today we’re “relying on faith over experience, hoping that sustained growth will erase deficits and that the ballooning costs of Social Security, Medicare and Medicaid will be manageable in the coming decades without difficult reforms.”

Absent a brutal reset, we are on a historically predictable course says Kevin Phillips, Nixon strategist and author of “Wealth & Democracy:” “Most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out.” Yes, burned out, unprepared.

So pray for a Good Depression earlier rather than later. Choose now and we can be prepared for whatever comes. Or a Great Depression will hit later, when we’re least prepared, the problems bigger, our faith weaker … don’t raise the debt ceiling.

This article originally appeared on MarketWatch. See 7 reasons U.S. needs a Good Depression now.