Market Analysis

The Big Bad Bear Case


My aim with this article is to outline, with facts, large global structural issues that I believe everyone, bulls and bears alike, should be fully aware of. While some of this discussion may rattle the cage a bit you will hopefully find this article well researched and informative.

Recently I’ve outlined why we switched our trading stance from buy mode (Door Shut) to sell mode (Inversion) on stocks. This week I’ve also outlined the aggregate technical factors that have us very cautious on stocks in general (Totality) while not precluding the possibility of new highs.

This article, however, will focus on much larger structural issues that have been building for years, decades indeed. And no this article is not so much about central banks, debt issues, Greece, China, deficits, etc. While all these are important as part of the overall picture, they are mere current symptoms of a much larger issue that is at the core of all that is already in play and will only deepen in our societies in the decades to come: Institutionalized poverty with an ever widening divide between the haves and the have nots which will result in an eventual drastic revaluation of asset classes across the board.

And before you think I’m off on a hyperbolic rant let me assure you my reasoning will be very much fact based and I have reason to believe the US Fed and Janet Yellen are very much aware of it all, but have no solution to prevent it from happening. In fact it is mathematically unavoidable.

A few weeks ago in The Greek Butterfly I discussed the concept of a global math construct that needs to maintain its integrity to make global debt serviceable. To that end I concluded that they would not let Greece default.

After much scary talk and fluttering stock prices we now know the conclusion: Greece was saved yet again and new debt negotiations are under way.

During the same time we saw China correcting hard and quickly the Chinese spent $800 billions dollars to prop prices back up. Again: Fighting symptoms, but not addressing a root cause gnawing at it all.

And we have seen this need to rescue falling stock markets in action for years and indeed central bank intervention has only accelerated in 2015 with over 50 global central banks rate cuts and a new massive QE program launched, this time courtesy of the ECB.

Why do you think they are all doing this and have been doing it for years? Decades even? The simple answer is they HAVE to. They have no other choice. And let me explain why.

I’ll do so be telling you a story that starts with the symptoms, the larger trends we have all been able to observe. I’ll also throw in some factoids that may surprise and/or shock you.

Let’s start with the basics to get everyone on the same page:

Since the early 1980’s debt, both in absolute terms and as a percentage of GDP, has increased exponentially to the point that debt is now over 100% of GDP:

Debt to GDP

Public debt

In short governments, globally, not only the US, have wildly overstated organic GDP figures and borrowed heavily maintaining the illusion of growth.

It’s called deficit spending and its impact is enormous. For example, following the financial crisis US deficit spending alone constituted over 10% of GDP at some point. It has improved since then, but still remains squarely stuck in negative territory:


The public justifications for these deficits: Usually a combination of “we must prevent a crisis or react to a crisis, and we need to cut taxes to incentivize businesses to create jobs and this will promote growth”. And future growth will justify the expense.

The result: Huge sums of debt that need to be financed with debt service payments impacting the discretionary government budget. The truth: These debt service payments are only manageable via artificially induced low interest rates. At current debt levels the discretionary budget would simply buckle under normalized rates.

The problem should be obvious: Debt keeps growing and GDP growth remains completely elusive and the trend shows ever shrinking nominal growth:

GDP vs Sales

On a real basis it appears it will not get better either. Ever. In fact it will get worse according even to the Federal Reserve, an institution known for consistently overestimating growth:

FED projections

Note these projections above never see a recession coming and unemployment will forever improve while rates are rising for years to come. To which I say: Pure fantasy.

Let’s address the employment picture and the quality of jobs and benefits.

According to policy makers businesses were incentivized to hire via tax cuts and low interest rates. Yet, oddly enough during the same time of debt expansion labor markets have shrunk on a relative basis with more and more people no longer in the labor force and the labor participation rate shrinking dramatically:

not in labor force


Hence it can be clearly stated that taking on debt and cutting taxes has not resulted in an aggregate increase in employment. The opposite has happened and employment peaked during the 2000 market bubble.

But at least we have growth and people are making more money. Right? No.

Real median household incomes have shrunk since their peak coinciding with the 2000 stock market bubble:

Real median income

They have not recuperated at all, in fact median household incomes are at roughly the same level they were over 20 years ago.

Which is odd since officially the unemployment rate has been shrinking to a level consistent with levels that typically constitute low unemployment, i.e. indicative of a growing labor market and a demand for workers which would typically result in rising wages:


Several items to note here:

1. During the previous drops in the unemployment rate in 2000 and 2006/7 real median household incomes had experienced a temporary spike. Not this time around.

2. Since the 1990s reaching low unemployment rates coincided with a “peak” in stock markets and preceeded recessions. More on this later.

And now it gets really interesting. As we all know the Fed reduced interest rates to zero as a response to the financial crisis in 2008. Yet a closer look shows that the Fed’s move was in essence only the logical conclusion of a trend that started in the 1980s, the same time debt expansion began and labor participation started to decline:

Funds rate

When the Fed under Ben Bernanke embarked on ZIRP combined with a massive bail-out and a QE program there was no stated intent or goal to have ZIRP in place for 7 years, no was there a plan for QE2, or QE3 nor did anyone envision we would still be in this place in 2015. So what went wrong?

A number of things frankly and this is where it’s going to get really dicey.

The root of the crisis this time was housing and people were losing their homes by the millions. But who was in more trouble? Financial institutions and they had to be made whole right? Mark to market was eliminated and banks had flexibility to make their balance sheets look sound when in fact they weren’t. Prices needed to rise to make the math work.

And it has been a seemingly smashing success as house prices have been reflated to almost 2007 levels:

HOUSE prices

All thanks to zero rates. The premise was to rescue the financial system, to encourage lending, business formation and hiring to produce economic growth. Right?

But that didn’t really happen. It happened on the surface, but a closer examination of the data leads to the conclusion that there is major cyclical downturn under way already.

To start: Not only have housing prices increased substantially so have rental prices and they are higher than ever:


While zero rates have permitted many consumers to refinance their mortgages at cheap rates many others couldn’t. Most because they can’t afford to or they don’t qualify or both.

And this is a problem because housing is still the largest expense line item in a family’s budget.

Though to deal with rising housing and rental prices when your real income growth looks like this:


So flat out 85% of Americans have experienced negative wage growth since 2007 while housing prices have gone up. And many more Americans are no longer in the labor force as we have established. That’s a problem.

Other key issues: Almost 50% of Americans don’t have full time jobs and one large consequence of this: Little to no benefits and no pensions. Even the folks at Blackrock are getting concerned. Here’s COO Tony James recently who calls the issue a hidden crisis:

I have the view that the hidden crisis in America that no one is talking about is what’s going to happen with all of these 20, 30, 40-year-olds who no longer have corporate pension funds of defined benefit.

But this type of job creation is celebrated on Wall Street, think Chipotle a restaurant chain whose stock keeps soaring, but what’s the aggregate job creation: Hourly jobs. As of December 2014 48,500 employees out of 53,090, or 91%, are hourly. Now I suppose that’s true for most restaurant chains and even Starbucks has an army of 130,000 baristas. But for all the hoopla about free college degrees and 401K matching programs the fact is those folks don’t earn much and there’s no real wage growth:

But baristas say Starbucks’ focus on profits and cost-cutting has increasingly led its leadership to tune workers out. Locke, who has worked for the company since 2006 and who earns roughly $16,000 a year, said she yearned for the Starbucks of old.

Hey, I’m just pointing out reality: The earnings potential for most people is grim and hence people are desperate to improve their odds. The big lure? College education and here too the answer is debt as people are forced to burden themselves with significant long term debt to even have a chance of an education:

Student loans

And the effects on the overall economy are crushing:

“The numbers are staggering: more than $1.2 trillion in outstanding student loan debt, 40 million borrowers, an average balance of $29,000….Men and women laboring under student debt “are postponing marriage, childbearing and home purchases, and…pretty evidently limiting the percentage of young people who start a business or try to do something entrepreneurial,” said Mitch Daniels, president of Purdue University and the former Republican governor of Indiana. “Every citizen and taxpayer should be concerned about it.”

So to summarize: Fewer people working overall, with 85% experiencing negative wage growth in jobs with little to no benefits and little upward income potential and no pension on the horizon while many are forced to indebt themselves and change their behavior to even have a shot at a higher education all while the cost of housing has increased dramatically. Any wonder retail sales stink?

But it gets worse.

We were told that tax cuts would promote business expansion, zero rates would promote growth and lending and a new dawning of the day.

It didn’t. Here are the long term trends:

New business formation:

Firm creation

Note goods producing firms continue to shrink and this also has ramifications and I address this further below.

Fixed Investment? The weakest cycle in over 50 years barley above par:


But stock markets are at all time highs, stocks are flying so there must be much growth? No:

sales growth

We never came even close to the growth of the mid 2000s and are continuing to see a regression in sales growth.

But then earnings expansion right? For some and for a while yes, but operating earnings are declining and buybacks and dividends have largely masked it all:


In fact about one third of market cap gains since 2009 has been attributed to buybacks and dividends:


Yet enormous wealth has been created and valuations have soared. Who benefits? Well we have already established that 85% of Americans have seen a decline in real wages. 50% of Americans do not own any stocks at all. I won’t go into depth on income and wealth inequality here as the facts are well established but the reality is this: 80% of Americans own virtually nothing whereas the top 10% own virtually everything:


And the most structurally disturbing and frankly atrociously embarrassing data point for America the richest country on the planet:

Twenty-two percent of American children were living in poverty in 2013 compared with 18 percent in 2008.

22%. Frankly unfathomable and structurally dooming as children’s future income, despite the occasional examples of exception, are squarely linked to the income of your family history. In other words: If you are born poor, you will remain poor, if you are born rich you will be rich:

poverty income

Adding to the long term structural fragility of the system: 1 in 3 Americans have a criminal record several limiting future employment chances:

The FBI currently has 77.7 million individuals on file in its master criminal database—or nearly one out of every three American adults. Between 10,000 and 12,000 new names are added each day.

Aside from the obvious reality of millions of people in and out jails and the long term consequences on children growing up in broken families, an entire generation of Americans will simply not be able to compete for higher paying jobs on this basis alone,

So a reasonable question may be: How are people who own nothing, who have been experiencing a decline in real wages and who are leaving the labor force in droves, ever to contribute to the economy at large? As in help GDP grow?

Look I have no problem with Mark Zuckerberg and Jeff Bezos and others getting stupidly rich off of their business ventures, but there are only so many yachts, islands, mansions, jets and bling one can buy. Despite popular belief it does get boring. Hence many billionaires are already pledging to get rid of all their wealth when they die and fair play to them for doing so.

But that doesn’t answer the larger question: How are all these trends pointing to a structural bull market? Why instead is this all pointing to a major bear scenario?

Two answers and now we get to the meat of all this:

1. Productivity growth. It’s frankly depressing:


And this structural reality will eventually kill this bull market and Janet Yellen knows it’s a big problem as she admits in this clip:


She is hoping. Well good for her, but hope is no strategy and the plain fact is productivity growth is and has been regressive and without it there’s no growth, no wage increases and no inflation.

In fact everything is pointing to deflation as commodities are crashing across the board:


Not exactly the stuff that economic expansion dreams are made of is it?

So what’s the problem? I suspect there are 3 major underlying macro trends that all live under the same umbrella:

2. Technology.

First let me say that technology is awesome, it’s made our lives so much better in many ways and I wouldn’t want to live without it. Heck my entire livelihood centers around technology, but it is coming at a price and a heavy one indeed.

Let’s start with the commonly known one:

a. Outsourcing and restructuring.

For many years companies have sought to improve their cost efficiency by outsourcing jobs into other countries. no problem with that, but it has created a structural shift and the slack is not being picked up within the domestic economy. Yet this trend accelerated after the financial crisis and took on additional forms, mainly: Do more with less. Companies laid off millions of employees and the original notion was they would hire them back when things would get better. They haven’t in many cases, hence the labor participation rate has shrunk.

Instead what companies have found is that they can get away with fewer employees. Technology improved to the extent where this was possible. As manufacturing and production based companies took a second seat to the information economy greater scalability could be achieved. In fact unprecedented scalability. Hence a company like Facebook that reaches over a billion people needs relatively few employees. Hence small app companies can have billions in valuations but only have a few employees.

In short: Massive wealth concentration in the hands of just a few versus a much more labor intensive economy in previous times. And, combined with an economy that invests less in capital investments, productivity growth appears to be limited for years to come.

b. The decline in Moore’s law:

According to Brian Krzanich, the current chief executive of Intel, the era of Moore’s Law may be coming to a natural end. In a discussion with analysts on Wednesday night, he admitted that while his firm had “disproved the death of Moore’s Law many times over”, its next generation of microprocessors would take slightly longer to produce.

The issue of course: Staying ahead of the innovation curve and frankly it appears $GOOGL glass and $AAPL’s Watch are examples of companies struggling to define the next big thing. Note Tim Cook was very shy on providing any details on sales for the Apple Watch during the recent earnings call. Niche product yes, applications that are new category defining? Not so much.

Yes $AAPL will continue to generate massive earnings as a upgrade and product replacement engine. But it’s also vulnerable to regional issues as the China sales figures have shown. And if you have a market cap north of $700B you better come up with new revenue streams or you flat line eventually and your valuation falls.

But there’s nothing compelling new on the horizon for the moment. Yes the screens get better, the memory gets bigger, the processors get faster, and even a better camera is coming. But that’s all cosmetic isn’t it? What is it I can DO with it that’s different?

The next big thing? Tim Cook is hoping it’s the watch? TV? Cars? Really? Sounds like the rehashing of decades old platforms to me, improved, yes, repackaged, yes, but still the same old platforms.

So this question remains unanswered for now and with declining productivity, a declining Moore’s law, and shrinking real wages it doesn’t take a genius to figure out why there are issues ahead.

c. Social Impact.

As much as I love technology there’s a real dark side to it all that concerns me deeply and it goes to the core of the question: Does it make for a better society ultimately.

All the numeric data points above suggest that so far the benefits appear to be lacking. Wage growth, income inequality, GDP growth, employment availability, etc. all are pointing to a declining health in overall society. Yet technology provides more information at our fingertips than ever, the ability to get things done are unprecedented in human history. Frankly the tools available to us are fantastic!

So there’s a dichotomy here. What’s the problem?

It may come down to what people are choosing to do with the available technology and how and what companies are promoting to sell to consumers.

Let’s first look at the actual result in terms of human behavior and it’s not pretty.

In a nutshell: During the last 10 years Americans have chosen to use technology to spend more time glued to screens for entertainment and less for education. They also sleep more and work less:


This data seems to support the lack in productivity growth. But it’s not a sudden trend, it’s a continuation of a trend that has been going on for decades: A sedentary lifestyle glued in front of screens and a food industry catering toward big appetites and offering huge caloric consumption (i.e Starbucks and Chipotle). The results are depressing:

An analysis published in JAMA Internal Medicine on Monday found that 75 percent of men and 67 percent of women ages 25 and older are now overweight or obese. That’s a startling shift from 20 years ago when 63 percent of men and 55 percent of women were overweight or obese.

And look what Wall Street values the most: Companies that are either promoting entertainment and screen sucking or enabling the same behavior. I use my recent compressed valuation sheet of just 6 companies as an example:


Facebook? Screen sucking for entertainment purposes. Sitting still. Amazon? Buy stuff with a mouse click, no need to move. Netflix? Watch TV on the couch, maybe with a burrito in hand. Google? Wall Street recently jammed the stock up on growth in youtube: Again sedentary entertainment. Apple and Microsoft can be argued are part of the enabler group by either providing the devices or software making it all happen. Of course gaming is an entire additional category of sedentary entertainment keeping people in front of screens and $MSFT is a big player in this industry as well.

The end result? Watch this short clip and weep as it shows you what has happened to society at large from a generational perspective in just a few short years:

What the impact on culture and society will be in the long term cannot not yet be clear, but behavior is changing rapidly.

To summarize: We have society at large growing in waistlines, but not in incomes, wealth or jobs, benefits or security. We have witnessed the largest expansion in debt in modern times financed by artificially low rates and precious little evidence of organic and structural growth in the system.

Yes we see select winners in this new economy but overall wealth generation is completely skewed toward the benefit of the few which brings me to the next point:

It won’t change and will only continue on its current trend. Why?

For one Americans are checking out of the political process:


On the one hand who can blame them. Aside from social issues perhaps does voting make really make any difference? The trends above suggest not.

Approval ratings continue to paint a deep level of dissatisfaction with Congress’s performance:


Yet both political parties, with the help of the Supreme Court and fund raising laws (think PACs) have made it a Nirvana for political incumbents to stay in office no matter what:

In the House, we counted 390 incumbents who ran on Election Day. Of those, four haven’t had their races called as of Nov. 10, so we’ll set them aside. Of the remaining 386 incumbents, 373 won, for a winning percentage of 96.6 percent.

16% approval rating and a 96.6% re-election rate. There. Democracy. Somewhere Putin must be smiling.

Of course we are not dealing with a well informed electorate either. When it comes to one of the largest issues impacting their lives (monetary policy) Americans are utterly uneducated as only 24% can even name Janet Yellen as chair of the Federal Reserve:

Janet Who

Yes, it’s somewhat depressing, but then Americans have zero input on the Fed, who runs it, or what they do. And this is the truth for all central banks. The world is run by big institutions and central banks none of which are democratically elected (think IMF, ECB, PBOC, BOJ, etc). And I understand this may never be a practical possibility given the complete focus of the electorate on entertainment and not education. But let’s acknowledge that we have democracy on paper only and only an illusion of choice.

And nobody has ever summarized this state of affairs better than George Carlin who predicted all this perfectly years ago in this now classic rant (NSFW):

So there you have it. Facts, numbers, trends all pointing to a picture not exactly compatible with an ever expanding bull market.

Quite the opposite. What all these data sets point toward is a structural malaise that has been masked by debt and zero interest rates. Janet Yellen is now talking about wanting to “gradually” increase rates. Best of luck with that.

I submit that all the data above points towards a structural bear case that is already in play, but masked by years of debt increases, QE programs and ZIRP policies.

And it’s not limited to the United States, technology is global and so are its impacts. Companies can do more with less. Fewer employees that is and pay less overall. And without a new impetus of growth this trend will not change, but only accelerate.

That unemployment chart from earlier? Let’s look at it again with some modifications:

UE trend

Each time unemployment reaches the 4-5% mark history suggests we get hit by a downturn and companies will lay off people by the millions. And we all know they will again. They do it even during supposed good times. Microsoft, Barclays, Qualcomm, etc. are already laying people off by the tens of thousands.

So what can the individual do? From my perspective people need to make a fundamental choice to the extent that they can do it: Take control of their own destiny. Decide whether they want to be serfs or in charge of their own future. The reality is this: One cannot rarely achieve independence working for someone else. Jobs are not secure, there’s no loyalty toward employees and jobs are fragile.

Our family has landed in the world of trading and we are very fortunate that this choice has allowed us to lead a life of independence. And this is the bright side of technology: It gives each individual the opportunity to reach a global marketplace with a product or service idea and partake in the flow of capital and create their own financial freedom.

All you have to do is get off Facebook, Netflix, youtube, eBay, and Amazon and start using the screens for something productive and work your butt off. Janet Yellen will appreciate the resulting productivity growth 🙂

All joking aside the message is very clear: Those that don’t find their way out of this will be stuck in low paying jobs, in debt, and with virtually no upward income mobility. And the trends suggest that nothing in the future with change this. In short: Institutionalized poverty for large swaths of the population. Now you can choose to believe this is all long term bullish, but I’ll take the variant view. All these factors point to a coming large secular bear market that central banks and governments have been seeking to avoid by spending tens of trillions of dollars. For now they are still managing to keep the math construct going, but it seems to be getting more and more difficult to keep appearances going and that fact is seen in the chart of the $NYSE:


Whether it cracks in the weeks to come or whether the construct can be maintained for longer is almost secondary to the end conclusion.

My only hope is that eventually we can do better with all this technology available to us, but I suspect we won’t until we can have an honest debate about what is actually happening to society. Hopefully this article makes a contribution to that end.

22 replies »

  1. the biggest problem with these “fundamental“ armageddon calls is timing. The facts and graphs you are repeating are nothing new and have been used many times over the last 2 years to call for a 30%+ correction. As always a balanced approach and common sense trumps statistics.
    I am sure at some point in the next 10 years you and others will be proven right but for now…..
    It does not matter until it matters and in the meantime lets continue to make some money and BTFD.

  2. what many in the know feel put into hard hitting facts and terrifying conclusions.. As the years play out. My personal take. A quote from.G handi ” if u want to see change in this world then it must begin with you”. excellent well thought out. Do we really expect anything less from the brilliance of Mella and Sven?

  3. timing matters…. imo this phrase would be an understatement…$MS Parker remains bullish on US stocks. Parker’s year-end S&P 500 forecast is 2,275

  4. “My only hope is that eventually we can do better with all this technology available to us, but I suspect we won’t until we can have an honest debate about what is actually happening to society. ”

    This is not the first challenge we are facing. It has to be taken into perspective with others the cold war, the Cuban missiles crises and others. Thus keep things into perspective and acting rationally is key to prosperity.

  5. …..Whether it cracks in the weeks to come or whether the construct can be maintained for longer is almost secondary to the end conclusion……
    Coming back to the important timing issue : the above is a useless statement for a trader who depends on his/her daily or weekly P&L.
    I am not sure what the message of this post is supposed to be : go to 100% cash or be short or continue to zip on your Martini ?
    I think we all know that at some point the game of musical chairs will be over but the $64K question is WHEN which brings me back to the beginning which is TIMING !!!

  6. Economic activity requires energy. NET fossil energy extraction is coming into its peaking phase. GDP growth is slowing as a result. Economics meets physics meets mathematics meets finite fossil energy resources meets reality; result: pain because we have made promises during our energy ascent that we can’t fulfil during our energy descent

    This is another article denying that there are limits to growth, denying that the goods and services are totally dependant on fossil energy, denying that fossil energy is a finite resource and denying that we have reached the apex of the oil age.

  7. Writing the hidden truth is hard especially when you are against the norm – the global economy may have to look back historically to learn what work best to remedy the current situation – probably with severe calamity and wars – the world is overpopulated and far too advanced for Capitalism

  8. Sven,

    Excellent writing sir. As we age we see the bigger problems we feel will be our undoing as a society. But somehow, we continue. Perhaps the children of today will create a new future we can’t imagine based on the skills they are learning today. Even though we think they aren’t learning anything today. It seems every generation thinks the same thing about the next.

    Concerning the markets (the reason we are reading this article) well – damn good analysis. This pig is going to die. We don’t know when, but I am confident you are agile enough and conscience enough to keep us informed and change your mind when the facts change, when the math changes. I am lucky to know your work.

    Thank you.

  9. You seem married to the bear case.

    As an intellectual exercise, you should build the case for the opposite side of the trade.

    What if the Fed’s plan actually works? What if the economy never melts down? THAT would be interesting.


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