In the face of the current market run-up, Harry S. Dent, Jr. has been attracting quite a bit of attention for his prognostication of a pending crash in the second half of 2013. Then again, those familiar with his work with demographic trends and behaviorial economics know that Dent’s forecasts are based on long-term trends that have proven out over numerous market cycles throughout the U.S. economy’s history. As the author of The Great Crash Ahead: Strategies for a World Turned Upside Down, and editor of the free newsletter Survive and Prosper, he outlines very clearly how he sees his bold proclamation playing out for the coming year, as well as the rest of the decade.
Dent: The only thing for me is we’ve seen even more massive stimulus programs. The Federal Reserve introduced QE3 in mid-2012, and then extended that substantially later in the year. China’s also been stimulating more to help turn around their economy after it started to slow when they tried to curb their real estate bubble. Now, Japan has absolutely gone off the charts recently. They’re going to stimulate with quantitative easing and bond purchases at three times the rate that Europe and the U.S. have been doing. After two decades of being in what we call a coma economy, they are so desperate that they’re just throwing in the towel and basically saying they’re going to print money endlessly.
That seems to have been the theme from 2012 and forward. It started with Europe and ECB President Mario Draghi when vowed to do anything to save the euro, Spain, Italy and other countries from bank runs and falling trends. Then the U.S. pumped up QE3, and now Japan and China are stimulating. In fact, I expect Europe will do another round of stimulus too. So we now have even more stimulus, which means the first half of 2013 is likely to be even better for economies around the world and stocks. At the same time, however, it is still a greater sign that the economy is so weak fundamentally because of declining demographic trends, which will only get worse. As a result, we’re going to see the next bubble burst in the second half of 2013 and spill over into 2014 and 2015, because debt levels that have only gotten worse with all this stimulus from governments. This has been the trend in the economy since the mid-1990s. The tech bubble burst in the early 2000s, then the emerging markets and real estate bubbles burst and crashed, and now governments have stimulated a rebound that is totally artificial.
Without that stimulus we would not have any recovery. We would’ve gone through a great depression, and would actually be coming out of it by now. So this bubble is going to crash at some point, and it’s just going to take something to prick the bubble. In 2008, all it took was four states in the U.S.—California, Nevada, Arizona, and Florida—to go through a subprime real estate crisis that started hitting the banks, which then spread around the world. That happened because the world was so overstretched with so much debt and with slowing demographic trends. While things look good for the world economy right now, I think some time later in 2013, something will blow up—perhaps Spain or Greece—and that’s going to trigger the next crisis, because this is all artificial.
EQ: This trend, if it plays out the way you’ve outlined, is what you call the megaphone pattern, where assets reach higher highs and lower lows. Can you tell us more about this? Are we entering the final leg of this pattern?
Dent: It’s so funny because when I go speak in the media and say that the Dow could go to 6,000 in the next couple of years, people say that it’s too extreme or it doesn’t make any sense. Well, look at the trends of the last two decades: bubble boom, bubble burst. So the megaphone pattern that you’re referring to shows that each bubble since the 1990s has taken us to new highs, and each bubble burst has taken us to slightly newer lows. We had a peak in the early 2000s for stocks, followed by a big crash, then a slightly higher high in 2007, followed by a bigger crash to slightly lower lows. Now, I think we’re going to see new highs in most stock indices in the U.S. by mid-2013 or so, then another crash to new lows.
We saw the Dow hit 6440 in 2009, so 6,000 is just a slight new low. This is not an outrageous forecast. Governments are trying to prevent this by stimulating like crazy, but the reality is it’s going to be bubble boom, bubble burst until we finally get to the point where we’re forced to face our debt and deal with our debt entitlements. We need to get a more realistic view of this slower growth economy, which is going to continue for decades. The demographic trends in the U.S. and most major countries around the world point indicate this will last until the early 2020s. Older people are going to spend less and less money no matter what the government does. The debt ratios that we hit in extremes in 2008 (both government and private debt) are getting even worse as governments keep printing and borrowing money to stimulate our economies. They’re increasing the total debt, not deleveraging debt like we did in the 1930s, 1870s, and every other debt bubble crisis in history. They’re increasing the debt to fight debt deleveraging and deflation. This is very bad policy and it cannot end well. It’s like taking more and more of a drug until you just collapse.
EQ: What other asset types is this trend happening to besides stocks? Is real estate another example?
Dent: The biggest thing that we look at and tell people to look at (but nobody ever does) is Japan. Japan’s baby boom peaked just after World War II, which was way ahead of the U.S., Europe and most other major countries around the world. Their whole bubble boom with this massive generation spending peaked in the 1980s and mid-‘90s. After that, Japan fell off what we call the demographic cliff. That happens when the largest generation in history peak in their spending, but not only that, they have a smaller generation to follow after them as opposed to a larger one that may be able to support the drop-off. As a result, Japan’s real estate market is still down 60 percent 21 years after the peak in 1991. Stocks are still down 70 to 80 percent off-and-on 23 years after their peak in late 1989.
That’s the future for the U.S. and Europe if we just keep stimulating. There’s no easy way out of this. The demographics and debt ratios say we have more to work out ahead and the next decade is going to continue to be difficult. Yes, governments are going to stimulate the economy and prop it up, but even in Japan, we’ve seen no recovery from quantitative easing and monetary stimulus that lasted more than four years before stocks crashed to new lows and the economy went back into recession.
So we see the stock market in the U.S. and around the world look like a rollercoaster. We’ll likely see new highs in the markets this year on the S&P 500 and the Dow, but we’re going to crash again when stimulus proves that you can’t just create an artificial economy forever. The people who are going to buy houses or cars have probably already bought them due to all the special government programs and incentives. As a result, you just run out of steam again because demographics say that consumers are going to spend less.
EQ: If the market is expected to crash in the second half of this year, dropping by over half its value, what are some signs that we’ll see to indicate the beginning of that crash?
Dent: One of the things we look at is technical analysis, but it’s getting harder and harder. You look for divergences where the “smart money” is starting to exit the market while the “dumb money” (everyday investors) are still piling in. There are a lot of different indicators there, but in a Fed-manipulated economy, these indicators don’t work as well as they have in the past. In mid-2012, we started to see these divergences and it looked like stocks would be topping. However, the Fed came in with QE3 and all these other stimulus programs, so these indicators reversed and now it looks like stocks are going to go up for the next several months.
But we’re going to be looking for divergences where maybe small cap stocks start underperforming large cap stocks. Some other indicators will be when we see buying pressure start to underperform selling pressure, even in the next rally. The biggest thing we look at, though, is that in 2012, Europe had a major second stimulus program of $1.3 trillion in the Long-Term Refinancing Operations (LTRO). It was a massive stimulus that is equivalent to twice the size of QE2 in the U.S. when compared to their economy. Yet, literally within months, their economy went into recession. They were trying to prevent a recession, and they probably prevented it from getting worse, but there’s a point where stimulus doesn’t work. That’s the biggest issue.
When world realizes that the U.S. and Europe keep upping the stimulus, and that stimulus has little effect, then the stock markets and everyone else will realize just how much trouble we’re actually in. I mean, Japan’s new stimulus program is so off the charts, it’s essentially like shooting heroine straight into your veins to get out of being in a coma economy. If people realize it isn’t working, then that’s what probably will trigger the next crash. There’s also the potential of something blowing up in the economies of Spain or Greece, which are very ripe. It would take very little to trigger the next crash.
EQ: Is there anything investors can do to protect themselves in the coming months?
Dent: The big thing here is we’re in what we call the Winter Season of this decade of debt deleveraging and slow growth. It’s similar to the 1930s in the US. What happens is that a bubble boom accelerates stocks crashing like we saw in 1987, 2002, and 2008. It starts to decelerate, but you still get this bubble mania because governments stimulate and stocks bubble up again. As an investor, you can’t just get out of stocks for the next decade. We just had an over 100-percent rally in stocks. You don’t want to miss that. What you have to do is think like a long-term trader. When stocks get back to their highs and bubble up, you start moving out. In this economy, with deflation and debt deleveraging, everything crashes. Real estate, commodities, gold and silver, oil, all crashed in late 2008 and early 2009. When there’s a crash, then you go back and buy stocks and commodities and other types of assets again.
That’s the trend we see going off-and-on for the next decade. Bubble boom, bubble burst, but with maybe less and less bubbles and more bursts. Right now, we’re close to the highs in the stock markets. By our measures, commodities and Europe have already peaked. But U.S. stocks are still edging up, and I think they’re going to go higher to maybe even 15000 on the Dow, but then it crashes to 6,000. The trend right now is to actually sell over the next several months, and get out of risk-on assets like stocks and gold. Then when there’s a crash, you get back into it because we could see another 50 percent to 100-percent rally once stocks fall that low. If stocks fall to 6,000 on the Dow and rally back to 10,000 or above, that’s going to represent a 60-percent to 70-percent rally over the next couple of years.
We see a cycle similar to the Great Depression where there’s a crash, followed by three-to-four year rally, but then it crashes again, and then is followed by another three-to-four year rally. That’s kind of the cycle, so you have to play it that way by getting more aggressive when things crash, and more defensive when things get overvalued. Right now, we are clearly in the overvalued range here.