Harry S. Dent, Jr.: Winter is Coming

Harry Dent  |

Economic researcher and renowned market prognosticator Harry S. Dent, Jr. is no stranger to bold predictions. He is the best-selling author of such books as The Roaring 2000s, The Great Depression Ahead, and his most recent, The Great Crash Ahead, each detailing the boom and bust cycles of the economy. In the late 1980s, he developed the Dent Method, a widely used forecasting tool based around his research. What makes Dent's methodology unique, however, is his emphasis on using demographic trends and tracking consumer spending cycles.

He compares the typical 80-year economic cycle to that of the seasonal changes in climate. The four phases of Innovation, Growth Boom, Shake-Out, and Maturity Boom correlate with the four seasons of summer, autumn, winter, and spring. Essentially, technological innovation sparks the beginning of a new cycle. As it gains acceptance, a rapid growth rate occurs and economic expansion is at its peak. This leads to over expansion and a correction that results in a massive "shake-out" or depression.

Equities.com had the privilege to speak with Mr. Dent at the most recent FSX Conference held at the Ritz Carlton Marina Del Rey, where he was the event's the keynote speaker. Dent spoke candidly about his thoughts on the economy, his prediction of 3800 on the Dow in the near future, and where investors may want to put their money in the coming depression. Unfortunately for the economy, winter is coming, and it may be a long and cold one at that.

EQ: Can you talk about the Dent Method and why you focus on generational demographics and consumer spending trends?

Dent: In the early 1980s, when I was consulting at Bain & Co. to large companies and new ventures, I found, and kind of by accident, that the baby boomers were driving all the trends during that time. So I started studying baby boomers and realized that we had all this data and knowledge on them. We know when and how they spend their money, and what they're going to do during different life stages. From there we just kept digging and found this wealth of data from the U.S. government surveys, which is something most other governments don't do.

In a way, demographics is down to a science, and we can use it to see how they affect certain industries and the economy as a whole. We have data on about 600 different categories such as home buying, cars, health insurance, and really most of the things you want to look at. So we know when consumer do these things. For example, people buy camping equipment when their kids are still in elementary school. They don't buy it when their kids are in high school because their kids don't want to hang out with them anymore. So consumer spending and behavioral patterns are predictable, and you can use it to see certain trends in the economy decades in advance.

EQ: What were some of the most interesting correlations that you found as you were developing the Dent Method?

Dent: I was most amazed when I ended up comparing the S&P 500 chart versus the chart of the U.S. birth rate chart one day. It was basically the same chart, and it correlated a 45- to 50-year lag. When I saw the inflation chart and workforce growth, it took me a while to figure it out, but we learned why young people cause inflation.

Another thing we found, was that there's a life cycle to everything, and it happens in the form of an S curve. Innovation happens, then it moves into niche markets and grow to about zero to 10 percent. Once you hit 10 percent and if it catches on, it's going to go from 10 percent to 90 percent very quickly. After that, it's going to slow down. We predicted in the early '90s that the internet would go from 10 percent to 90 percent by 2008, and that's exactly what it did. These things are precise: the S-curve, how new products and technologies move into society and demographics, what people do as they age and how they change. It's all totally predictable.

EQ: You've predicted that the Dow will fall to 3,800 in the very near future, and the economy will enter a Great Depression lasting until 2023. How much of this has to do with an aging baby boomer generation? How much is due to other factors?

Dent: It has more to do with the debt situation. The real estate bubble and the debt bubble are the biggest thing going. Demographics happens more slowly. Baby boomers are just going to spend less and less, but it's not like that is going to cause a crash. However, markets that are used to seeing never-ending growth will go down substantially. So I'd say half of it is due to demographics, but the other half is due to this unbelievable bubble in credit. They were lending people nine to 10 times their income to buy a home when the historical standard of what people can afford is closer to three times their income. A lot of people got homes that shouldn't have and now they're getting kicked out of their homes and their credit is being destroyed. It's that bubble that the government stopped from bursting, and but it's still going to have to be dealt with. We're going to have to write down these debts, and home prices are going to have to come down further to be affordable. The good news is it's going to be a huge boon to the young generation, what we call the "echo boom" generation. They're going to be the next wave.

When home prices come back down to reality, they're going to benefit because they're buying homes at much cheaper levels and at much lower mortgage rates than they ever expected. Based on the way we look at this crash, the older generation has all the assets and the real estate but they're the ones that get hit when this bubble bursts. The young other than some unemployment early on, it's going to work in their favor. But ultimately, that's who matters, because old people don't drive your economy. Young people are always the next ones to earn, spend and innovate. Young people create all the innovation.

EQ: The echo boom or "millennial" generation has been criticized for delaying traditional life milestones such as buying a house and starting a family. Does this trend have any impact on your research?

Dent: It does, and we'll see this and pick this up. The age for entering the workforce has been around 20 years old for a long time, and the age for retiring has been 62 to 64 for a long time. This is going to change because you're going to see baby boomers stay in the workforce longer now that they realize they can't afford to retire. That's going to make it harder for young people to get a job, and if their jobs are not secure, they're going to hold back on buying a house, and live with their parents longer or pool together in apartments. So I do expect workforce entry to advance a couple of years and workforce exit/retirement to advance. We'll have to see how much that happens, though.

EQ: If population growth is a major driver for economic expansion, is the trend of lower birth rates in developed countries a detriment for future growth as more markets modernize and urbanize?

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Dent: It's a natural trend, and this is another thing that's absolutely predictable. Just about every country in the world is on a declining curve for fertility. The more people move to urban areas and the higher the income they earn, the fewer the kids they will have because it costs more to raise kids in urban areas, and they'll have more social opportunities. When people live in rural areas, they have anywhere from four to eight kids. In urban areas, you typically only see around one or two kids.

A lot of countries--such as those in Southern Europe, or in Korea, Japan, and China--all have very low fertility rates, which means their economies are just going to shrink in the future as we see their population shrink. So how do you deal with a country that actually has a workforce and population that's shrinking? We've never seen that before. Even Africa, which has the highest birth rates, is falling rapidly. So it is a predictable thing. The irony is that the very thing that created growth and prosperity ultimately works against it.

EQ: Your book, The Great Depression Ahead was a New York Times bestseller. Your newest book, The Great Crash Ahead discusses what the government did to avoid that depression, and why it ultimately won't work in the end. Can you talk about those books and how they're connected?

Dent: The Great Depression Ahead was about setting the stage just like we did for the winter season of the 1930s. The credit and debt bubble has to burst and be deleveraged and in this case, a very large generation is going to slow down because you just can't get old people to spend money. The Great Crash Ahead talks about the stimulus and the degree of the debt, and why the government really doesn't have the resources to handle it. It's similar to how Europe is going to eventually realize this as well. They bailed out Greece, kind of bailed out Portugal and Ireland, but when it comes to Spain and Italy, they're going to have to say they can't bail them out. Well, the U.S. is in the same position.

To add to the $16 trillion and growing federal debt, we have $38 trillion in private debt in the U.S. which is massive, and the underfunded entitlements for Social Security and Medicare/Medicaid are $66 trillion plus. When you are talking about $120 trillion plus in total debt, these numbers are mind blowing! We have way more debt that we can ever sustain, especially with slowing demographics. Then you have 92 million baby boomers that are going to want to spend less and save more every year because spending peaks at age 46 to 50, and it just falls like a rock from there. People in their 60s and 70s spend as little as a couple that just got out of school in their 20s. So, the government is fighting a war they can't win.

They're going to keep stimulating as long as the bond market will let them, but at some point the bond markets and people in general are going to lose faith. They're going to see that every new stimulus plan will be less effective, and more desperate. I saw a poll that 66 percent of economists said they felt the stimulus was pretty effective in stopping a major downturn, but 81 percent said we shouldn't do anymore. You can't just keep throwing trillions of dollars at the problem like that. The economy is still on life support, but it's essentially dead. So just let it go through its process. The big benefit of that is we'll be able to get rid of about $20 trillion in debt. That's huge.

EQ: So in that sense, would it be better if the economy actually entered into a great depression?

Dent: I wouldn't go quite that far. The Depression was the result of a cold-turkey approach and the government did nothing to save the banks. They lowered interest rates but they didn't do QE. What I think the government should do here is a little more civilized. They should only give stimulus to banks that write down this bad debt. That relieves the consumers and the businesses of mortgages and loans they can't afford. So maybe they could say, for every $3 of debt a bank writes down, the U.S. government takes $1 of it. If they would've taken the $2 trillion spent on QE1 and QE2, and applied that to help take the pain from banks to write down $6 trillion in debt, we'd be $4 trillion less in debt instead of $2 trillion more. I'd call that a win-win.

That's the way to do it in a more civilized way because if the system goes down, the government will have to do a certain amount of bailouts to support the economy. So why not support banks for doing the right thing? Right now, they're supporting banks for doing the wrong thing. Banks are using the stimulus money and investing with high leverage and creating a bubble. They're still paying high bonuses to some people who should be in jail. They're perverting the system by pushing interest rates so low.

The goal has to be getting the total debt number down. We had $20 trillion in debt before this bubble, and we have to get back to the pre-bubble level. We have to get rid of $22 trillion in debt. It may cost the government $5 trillion to $7 trillion in a scenario like this, but we're going to eliminate $22 trillion in debt and come out way ahead.

EQ: So if the economy is going to enter a prolonged recession that spans for over a decade, what assets or investment strategies should investors be looking at?

Dent: The key thing in a winter season is that cash is king. You'll need cash and cash flow, because banks will get even tighter in lending. You're going to have real estate at 20 cents on the dollar, businesses you can buy for 10 cents or 20 cents on the dollar, but you're going to need to have money and cash flow to buy it. So build up your cash flow, sell off assets you don't need--including business assets--and look to buy when things are cheap.

The other thing to understand, and this applies to general investing, is that you just can't buy a large-cap growth fund anymore. You have to invest in managers that are going to play the ups and downs almost like hedge funds because there's not going to be a bull market like we saw from 1983 to 2007. Stocks are going to be sideways with a downward bias for the whole next decade. It's what we saw in the 1970s, and the 1930s was even worse. There were huge gyrations. The first crash saw an 87-percent drop. So if you're just sitting in a normal asset allocation or stock fund, you're going to get crucified.

EQ: Tell us more about HS Dent and how readers can get more of your insight and research.

Dent: We have two newsletter services: the HS Economic Forecast and HS Dent Perspective. The HS Economic Forecast comes out twice a month and that's more for active investors. It's about 20 pages of analysis, both long term and short term. So we cover the whole gamut.

The HS Perspective is intended to be more educational and focuses on more long-term, major financial decisions like the right time to refinance a mortgage or to get into real estate or stocks. It isn't meant to tell people what the market is going to do every week. It's for people that are not as active in the market, but still want to stay educated and to know when we're saying to make major changes. It's easier for most people to understand because it doesn't focus on the short-term market gyrations and volatility.

It's the short term that's hard to predict. We have to tell our newsletter audience that it's the hardest thing. Don't expect us to be as right as we are long-term on demographics in this short-term stuff. Most people are wrong more than half the time. So if you can be right two out of three times in the short term, you're an absolute hero.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.


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