In our recent interview with demographics and economics prognosticator Harry S. Dent, Jr., Equities.com gets his thoughts on the effects of the Fed's extended stimulus program, China's inevitable hard landing, and why investors can't trust fundamentals.
Dent's latest book, Demographic Cliff: How to Survive and Prosper During the Great Deflation of 2014-2019 came out earlier this year.
EQ: The market got its first pullback in a long time earlier this month. It managed to recover pretty quickly. Does that affect the timeline of how and when you expect the market to break down?
Dent: Well, it went down strongly and then popped up a new life the next day. When you see that, especially with the Ukraine-Crimea/Russian crisis going on, it shows that investors still think this market is going up. We still need to see the smart money start to leave the market, and we’re still not seeing signs of that yet. However, we are seeing many patterns come together. There’s been the rising range in the S&P 500, the channel in the Dow, and there’s been giant megaphone patterns, which we’ve talked about in the past with higher highs and low.
We’re getting very close to some really strong resistance levels around 17,000 on the Dow and 1900-plus on the S&P 500 that are going to be pretty hard to break. So we’re not quite there yet. So we’re not pulling the trigger and telling people it’s time to sell, but we think it’s getting close. And we might not get some of the normal divergences you get in the past, because this is a Fed-manipulated recovery and artificially driven stock boom.
We have two great leading indicators that just don’t work anymore. It’s not that they don’t work, it’s that they’ve become coincidental. They’re not leading anymore because this is not a real recovery that’s measured by real things consumers and businesses are doing. The Fed’s just pouring money into the economy and it’s got to go somewhere so we get a wealth effect into bubbles and markets, and people feel a little better and spend a little more. But you’re not seeing businesses expand capacity and debt systematically. You’re not seeing consumers do the same thing. Everybody is still too much in debt so there’s nothing to expand. It’s just an artificial recovery by the Fed to keep the high going.
EQ: How much longer can they sustain this strategy, in your opinion?
Dent: I mean,this stimulus works. The money goes in and it’s got to be invested somewhere. It’s not being lent so it goes into the financial bubble. But that’s the catch-22 for the Fed. The more they succeed in creating this wealth effect, the more extreme financial bubbles we get. And bubbles don’t even need a trigger to burst. It’s better if there’s a trigger but they don’t need a trigger.
The real estate bubble in early 2006 peaked, and the economy didn’t go down, interest rates didn’t suddenly spike up, supply limitations in places like California didn’t suddenly pop up. It just got too high and then young people couldn’t afford to buy. So the Fed is creating bubbles with other central banks around the world, but they’re all going to have to burst eventually. Then they think they can bring it down easy, they are full of [it]. Nobody has ever brought down a bubble easily, never ever. If somebody can find one, they should let me know. I haven’t seen it ever happen.
Bubbles don’t correct, they don’t deflate slowly—although they can somewhat in real estate—but especially not in stock and commodities. Look at oil in 2008, or look at stocks in 2000-2002 after the tech wreck. Look at China in 2008. They had a 70-percent decline in one year and the Chinese government is supposed to be able to stop bubbles from bursting? Well, good luck. So when this thing blows, it’s going to be bad and it’s been so extended by governments for so long that I think it’s certainly going to be a worse downturn than 2008. That’s what we’re saying. We have a Dow target of 5000 to 6000 on the downside, falling from 17000 roughly on the upside. That’s a big fall.
EQ: And just to clarify, you’re not against stimulus. You just feel this current Fed regime has let it go on for too long?
Dent: That’s right. In a real financial emergency, the system does need liquidity so things don’t melt down more than they have to. But you should not save banks. You shouldn’t say, “Oh, you don’t have to mark loans down to market,” or say, “We’re just going to keep building up your reserves and feeding money into the system so you don’t have to write down loans.” That’s bad. That’s debt that you need to rebalance.
It’s fine to come in for three to six months and provide an injection of liquidity like they did in late 2008 and early 2009 so the system doesn’t just totally melt down. But QE has now been a five-year policy, and that is absurd. If an economy needs that much then that tells me this is not a real recovery, and nobody should think it’s a real recovery.
And the Fed has just kept all these excesses in debt, excesses in financial bubbles, excesses in leverage and investing, and allowed it to go on. I just saw a graph that the top 5 percent now have even a higher share of the income than they had before the last bubble burst. I mean, they’re promoting more income inequality. The wealthy are getting wealthier because they’re pushing up markets, meanwhile the everyday person is only seeing their real wages go down and job opportunities become more limited. They don’t feel a recovery, but the top people that own a lot of investments, especially stocks, sure feel better than ever.
EQ: A lot of bulls are focusing on fundamentals and pointing to those numbers as a sign of strength…
Dent: There are no fundamentals. That’s ridiculous; utterly ridiculous. Without the Fed stepping in and pouring trillions of dollars into the economy, we would have no fundamentals. We would have melted down, the banks would have gone under, businesses would have gone under, unemployment would have gone up, and we would have deflation in prices just like the 1930s. We were heading directly on a Great Depression track, and what they did was keep the bubble from bursting and the financial system from deleveraging like in the 1930s.
But that deleveraging was a great thing for the long term. So all they’ve done is what they’ve been doing, which is constantly kicking the can down the road. Now we have more debt in our economy than we had before. We have an even greater bubble in stocks than we had at the end of 2007, and on and on and on.
And if the China bubble blows, I don’t see how anybody can stop that. The Fed, the ECB, Japan--they can do whatever the hell they want, but when that China bubble blows and the rich Chinese stop spending money, and they have to sell their real estate and stop buying real estate around the world, you’re going to see problems.
EQ: So China, for the most part, is going to be the trigger that pops this bubble.
Dent: They’re the ultimate trigger. I don’t know if they’re the first to blow, although the cracks are showing increasingly over there. When you see that export growth dropped 18 percent in one month, the last time that happened was in early 2009. The crisis was bottoming and getting worse. They’ve had some smaller financial institutions blow up while they just bail them out and cover them up, but I think you’re going to keep seeing these things like a popcorn popper. There will be more and more of them and at some point the financial markets are going to lose faith in China’s financial system.
George Soros said about a year ago that China is looking like the U.S. subprime crisis, and that’s because they are. Most of their loans are now coming from private institutions doing subprime lending. It’s no longer the major banks because the governments have reigned them in.
So our big emphasis is to watch China. They keep having more cracks there. If things accelerate or the commodity prices keep going down and their exports keep slowing, then they are toast. They have bubbled up that economy so far and put it on so much steroids, there is no way to have a soft landing. Anybody who thinks there’s going to be a soft landing doesn’t understand anything about bubbles.
And by the way, Soros is short U.S. stocks right now. He just doubled down his bet not too long ago. I’m with him, but it just hasn’t quite topped yet.
EQ: Your focus has always been on demographics and long-term generational trends. Do you think the market has been getting so increasingly caught up over the last couple of decades on short-term results that they’re missing the bigger picture?
Dent: Yes, the markets don’t understand demographics. All they understand is that around the world you’ve got large aging baby boomer generations that are going to weigh on smaller numbers of young people to support them. They understand that. They understand the aging, but they don’t understand how generations cause booms and busts with their spending and their borrowing and their investments and all the other trends that we study. They just don’t get that. They’re not taught that so they don’t understand it. They don’t understand how new technologies accelerates the economy. Every several decades they’ll accelerate the mainstream for about 14 years and then they’ll mature in the cycle. We all have internet now; we all have broadband, and PCs and smartphones.
There’s always going to be improvements in technology, but the big surge was the 1990s and 2000s where everybody got internet and broadband for the first time. That creates huge new markets, and changes productivity. But getting social media on top of this now, that’s nice, but it’s not going to change the world in terms of on the productivity realm.
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