After the Second World War, the U.S. was — to put it politely — in a very fortunate situation. Our major industrial and manufacturing competitors were in ruins, and needed to rebuild. They needed materials with which to rebuild. During the war, the U.S. had harnessed all of its industrial might to support the war effort, and soon was able to shift many war material manufacturing plants to industrial uses. We made steel, aluminum, copper, and iron products. The U.S. made cars, trucks and airplanes, and built an interstate highway system to tie it all together. Air travel began for the wealthy, and Americans began to travel extensively within their own country for the first time.
As a result, American industrial products became well-known worldwide (and they developed recognized brand names) and we were ushered into new markets for our consumer goods as well. Exports of cigarettes, soft drinks, grain, meats, vegetables, forest products, shipping containers, railroad locomotives, autos and trucks, turbines and electrical equipment, transport ships, military products and many other industrial products were all part of the initial boom.
The Rise of Stocks
After the war, many expected the U.S. to return to the Great Depression, but a national plan to educate former soldiers and to help them buy homes changed all of that. The U.S. became a major industrial, commercial, and consumer powerhouse. In the period between 1950 and 2000, the U.S. endured some difficult periods, but in general the economy grew to become the world’s largest and most impressive.
[Hear More: Doug Noland on the Granddaddy of All Super Bubbles, the Global Sovereign Bond Market]
The Beginning of the Bubbles
By 2000, many excesses had occurred in the stock market. The internet revolution and the technology boom had given way to a bubble in many technology stocks, as people bought them blindly, completely disregarding the normal analytical framework for valuing stocks. Worthless companies reached stratospheric valuations. We here at Guild Investment did not participate in this madness, and even shorted tech stocks for those clients who would engage in short selling... The bear market of 2000 to 2003 destroyed the value of many technology stocks, and was the first phase of the purification process. It was the bursting of the tech stock bubble.
...Then Came the Real Estate Bubble and the European Debt Crisis
In 2006, we began to warn of the second bubble that would burst, and that would be a bubble in real estate finance and home-ownership. We believed that it was going to occur because many who could not make the payments to purchase a home were nevertheless lent money to purchase. We all know that in 2008, a crash in U.S. real estate and real-estate bonds led to a crisis that strongly undermined the strength of the U.S. banking system. The crash was handled by bailouts and multiple rounds of quantitative easing (QE). In the ensuing years many new regulations have been implemented to diminish speculation by big banks. Big banks raised substantial capital and are now more rationally capitalized. However, banking regulators must resist the pressure of lobbyists and implement all regulations effectively.
By 2010, a third bubble was bursting as a major crisis hit sovereign nations in Europe, and the European banking system became seriously compromised when Greece, Portugal, Spain and other nations had problems repaying sovereign debt. The crash was handled by the implementation of many strong measures, including refinancing debt, bailouts, and further rounds of QE by the U.K., U.S., Japan, China, and many other countries. Japan and Switzerland went so far as to purchase common stocks in their national stock markets to stimulate stock market demand and raise the price of assets to avoid deflation. While Asian banks are well capitalized, European banks have to raise enough new money to be stable. We believe that Europe should move aggressively to recapitalize their banking system.
The Next Bubble and Why Owning Stocks Is a Way to Benefit
Today, the fourth bubble is on the horizon and will burst within a few years. This bubble will come from overleverage in municipal and junk bonds. While the balance-sheets of high-quality companies in the U.S. are very strong, the balance sheets of lesser-quality companies in some industries are far too extended with levered debt (junk bonds).
Simultaneously, an even bigger problem is facing U.S. municipalities and states. States and municipalities in the U.S. are dangerously over-extended. They have promised public employees more than they can ever hope to pay in the form of salaries and retirement benefits.
They will have to do one of three things:
- Renege on many of their promises to public employees;
- Go bankrupt, cut services, and hurt their bond holders;
- Or ask the Federal government to come in and bail them out.
We feel certain that both the state and municipal finance problem, and the excess debt of levered corporations, will emerge as problems in the next few years.
Stock Ownership Will Be an Important Method to Grow and to Protect Your Capital
Knowing this, how can we act to protect our capital and to grow our assets?
Clearly government will be called upon once again to bail out the states and municipalities, and that the levered corporations will be allowed to fail.
Our strategy: own stocks, not bonds.
- We have been bearish on bonds for some time — and world bond yields have risen, causing bonds to fall in price.
- Do not own low-quality debt of levered corporations — for obvious reasons.
- Do not own municipal debt of weak states and municipalities — also for obvious reasons.
After a period of panic, and fears that a depression will ensue, further QE will be implemented; however, everyone knows that repeated QE is losing its effectiveness and deflation remains a risk...
At a point soon after the risk of deflation is realized, we expect the Federal government to apply the technique that both Switzerland and Japan have used to stimulate optimism and raise asset prices in their countries. The U.S. Federal Reserve or the U.S. Treasury will buy common stocks. The purpose will be to encourage people to support the stronger companies that will grow, provide jobs, and boost overall economic growth for the nation. If the government has a socialist bent, then we will also see increased transfer payments.
To get the economy moving, we believe that the U.S. government will encourage the ownership of stocks. The purpose will be to help finance the growth of companies which will employ more people and will produce exports — to spur economic growth for the U.S. and for the interrelated world economy.
Until the crisis hits, be sure to keep invested in growing companies. You will benefit from the flow of liquidity that has been pumped into the world stock markets. We continue to favor the U.S., Europe, and Japan.
Therefore as investors, we plan first, to watch carefully for a collapse of the coming bubble; second, to exit the markets if it starts to occur; and third, once it has occurred, to take advantage of low prices to own stocks of two types:
- Fast-growing high-tech companies in technology, medical, consumer, industrial, and foreign categories.
- Solid, well-managed large companies who can withstand a crisis in municipal finance because of their long-term and efficient growth prospects, their brand names, and their established market-share characteristics.
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