February/March 2019 - Introduction -

Last month`s newsletter was incredibly hard to write. On both a fundamental and technical level the US markets made no sense whatsoever. Now that March is almost coming to an end, and numbers are starting to come out about the economic activity in the last quarter of 2018 and first months of 2019, things start to make sense again.

When I talk about “making sense” I don`t mean to say that the market became rational. Not at all. But I did finally find proof that the market was still being irrational, which can often be worth just as much. Let`s say Christmas sales did go through the roof, let`s say the tariffs on China did decrease the trade deficits, let`s say that the other major economies were picking up steam and pulling the U.S. along. Then the markets would have a valid reason to go up!
Unfortunately for Mr. Market, the data was looking bleak. Germany has dodged an official recession by 0.1%, Italy`s economy went down the drain, trade deficits with China went up even more, Industrial production in Spain went down, Singapore`s exports crashed, and so forth.
As I described last month, we saw a technically driven move in December, a headline driven move in January/February, and now we are on to the next part of this bear market, which is pure fundamentals. There used to be a time when markets were at least 6 months ahead of the economy, but it seems like lately the market is just trying to keep a blind eye as long as it possibly can.
So here we are, at the brink of recession in many developed countries worldwide, despite continuous heavy financial support by central banks. These central banks have done everything in their power to make the great recession of 2008 disappear, without fixing the underlying issues. They have used every single tool in their toolbox, without realizing that once the next inevitable economic cycle starts turning, there will be no more tools left to dampen it, or better yet, fix it.
It is human nature to prefer short term gains leading to long term pain, even though the opposite, short term pain leading to long term gains, is much more beneficial. This is true for both health and wealth. 

The Behavioural economist Daniel Kahneman would call the side of you that picks the short term gain the “system 1”, or the fast, reactive thinker, and the side of you that picks the long term gains the “system 2” or the slow, proactive thinker.
Interestingly, central banks don`t seem to be behaving any differently. They have been brought to life to counteract economic recessions by spending when the economy goes down and tightening when the economy is overheating. But the past 30 years, or since Alan Greenspan took the reins at the federal reserve, it seems like it has only been spending, without thinking about future consequences.
Personally, I think that it`s not a matter of wanting to spend, but more a matter of not having any other alternative. As you know, I like to zoom out and look at the bigger picture, and it shows me that the main culprit is the population growth.
Our system has been made in a way that we continuously borrow from future gains, knowing that the future will always look brighter than today. The future has always looked brighter for the next generation, for centuries in a row. Hence it has been engrained not only on the individual level, but also on the institutional level, that we can borrow our way out, no matter the financial mistakes we make. I see two main fallacies in this assumption. The first fallacy is the expectation that the (world) population keeps on growing. The second fallacy is the expectation that productivity keeps on growing.

Population growth means that there will be more consumption in the future, while productivity growth guarantees us that increasing demand is covered by the same amount of labour and tools.
The western populations have stopped growing, and it has now been for the first time ever that there are more people over 65 years old than people under 5 years old. In the first world countries,  birth rates are reaching all-time lows, which can`t be covered by the increase in life expectancy. In third world countries the populations are still growing, but the birth rates are already stagnating.
This means that the adage “borrowing from the future because the future always looks brighter”, will most likely end soon. We have never had a time in history when the world population started stagnating, even during times like the plague or world wars.
It`s much more difficult to measure productivity growth over the past centuries, although you will most likely agree that the industrial revolution that started in 1760, will never be surpassed when it comes to percentage increases.

Productivity growth can be divided into two sections; automation and education. While I do see continuous growth in automation (if I would bet against human ingenuity, I might as well quit), I think that we have reached a peak in education. Ask yourself this: what percentage of your childhood classmates is not working in the services industry right now? And what percentage does not have a diploma or a degree? Most likely the answer lies around the 10% mark. Everyone is aiming to get at least a bachelor`s degree, everyone`s aiming to get a nice job behind a computer, and everyone`s loading up on student debt. As weird and perhaps far-fetched as this might sound, I think we might have reached “peak education”. If everyone has a bachelor`s degree, then what is that degree still worth? If we are going to let machines do all our work in the future, then who is there to build these machines?

With this in mind, I think the central banks damn well know that we are reaching the end of the “borrow from the future” game and instead of biting the bullet and create short term pain which might result in long term gains, they just kick the can down the road and try to avoid the inevitable long term pain as long as they can. What would this short-term pain look like? One word, deleveraging. Governments, businesses and individuals need to start lowering their debt to income ratios by spending less and stop borrowing from future returns.  When a government starts deleveraging, it hurts their citizens in their pockets. Citizens start to revolt (because “my neighbour should tighten his belt, but i`m damn sure not going to tighten my own”) and populism rises.
How long can we kick the can further down the road until short term gains also equal short-term pain? At what point does printing another Dollar just make no more difference? 
This is the main question that i`ve been trying to explore, and it seems that it will take a lot more research to figure out how long it can actually take. If it`s up to the believers of the Modern Monetary Theory (MMT), we should be kicking the can down the road into infinity, as long as countries borrow in the currency that they themselves can print. I think that MMT is a great example of my “peak education” theory; If everyone`s smart, then nobody`s smart, and if nobody`s smart, then weird theories could suddenly become mainstream.

Enjoy the ride, and don`t forget to stay positive after reading this newsletter, this too shall pass!

Robbert-John Sjollema

The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.