US Asset Markets – A Long View
“The farther backward you can look, the farther forward you can see.”
Winston Churchill
The way in which the Covid-19 crisis has impacted the world may not have been seen in living memory. The suspension of large parts of economies has impacted millions of people and governments around the world. In the depths of a crisis, concern can quickly turn to nervousness and then fear, not only of one’s health today but also on the outlook of the future. Under such conditions, it is almost natural to have a more cautious, doubtful, and increasingly gloomy view of the time ahead.
However, even though it may not be exactly the same, the world before our time had seen something similar. Economic lockdown imposed by Governments may not have been a feature of the past, however pandemics, abnormal death rates, shocks to the system, rapid rises in unemployment, and unexpected economic swings are not new.
Looking Back to see Forward
Readers of economic history and market cycles would be aware of the 16-18-year cycle in land/real estate, particularly in the United States. To highlight recent history, the last housing peak was in 2006. Prior to that was 1989-1990 and before that was 1973. These real estate or land price led downturns are typically more severe than other downturns and come with similar features like huge indebtedness, banks and lenders going bust and, very often, fraudulent activity.
If we go back in history even further, the same was happening 100+ years ago. A high in public land sales in 1888 lead to a panic in 1893 and a major depression throughout that decade which saw unemployment consistently above 10%. Less than 20 years later the country was hit again by banking panic and another peak in land in 1907-1908. Shortly after that the Federal Reserve was set up in 1913. Then there was the Great War (First World War) from 1914 which ended at the same time the Spanish Influenza hit in 1918.
The Spanish Influenza killed more people than the war itself. It is estimated that some 500 million people were infected, about a third of the world’s population at the time, and 50 million people died. There was more than one wave that hit the populations, and the way in which people were dying was terrifying.
Why Spanish Influenza and Covid-19 can be compared is because they both hit at similar points in the 16-18-year cycle in land/real estate which has a direct impact on the economy. In economic and market terms, there are more similarities than one would think. More surprisingly, what this comparison shows is that the current downturn, while severe, may not lead to a long-lasting depression but instead a major bull run that could last into the mid 2020’s, particularly in real estate.
The Great War and Spanish Influenza
The environment just over 100 years ago was arguably worse than today, especially in Europe which was at war from 1914. In the United States, there was so much concern about the impact of War that in 1914 exchanges were closed from the end of July until end of November. It was thought that the depreciation of investment securities will doubtless lead to many bankruptcies, if not a general crisis. However, it was not until after the war, 1918, when troubles began for the US. During the war, the American economy benefited by winning contracts to supply agriculture and machinery to Europe. The end of the war saw the absence or reversal of such demand. Simultaneously, the Spanish Influenza pandemic came about, which killed even more people than the war. Approximately 500 – 750 thousand people in the US died from this influenza and even more in Europe and Asia. A similar ratio today would put the death numbers around 1.6m in the US which is roughly 17 times the current toll. A major market and economic downturn hit between 1919-1921.
Source: Bloomberg, Aspen Graphics
The stock market was down by just under a half from Nov 1919 and Aug 1921. There was a credit panic with market rates rising well above the Fed’s discount rate. Unemployment in the United States shot up above 10% (Perhaps more than double that number according to some sources). Prices fell as did wages. Worse still were the conservative policies of the time. The Fed actually hiked in 1920.
The post War & Spanish influenza recession of 1920-1921 was deep, but it did not turn into a depression. The conditions evolving in its aftermath were key
- Interest Rates – The Fed cut rates from 7% in 1921 (a very high rate that was not seen again until the 1970’s). Interest rates were cut progressively down to 3% by 1924.
- Credit spreads narrowed
- Taxation:
- Reduction in the top rate of tax from 73% to 58% in 1922 (reduced further to 46% in 1924 and 25% in 1925)
- Capital gains tax at 12.5% instead of the rate of income tax (1922)
- Corporate tax rates reduced to single digits.
The result? A boom.
The Dow was already partly recovering after the 1921 low which is when the Fed started cutting from an interest rate of 7%. By 1924, when rates had fallen to 3%, it completely regained the 1919 high. It then continued a steeper trajectory.
Source: Bloomberg, Aspen Graphics, Federal Reserve Bank of St. Louis.
The roaring ‘20’s had arrived. A decade that started with a major downturn, a loss of half a percent of the population due to a pandemic, high unemployment and falling wages was, before the middle of the decade, changing rapidly. The central asset market boom was real estate.
The price of urban land doubled between 1920 and 1926. A lot of commentary regarding this period focuses on Florida which was promoted as a vacation destination for Americans. However, it turns out the boom was nation-wide. With the assistance of automobiles, people could live further out of city centres so property boomed all round. There is even talk of similar outcomes today if working from home becomes more popular or necessary. There was a lot of development in Manhattan during this time which had become the money capital of the world. Developers and tycoons were keen to build the world’s tallest buildings. What fuelled it? Cheap credit.
The Boom of the 1920’s lasted many years though ultimately ended abruptly in 1929. Lenders were hit with a double whammy – falling land and real estate as well as over extended lending on securities which all declined after the 1929 stock market crash. Bank runs were common, and a depression followed. The 1929 stock market high on the Dow Jones Industrial Average was not seen again for 25 years.
Where are we today in this timeline?
Today we are hit with another pandemic that has come at a time of some economic instability. However, the economic conditions of the day are not necessarily so bad as to expect a depression. There is no real estate bubble to talk of, just as there was not one at the time of the Spanish Influenza. Excess mortgages or lending by banks to households chasing higher property prices is not a current day feature. Consequently, we do not see major bank runs and should not expect a major debt overhang for many people to deal with.
The Federal Reserve and other Central Banks have been quick and bold this year – far quicker than 100 years ago after the Spanish Influenza, as the charts show. Similarly, today government finances have moved to support the economy. This is much more aggressive than what occurred 100 years ago when federal spending declined from $6.3 billion in 1920 to $3.3 billion in 1922.
Focus today is squarely on trying to manage through the pandemic and supporting the labour market. This quick action and enormous liquidity provision have already supported equities. The increase money supply is also why Gold, the hard currency, is up.
It is the hard assets that will do well at a time like this. Gold has already benefitted leaving Silver to catch up and perhaps outperform. Both should rise. The other major asset is real estate. The money being printed must go somewhere, especially when bonds yield so little. The money will move through the banks which will soon be actively encouraged to push out credit.
The former Chancellor of the Exchequer in London, Sajid Javid, wrote on May 9th
“I’m confident in the stability of our banking system. But as we seek to bounce back from this crisis, we need more than stability – we need our banks to stand tall and lend, particularly to SMEs…
…HM Treasury and Bank of England have done a lot to support lending but may need to go further with banks, including looking at forced capital raising and good bank/bad bank structures. The last economic crisis started with the banks. Now we need banks to help end this one.”
Expect more of this push over the coming months. Also look out for any tax incentives for construction and housing related activities and/or matters in the agricultural industry. What will also be important is the development of the yield curve. Unless the Fed is going to negative interest rates it is difficult to engineer a bull steepening of the curve now. There is no view here on their policy stance, though a little bear steepening over time might also do the trick in incentivizing banks to lend long. The emerging policy of underwriting business loans by some governments is not a permanent solution and is open to abuse, which readers of the Savings & Loans Crisis should be aware of.
Today, undoubtedly there is hardship in the near term. There is a recession here and now in perhaps every country. However, the conditions for a long-lasting depression which have normally come about from earlier booms, asset price bubbles, and significantly high debt levels are not in place even if Covid-19 is a shock. Financial institutions also do not seem particularly vulnerable like they normally are after the end of a boom. Instead the conditions are being laid now for the next swing up – a rise in real estate that should last until 2024-2025, about 18 years after the last peak. This is also the time to note that it is often the latter parts of the cycle that see the steepest price rises.
SKA
Footnote: If this timeline is correct then it forces the question about whether it will lead to a bust like the 1930’s in years to come or will it be smaller? That will depend on how the next few years shape out. There are arguments to be made for either – perhaps the last downturn after the subprime crisis was too large to now create a mega boom again in the 2020’s. Or perhaps the amount of Money supply is just too large that we are living in a world where monetary conditions create major swings in assets prices that move well beyond even excitable measures of value thereby leaving them to fall violently when the steam runs out. Time will reveal more but the outlook today for the next few years is not as bleak as one would think.