Complacency Breeds Stupidity

05.03.2018 • Australia

Vern Gowdie – Markets and Money (Australia) –

When the next crash of epic proportions hits, there’ll be a host of negatives.

Suicides. Job losses. Retirement dreams shattered. Homes lost. Marriages broken. Bank closures.

Real doom and gloom stuff.

The sort of depressing stuff no one really contemplates, let alone talks about.

As a society we’re ill-prepared for a sustained period of financial hardship.

The good times — credit funded lifes we cannot afford — have gone on for so long that we consider this as normal. I can assure you that it is not.

The piper has to be paid.

One of the positives that will emerge from this very difficult period of adjustment is going to be the gaining of wisdom.

Let me give you a couple of examples of how rational thinking has been completely abandoned.

In The Australian Financial Review on 6 February 2016, there was an article about how, in spite of the Dow’s flash crash, the outlook for shares remains positive (emphasis mine):

Global sharemarkets may have been sold off heavily this week but economic conditions remain the strongest they have been in a decade.

The S&P 500 index posted its strongest ever January performance. While United States equity market has been hit, the outlook for company earnings in the US, and many other parts of the world, are the best they have ever been. Since the global financial crisis, global macro-economic conditions have never been stronger and synchronised global growth is set to continue.

This article is not an isolated case of the ‘don’t panic, the economic outlook looks strong’ argument…it’s widespread.

‘Buy the dip’ is such a strong catch cry.

Just to recap the mainstream line of thinking…the economic outlook is strong, therefore the outlook for the share market is positive.

Got that?


This is a chart of the Nikkei 225 Index (Japanese share market):

Nikkei 225 Index 05-03-2018

Source: Federal Reserve Economic Data
[Click to enlarge]

The Japanese economy was going gangbusters during the 1980s due to the private sector’s love affair with debt.

That all ended abruptly in early 1990…in the space of a few months the Japanese share market plunged nearly 50% in value. After the initial plunge, the ‘buy the dippers’ pushed the market back up but to no avail…the piper had to be paid.

By the time it was all over the Nikkei had lost around 80% of its value.

This is an extract from Wikipedia (emphasis is mine):

The Lost Decade or the Lost 10 Years is a period of economic stagnation in Japan following the Japanese asset price bubble’s collapse in late 1991 and early 1992. The term originally referred to the years from 1991 to 2000, but recently the decade from 2001 to 2010 is often include so that the whole period is referred to as the Lost Score or the Lost 20 Years.

Note the highlighted section…the period of economic stagnation FOLLOWED the Japanese asset price bubble collapse.

Prior to the bubble collapsing, the economic outlook for Japan was ‘this year will look pretty much the same as last year’. No one saw it coming.

And just to prove the ‘share market leads the economy’ and not the other way around, here’s a chart of the S&P 500 index. The light grey shaded areas represent US recessions.

S&P 500 index 05-03-2018

Source: Macro Trends
[Click to enlarge]

Note the share market topped out and turns down, and then the recession follows.

The US share market peaked in November 2007; three months later, on 14 February 2008, CNN reported:

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson both acknowledged problems in the U.S. economy Thursday, but both said they believe the nation will avoid falling into recession.

Share markets lead the economy, NOT the other way around

If the Dow falls 30%, 40% or 50% in the coming months, all those ‘stronger’ forecasts will suddenly be replaced with ‘weaker’ ones.

This is the ‘wealth effect’ in reverse, and it works much quicker. Money and confidence are joined at the hip…lose money and you’ll lose confidence. Spending tightens up and recessions occur.

Look at the chart of the S&P 500 and see where the S&P 500 is today and you’ll note it’s already started to dip down…is this the beginning of the end?

And that takes me to the next great myth… ‘I don’t care what happens to my capital, I’ll still receive the dividends’.

Even without in-depth analysis (which I will give you shortly) this is, at best, wishful thinking, and, at worst, blatant stupidity.

If we go through a prolonged economic downturn, then surely business profitability must be affected? If companies make smaller profits, how can they maintain previous dividend policies?

It defies logic. But logic-defying thinking is what happens after a prolonged period of reality being suspended.

Here’s the analysis to back up the logic. This is an extract from an article I wrote in February 2017…

My interpretation of this [logic] is if my capital falls it is of no relevance as I am not a seller, it’s the dividends (income) that’s important to me.

On face value that appears to be a fair point. However, it’s a mindset that’s evolved from the greatest Secular Bull Market in history…an expectation of dividends continuing.

It was Edmund Burke who said, “Those who don’t know history are doomed to repeat it.

The following are the earnings of the S&P 500 for the period 1929 to 1949.

earnings of the S&P 500 for the period 1929 to 1949 05-03-2018

[Click to enlarge]

In 1929, the [S&P] index produced average earnings of US$22.60…three years later, earnings had fallen to one-third of this figure.

It took nearly 20 years for earnings to reach the US$22 level again.

When a share market suffers a fall of 80%, you can be assured there will be economic consequences. People have less money to spend. Less money going through the cash registers means less corporate profits.

If businesses are earning less, guess what happens to dividends? They are reduced or even, cancelled.

In Barrie A Wigmore’s rather lengthy book The Crash and Its Aftermath: A History of Securities Markets in the United States, 1929-1933 there’s a treasure trove of data on what happened to shares during the Great Depression.

Here’s a selection of blue chip companies and the level of fall suffered from 1929 to 1933 and dividend being paid in 1933.

Company % fall from 1929 high % dividend paid in 1933
Coca-Cola 57% 7.79%
Sears Roebuck 93% No dividend paid
Colgate-Palmolive 92% No dividend paid
Gillette 95% 13.77%
B.F Goodrich 94% No dividend paid
Union Pacific 80% 9.84%
AT&T 82% 10.34%

There was some serious carnage to capital values. Not sure about you, but personally I would be affected by losses of this magnitude.

But let’s put the psychological impact of capital losses to one side and focus on the dividends.

You could say that the higher yields being paid by some — not all — the companies are proof that “if you sit tight and receive the income, that in time all will be OK.”

Nothing in markets is what it seems at first sight.

Let’s look at the highest payer — Gillette. From 1929 to 1933, Gillette fell 95% in value and was paying 14% (for round figures in 1933).

To keep this exercise simple, we’ll work in whole numbers.

Company Share Price Dividend % Dollar amount
of dividend
1929 $100 4% $4.00
1933 $5 14% $0.70

An investor who believed that irrespective of capital values that “dividends would continue apace” was receiving a 70 cent dividend in 1933 on their 1929 $100…an income return of 0.7% per annum.

Not only have you suffered a 95% reduction in capital, your income has fallen over 80% [from $4 per share in 1929 to $0.70 in 1933].

Whereas the investor who waited patiently in cash would be buying 20 shares for the price of one AND receiving a 14% income.

When the inevitable recovery does come, they have 20 times the number of shares taking that upward ride. In the meantime, they’re being paid 14% for their troubles.

Sounds a whole lot better to me than the alternative.

Granted, this is an extreme…but the fact is, it did happen.

Can it happen again?

In my opinion, the answer to that question is ‘Yes’.

I think we are on the cusp of a Greater Depression.

No one is expecting it. No one is talking about it.

They are all looking the other way…believing the economy leads the share market and that dividends can be maintained even if the world goes to mud.

Markets have never been higher. Debt levels have never been higher. The use of derivatives has never been greater.

Complacency levels are at all-time highs. And rational thinking is at an all-time low.

These are the perfect conditions for a market collapse.


Vern Gowdie,
Editor, The Gowdie Letter

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