Monday, September 6, 2010

Harry Dent's Outlook On Demographics, Debt, And Deflation

¹²Exclusive Interview: Harry Dent's Outlook On Demographics, Debt, And Deflation

By Brett Owens | 3 September 2010

The demographic trend expert and economic researcher expects a major bottom in the stock market sometime around 2012 that will take out previous lows.

This morning I had the fortunate opportunity to speak with demographic trend expert and economic researcher Harry S. Dent. It was a great conversation and we covered a lot of topics, including the demographic outlook in America, the inflation/deflation argument, potential inflection points for the stock market based on spending wave turning points, and more. I took copious notes, and I've been following Dent's research for a bit now, so here's a very detailed summary of our interview, and some topical background info in case you're new to his brand of demographic analysis.

Harry Dent's Previous Successful Bull Market And Depression Predictions

Beginning in the late 1980s, Dent began touting a bull market in US stocks that would go higher and further than most believed. He reiterated that call in 1992— a time when many analysts were very bearish (hard to believe in hindsight, but true— many bestselling investing book titles from the early '90s were doom and gloom). Impressively, he stayed bullish during the early to mid 2000s— again a time when many (including me) thought the stock market bubble had burst once and for all. Dent's analysis told him that there was one big last gasp for the party, thanks to boomer spending hitting its peak.

He did have some very high price targets on the Dow that weren't hit— some folks are a bit down on him for this, but I think that's missing the point of his research. Longer-term index-price predictions are very difficult. I'm more concerned with accurately predicting the direction of the trend— and he's been quite spot-on in this regard.

Dent's longer-term warning alongside these bullish predictions, though, has always been that another Great Depression would follow the boom of the '90s and '00s, sometime from 2007-09. Now, right on schedule, we're on the other side of the boom/bust peak— and into our current depression. As you can see from the chart below, consumer spending peaked in 2008, and is heading downward. According to Dent's research, this trend should be in play for some time. Why? Glad you asked.

How Demographics Drive Spending Trends (and Hence, Stock Prices)

Dent's research shows that human spending habits follow very predictable patterns throughout the human life cycle. Individuals typically hit their peak spending between the ages of 46 to 50 (see graph below). These spending waves drive the economy, as well as stock prices. In the US, as you can see, there's been a very tight correlation between family spending, and stock prices.

Peak spending rolled over for the first time in 2007— and the stock market rolled with it. If the economy continues to follow the spending wave, we're in for another lean 12 years, as the next peak spending pickup isn't scheduled until 2022 [[that's also about right on target for the 80-year market cycle— so start saving now in order to invest ahead of that anticipated big market surge of the 2020s: normxxx]]! This is due to the fact that baby boomers are now past peak spending— and we've got over a decade until the next "baby boomlet" hits peak spending stride.

Why Government Stimulus Spending Isn't Working This Time

For the first time in American history, government stimulus is falling flat on its face. It's starting to become apparent that the record stimulus being thrown at our economy isn't going to pull us out of this recession/depression. Why? Because, according to Dent's research, for the first time ever, we don't have favorable demographic winds at our back.

During previous recessions, the government could float easy money out into the economy, and eager consumers would grab it and spend it— because they were in the upswings in their spending patterns. But this time, Bernanke & Co are merely pushing on a proverbial string. The Fed can extend credit, but they can't force the consumer to take it!

They can't get the baby boomers to take on more debt because of where they are in the spending cycle. It's a time to save, not spend, in their lives. Want a mortgage at record low rates? No thanks— we're already choking on debt! And we hope to retire someday.

Hence, the Keynsian solution that "worked" (quotes for you Austrian econ fans) so well during the 20th century is shooting blanks here in our 2008-2010 and counting depression. Hmm, this is starting to sound like another advanced economy that's been stuck in the mud for a couple of decades now. And, also because of demographics?

Japan's Spending Wave Peaked In Tandem With Its Bubble

Dent's team accurately forecast the current soft depression in Japan in the late 1980s, at a time when the world was wildly bullish on Japan's future. The secret was, again, the spending wave— Japan's baby boom reached peak spending in 1990, and it's been downhill ever since for Japanese stocks and real estate. Since 1990, the Japanese economy has been fueled by government stimulus, and only government stimulus.

Click Here, or on the image, to see a larger, undistorted image.

Like a drug addict, as soon as the high of government spending wears off, the economy again slumps into recession. The same appears to be happening here in the US, as our initial stimulus begins to wear off. And we don't have much to show for it— except for a lot more sovereign debt, of course.

So Will It Be Inflation Or Deflation?

Dent cites the massive amount of private debt (estimated to be $50-100 trillion or higher) as a large pool of credit that's going to have a significant chunk written down (his debt deflation scenario is similar to Robert Prechter's in this regard, though less extreme). As this massive amount of bad debt floats away to "money heaven," the forces of deflation will overwhelm any amount of potential government stimulus, Dent believes. Also, with the US citizenry already quite ticked that the last stimulus didn't do much of anything, the Federal government's hands may be increasingly tied by voters calling for 'austerity' measures (or, at least, more responsible government spending).

Return Of The Bond Vigilantes?

"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."
— James Carville, political advisor to President Clinton

Even if Joe Sixpack doesn't rise up, Dent anticipates a far more powerful force will ultimately check the government's ebullient spending— the bond market. During the last wave down, the bond market benefited as a "flight to safety play". Dent doesn't see that repeating next time— instead, he sees concerns over government debt as being a cue for the "bond vigilantes" to ride back onto American soil and enforce some level of fiscal sanity— likely when the next stimulus package is floated out there.

He cites the speed at which the vigilantes can mobilize and drive up the rates on government debt— like the quick spike in Greek interest rates this spring— as an example of how fast spreads can skyrocket. Overall, his team is projecting a potential 2% rise in 10-year yields— which would push the 10-year yield up from 2.5% to 4.5%. Think the housing market is in trouble now? Imagine a 2% bump in mortgage rates!

Deflation Investing Strategies

"Cash is king" is Dent's mantra today— specifically US dollars. Why dollars? Because the supply of dollars is going to continue to contract as debt continues to contract— and it will contract at a much faster rate than the Fed can potentially create it.

The US dollar isn't going to crash— it's already crashed, says Dent. A 60% drop since 1985 is a huge move in the currency markets. Now, the deflationary period ahead will serve its purpose of restoring the value of the dollar, which is still the unchallenged world reserve currency. He also likes bonds, but not just yet.

He thinks the time to buy will be if and when the bond vigilantes ride into town and bring yields up to 4.5% or so. That would be a compelling buy, that could yield 5-6% per year overall, when factoring in his subsequently anticipated bond price appreciation. Dent forecasts that yields would then slump slowly for a long period of time— à la Japan.

Making Sense Of Today's Schizophrenic Markets

While Dent's demographic forecasting models have been extremely accurate in forecasting long-term economic trends, he readily admits that the immediate short term is often much more difficult to predict. And that's never been more true than it is now, as many experts are scrambling for a clue. This economic and investing environment is truly a once-in-a-lifetime event.

How To Manage Your Life During Deflation

In your personal life, Dent similarly believes that cash flow is king during this deflationary depression. If you run a business, he recommends you cut all unnecessary expenses, and work to maximize your cash flow and efficiency. Thinking of buying a home? You may want to wait until at least 2012 or 2013, as mortgage rate resets are set to continue through 2011. Given a one-year lag on price declines, and we won't see a housing market bottom until 2012 at the earliest.

In the meantime, your cash will increase in value, possibly quite significantly (see Nikkei chart above!) and you'll be able to get much more house for your buck if you sit tight and wait (also see my Renter's Manifesto for an admittedly biased rent-versus-buy rant)!

Countries With The Most Favorable Demographics

Out of the world's major countries, Dent likes India's demographics the best. China doesn't compare as favorably due to their baby nightmare "one child per family" policy. He thinks China will get old before it gets rich, and that per capita, their wealth will never reach that of the current US.

Looking at emerging markets, Dent loves the promise of Southeast Asia, and Vietnam in particular. He's also intrigued by the Middle East and sees opportunity there, provided— politically speaking— the area is able to keep it together (a big if, for sure!) Investing abroad will be very important for Americans after the current crash is worked out, he believes, because the cherry days of investing in America are over. While sectors such as health care may perform well as the US wheels itself into the nursing home, history has shown that the most compelling investment opportunities are often found in countries that are roaring up Dent's spending wave curve.

Summing It Up— Big-Picture Forecast

Dent expects a major bottom in the stock market sometime around 2012. He thinks that the previous lows will likely be taken out, with the market falling significantly once again (Dow anywhere from 3800-6440). If that happens, you obviously don't want to be in stocks.

Between now and then, he's allowing for another potential rally [[the Presidential rally?: normxxx]] that could set new highs in the market, and carry all the way into next year. That's not required, though, as he thinks it's possible the stock market rolls over sooner as people come to the realization that the economy isn't actually improving. Bottom line: He sees very little upside to stocks at this juncture, and a lot of potential downside.

Following the epic 2012 bottom, Dent says we could see a bear market rally as long as five years [[our next/last cyclical bull within the ongoing secular bear?: normxxx]], eventually giving way to another gentle slump that would take us up to the next spending wave uptick in 2022. Dent, like David Rosenberg, believes that ultimately, austerity measures will win out in America. It will be a painful 10-plus years, but this is what the [[Kondratief?: normxxx]] "winter" season is for, as Dent refers to it: to clean out the excesses of bubbles past, and prepare for "spring," a new season of growth.

It's not the end of the world— you can come out of this financially fine, and even ahead of the curve, if you're smart about navigating these deflationary waters. [[But I would also beware of bursts of inflation during this period— the next 10-12 years— and, more prolonged, further down the road: normxxx]]

Click Here, or on the image, to see a larger, undistorted image.



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