"Debt drains away vital resources from economic growth. Fighting a debt crisis with more debt is doomed to failure, yet that is not only what global central banks did during the crisis but long after markets stabilized (though the crisis never truly ended, just slowed). This was an epic policy failure that continues today."
-- Michael Lewitt, The Credit Strategist
Two questions come to mind as we mark the eighth anniversary today of the Great Recession's official end. First, how much further will the current recovery take us? And second, how severe will the contraction be once this recovery ends?
I certainly can't predict the future, but I believe that we can find answers to the above questions by looking at the recovery's fundamental core. What has driven this eight-year expansion, and how will that impact the future?
Well, Brian Barnier of Valuebridge Advisors (among others) has demonstrated a 93% correlation between the market's growth over the past eight years and the amount of money created by the Federal Reserve's many expansion programs. This correlation can lead us to only one conclusion -- when central-bank monetary expansion stops, so will the current bull market. Paraphrasing a slogan from the recent past: "It's the debt, stupid!"
With that in mind, let's look in greater detail at our two questions above:
How Much Further Will This Recovery Take Us?
The answer to this question lies first in determining how willing global central bankers are to keep piling on debt with their many initiatives, from printing money out of thin air to manipulating interest rates. We then need to see how the investing public reacts to these programs.
Well, with the Federal Reserve beginning a policy of rate increases and telegraphing that it might begin to shrink its balance sheet, the era of easy money could be ending. The central bank is going to see if the U.S. economy can run on its own.
Think of a child learning how to ride a bike. The parent runs alongside of the child, holding on and balancing the bike until mom or dad finally lets go. The child then either stays up or crashes.
In this case, the Fed is beginning to remove its support to the U.S. economy, and we'll see very soon if things move forward ... or crash.
How Severe Will the Next Recession Be?
How bad a contraction we eventually face will be directly proportional to the size of the expansion/bubble that markets created through malinvestment over recent years.
By contrast, any productive investment over recent years will serve as the rock upon which the contraction will settle and a new expansion will spring forth.
Unfortunately, I believe the next contraction's size will be quite severe, thanks to the extreme leverage and excesses that we've built into the system. After all, government intervention truncated the past several contractions.
Now, many people view those interventions as essential and successful. But it's my view that we never really corrected the system's inefficiencies, so the eventual next correction will be more painful and severe than anything we've endured to date.
How to Play the Next Recession
How does the individual investor or saver prepare for the inevitable?
First, use your common sense. Don't chase what's already expanded greatly in value.
In other words, buy low and sell high. Find those assets that are undervalued. Precious metals may be a great place to start.
As my good friend and fellow columnist Stephen "Sarge" Guilfoyle always says:"Stay disciplined in your approach and the results will be there for you."
How should you prepare for the next recession, and how should you play the markets in June? Check out our special June Trading Strategies report for answers, including our columnists' take on:
Editors' pick: Originally published June 2.