January 9, 2021
This newsletter provides some historical context about the Great Depression, goes into detail about the current economic situation in terms of how it relates to that depression, and gives an overview of recent portfolio changes and ways I’m continuing to position for the macro environment.
The Great Depression (1930s)
The Great Depression of the 1930s was one of the hardest times in American history, and it had a profound impact on fiscal and monetary policy for the next century thereafter.
Leading up to the 1929 economic crash, substantial financial leverage piled up in the system. When it came crashing down in the 1930s, it brought the banking system down with it. Unlike 2008, however, there was no immediate bail-out, so outright deflation occurred. The broad money supply (M2) contracted by 30% as thousands of banks went bust, with no FDIC insurance for depositors.
During that time, the unemployment rate was in the mid-teens for a decade straight, and reached a peak rate of 20-25% during a four-year period from 1932 through 1935. Brutal.
On top of that, the world engaged in a trade war. The US passed the Smoot-Hawley Tariff Act in 1930 to raise tariffs on thousand of imported goods. By 1934, with a new government, this trade situation was reversed, but it wasn’t until post-WWII that globalization fully opened back up.
As a final rotten cherry on top, improper farming techniques combined with a period of droughts in the United States led to the Dust Bowl during the 1930s. Farming became impossible in key parts of the country and massive clouds of dust rampaged the landscape, devastating farmers and forcing millions of people, in extreme poverty, to migrate cross-country in search of better opportunities.
“Dumpster fire”, I believe, is the correct economic term to describe this combination of problems.
The Hindsight Depression (2010s)
Alternative financial media often speculates about what would happen if the US were to encounter another major depression: something as terrible and long-lasting as the Great Depression.
However, the unfortunate truth is that by many metrics, the US and much of the rest of the world have already been in a mild depression for the past 12 years, ever since the 2008 global financial crisis. It’s just not as obvious as the 1930s depression, because higher levels of technology and anti-deflationary monetary policy disguised it in a nominal sense.
Images of millions of people unemployed and hungry, with droughts and clouds of dust blotting the landscape, are what we imagine a depression to look like. And in certain developing countries, that’s still what a depression can look like.
But in a 21st century developed economy, assuming no total economic collapse or raging environmental disaster happens, a depression doesn’t necessarily need to be that over-the-top.
A depression is characterized by a sustained downturn in economic activity, often with a major banking crises occurring as well. Advanced technology can disguise its effects, mitigating them in some ways, and the soaring values of tech stocks can conceal the economic rot under the surface.
Another way to put it, is that if you had to go through a depression in the 1930s or the 2010s, it’s preferable to do it in the 2010s, when technology is way better.
And yet, when assessing the macroeconomic landscape and thinking about overall asset allocation, it helps to contextualize the fact that, if we strip away the high-tech veneer, we’ve been in a twelve-year mild depression in the United States. This also holds true for large swaths of the world including Europe, Japan, and Latin America.
This depression was due to a series of events including the bursting of a long-term debt cycle in the United States, Japan, and Europe, followed by a strong dollar period and a gradual breakdown in the functioning of the global monetary system. We haven’t had a true global economic “boom” in over a decade, and are facing a demographics shift.
The Long-Term Debt Cycle
This is a chart of total debt as a percentage of the GDP over the past 100 years for the United States, along with short-term interest rates:
And here’s a chart that shows federal debt held by the public as a percentage of GDP and nonfederal debt as a percentage of GDP as separate items, showing the one-two punch of a private debt bubble and a public debt bubble about a decade apart that characterizes the peak of a long-term debt cycle:
A comparison I’ve made a number of times over the past year is that in many ways the 2010s were a lot like the 1930s, and the 2020s are shaping up to be a lot like the 1940s, in terms of monetary and fiscal policy.
1930s: Private Debt Bubble, Banking Crisis, Disinflation
After the 1929 peak, a recession and major asset price collapse began. In the 1930s, total debt as a percentage of money supply and GDP peaked, but it was primarily a private debt bubble. Federal debt as a percentage of GDP was pretty low, while private debt was extremely high. This massive crisis and deleveraging event resulted in a banking crisis and the biggest economic contraction in US history. Banks were recapitalized with a number of mechanisms including the devaluation of the gold peg. The first few years were sharply deflationary, but then the dollar devaluation and bank recapitalization turned it into a mildly reflationary environment, and the overall decade saw relatively low inflation.
1940s: Federal Debt Bubble, Wartime MMT, Inflation
By the 1940s, private debt had gone down considerably as a percentage of GDP due to a combination of deleveraging and expansion of the money supply, but due to World War II, federal debt skyrocketed. This era of wartime finance was inflationary due to massive spending and industrialization, with peak federal deficits exceeding 30% of GDP. However, the Federal Reserve used yield curve control (which was basically quantitative easing; creating dollars to buy Treasuries as needed) to peg Treasury bond yields below 2.5% despite double-digit inflation. I’ve described this period as “wartime MMT” due to the combination of massive fiscal deficits and the central bank creating new bank reserves to fund a lot of the bond issuance associated with those fiscal deficits. Treasuries and cash significantly underperformed inflation for the decade, and so the government inflated away a sizable chunk of its excess debt.
So far, we have an echo happening in the 2010s and 2020s, since we’re at the same phase of the long-term debt cycle.
2010s: Private Debt Bubble, Banking Crisis, Disinflation
After the 2007 peak, a recession and major asset price collapse began. Total debt as a percentage of GDP peaked in 2009, but it was primarily a private debt bubble. Federal debt as a percentage of GDP was moderate (about 65%) at the start of the crisis, but quickly grew to over 100% in the subsequent years as the private debt bubble was mainly pushed up to the sovereign level. The massive private deleveraging resulted in a bank crisis and the biggest economic contraction since the Great Depression. Banks were recapitalized via quantitative easing, but due to the major destruction in other net worth (stocks and houses) and several deflationary forces, and the fact that broad money supply didn’t expand very quickly, it was still a disinflationary environment rather than an inflationary environment.
2020s: Federal Debt Bubble, Pandemic MMT, Inflation?
By 2020, private debt had gone flat for a while as a percentage of GDP (household debt was down while corporate debt was up), but federal debt began skyrocketing from an already high 106% of GDP baseline due to the pandemic and subsequent economic shutdown. Federal deficits reaching 15-20% of GDP in 2020 approached World War II levels for the first time in modern history, resulting in federal debt levels rapidly moving to 125-130% of GDP and likely higher in the years ahead. The Federal Reserve began discussing yield curve control as an option, and bought a massive amount of Treasuries in mid-March when foreigners and hedge funds sold hundreds of billion in Treasuries, and the Fed continues to buy a significant percentage of Treasury issuance out of necessity. Unlike the 2010s, the broad money supply went up extremely quickly in 2020, because banks were already well-capitalized in this environment, so the combination of fiscal spending and QE (“pandemic MMT”) injected those funds directly into the economy, much like the 1940s.
Chart Source: St. Louis Fed
The biggest difference in terms of policy choices between the Hindsight Depression and the Great Depression, was the response time for the bank recapitalization and money-printing. In the early 1930s, it took about 3 years to do, while in the late 2000s, it took only months. As a result, during this second go-around, less private deleveraging was allowed to occur, fewer banks failed, asset prices were more quickly reflated, and money supply kept going up with no dip:
Chart Source: St. Louis Fed
However, when we stop looking at things in dollar terms (because they are, after all, expanding in number so rapidly these days), and start looking at things in terms of fundamentals, we can see the similarities between the two depressions more clearly.
Flat Industrial Production
Here’s a century-long chart of US industrial production:
Chart Source: St. Louis Fed
From 1930 to 1940, the US encountered a decade-long period of flat industrial production.
Starting with World War II, industrial production began a rapid expansion, and despite a series of pullbacks along the way, remained in a structurally increasing trend for over six decades to 2007.
Since 2007, and in some ways since as far back as 2000, the US has been in another industrial depression. During this period, the US offshored significant portions of its industrial base to China and other emerging markets. The US’s industrial sector represents a smaller share of its economy than most other developed nations in the world, and is roughly tied near the bottom of the list of major countries in that metric, along with France and the UK.
Flat Bank Stocks
During 2008/2009, several banks went bankrupt or were acquired during a period of insolvency.
Some of the biggest ones, like Bank of America, survived in a crippled state due to share dilution:
Chart Source: F.A.S.T. Graphs
Bank of America stock has been in a 20-25 year bear market, and that’s in dollar terms.
In gold terms (as things were priced back in the 1920s/1930s), Bank of America stock is in a 30+ year bear market. Some of the other big banks fared better, some fared worse, but most have had issues with their stock price for about two decades.
European and Japanese bank stocks are also in a multi-decade nominal bear market, worse than US banks. Deutsche Bank, for example, is at half of the market capitalization as it was twenty years ago, and its share price is one fourth of what it was twenty years ago. Latin American banks have been flat and choppy for 12 years.
Only in a handful of countries, like Canada, Russia, and Singapore have large bank stocks been any good in recent decades. Most of the world has been in a 10-30 year banking depression.
Homelessness and Lower Life Expectancies
New York City’s population has been relatively flat over the past several decades, but here is their number of homeless adults in shelters:
Chart Source: Coalition for the Homeless
Ever since 2008, twelve years ago, the number of homeless folks has skyrocketed. San Francisco and other coastal cities have a well-known homeless crisis as well.
These economic problems also showed up in life expectancy. US life expectancy was rising almost every year for decades straight. However, it peaked in 2014, and has been in a multi-year sideways trend for the first time in decades.
This recent flat-lining in life expectancy has been a uniquely US phenomenon. Life expectancy continues to increase in virtually every other highly-developed country/continent. Life expectancy went up from 2014-present in Japan, the Euro Area, Canada, Australia, etc. But not the US; we’ve fallen behind:
Chart Source: World Bank
Even a few countries that MSCI still classifies as emerging markets have outpaced the United States in life expectancy:
Chart Source: World Bank
For the US, an uptick in “deaths of despair”, referring to deaths related to suicide, alcohol abuse, and drug abuse, have played a large role in our diminishing life expectancy.
Here’s the chart of US opioid deaths:
Chart Source: CDC
Here are US suicide deaths, alcohol-related deaths, and drug-related deaths:
Chart Source: TFAH
This is pre-pandemic data, through 2018. The government cracked down on opioids in recent years, which helped bend the curve, but it’s unclear what the outcome will be post-pandemic with so much economic hardship. There’s pain under the surface.
This indirectly has a lot to do with the petrodollar system, as I described here. In order to maintain global currency reserve status in the post-Bretton Woods system for the past 45-50 years, the United States has undermined its middle class to a greater extent than most other developed countries, by rendering its manufacturing sector uncompetitive and running persistent trade deficits. This resulted in more outsourcing than most other developed countries. The problems became acutely painful to many people over the past decade.
Chart Source: Trading Economics
Macro analyst and CFA Luke Gromen, who is based in the Ohio area (one of the hardest-hit areas by the industrial/outsourcing depression) has been highlighting those statistics for years.
Those of us in the US that work in technology, finance, healthcare, or government have done extremely well, while many folks involved with manufacturing or certain other sectors suffered a lot of economic displacement.
As a result of this geopolitical policy and other fiscal policies, the median US net worth (representing the middle 50th percentile, rather than the average), is lower than most of our developed peer nations:
Data Source: Credit Suisse 2019 Wealth Databook
The US has a lot of mean wealth, but not much median wealth, because our wealth is a lot more top-heavy than most peer nations.
Germany on the chart is a unique case due to low rates of property ownership and high reliance on a broad pension system. So, the median individual is pretty comfortable but it doesn’t show up on their personal balance sheets. That leaves the US as the main outlier on the chart in terms of the ratio of mean wealth to median wealth per capita.
Poverty is correlated with poor diet, obesity, substance abuse, and all sorts of health issues. And the US continues to run by-far the most expensive healthcare system in the world on a per-capita basis, which strains employers, individuals, and fiscal budgets.
2020s: Populism and Pandemic MMT
My base case is for a rather fast growth rate in the broad money supply throughout the 2020s, due to the combination of large fiscal deficits and continual central bank balance sheet expansion to finance those deficits on the secondary market.
If that’s the case, the 2020s could look quite a bit different than the 1930s or 2010s; perhaps more like the 1940s or 1970s in some ways, at least in terms of inflation and the commodity cycle.
Meanwhile, the jobs market has been weak. Rather than a “V-shaped” recovery in jobs, it has been a “backward square root sign” recovery. This chart shows the number of people employed in the US:
Chart Source: St. Louis Fed
The key risk now is to see if it rolls over and goes deeper into a lower-case “h-shaped” recovery, or flattens out and then keeps grinding up slowly.
After several decades of operating under the petrodollar system, with a widening wealth gap and a hollowing-out of the industrial base, offset by bailouts for banks and corporations, populism has been on the rise.
Populism is described by Britannica as “a political program or movement that champions, or claims to champion, the common person, usually by favourable contrast with a real or perceived elite or establishment”. It comes in many flavors, and can take rational forms, irrational forms, and everything in between.
In 2010, this took the form of the Tea Party Movement from the right, and a year later, it was Occupy Wall Street from the left.
It continued in 2016 with the election of Donald Trump on the right, a candidate outside of the political establishment that was considered a longshot by most pundits at the start of primary season, who ultimately won. Bernie Sanders on the left also came in stronger than expected in the 2016 primary season, establishing himself as a national figure.
In recent years, populism has blossomed in myriad forms. QAnon on the right, Antifa on the left, an uptick in hate groups, a rise in riots and protests, etc. In recent days, the US Capitol building was stormed by pro-Trump rioters, resulting in a number of deaths including protestors and a capitol police officer, as well as many more injured.
Even the upcoming administration and legislative leadership group filled with long-term establishment politicians (Biden/Harris/Pelosi/Schumer) is embracing ideas that a year ago were more from the left, like federal student loan forgiveness and a third round of stimulus checks. An August 2020 Gallup poll showed 70% of the country supported more stimulus checks to the public. A week ago, the homes of Mitch McConnel and Nancy Pelosi were vandalized with graffiti demanding more stimulus checks.
Some political analysts have suggested that McConnell’s reluctance towards $2k stimulus checks, which were embraced by Democrats and President Trump alike (rather than cleanly along party lines), played a role in the Democrats’ narrow win of Georgia’s historically Republican-controlled Senate seats. Going forward, current news items are suggesting that the Biden administration, with backing from Schumer and Pelosi, will attempt another round of stimulus checks early in office, followed by a proposal for a multi-trillion dollar infrastructure plan. Some Democrats, including Senator Joe Manchin, are not fully on board, so we’ll see what passes.
Outside of these right/left dynamics, some folks such as Bloomberg’s Joe Weisenthal argue that Bitcoin is a new religion, complete with prophets, apostles, sacred texts, holidays, internal schisms, and frequently repeated sayings and incantations. Rather than relating to metaphysics, however, it represents a cultural war against the global monetary system as currently structured, with elements of libertarian politics and Austrian economics.
However, out of the tens of millions of people that own Bitcoin, most are not part of the “movement”. That cultural portion is perhaps numbered in the hundreds of thousands. I studied the Bitcoin community extensively this year and got to personally know many of the influencers, and advise a startup company in the space. Much of the Bitcoin community’s memes are self-aware, and the community is manifesting itself as a form of techno-populism that emphasizes self-sovereignty. Tons of smart developers and financiers have been involved in the space for years. There are also folks on the Ethereum side promoting a bankless life, based on decentralized finance blockchains.
This rise in populism throughout the 2010s, again, is similar to the 1930s, but of course it takes different forms nearly a century later. Populism comes and goes in long cycles, rising when something is seriously dysfunctional with the established system.
Within the broad tree of populism, however, different branches interpret the causes and solutions for the problem in different ways. Some of those branches are more rational or fact-based than others, but they all point towards economic pain and correctly sense that something in the established system is dysfunctional.
When populism rises and hits a cultural shift, it tends to partially or radically transform the existing system and institutions, becoming the “establishment” of the next system. Whether that takes a light turn or a dark turn depends on which sorts of ideologies ultimately win out.
A way to express a view of rising populism in a portfolio is by being long global stocks, long commodities, and long scarce assets positions more broadly.
The US dollar seems to be undergoing its third major bear market within the post-1971 system vs a basket of major currencies, which tends to be very good for commodities and emerging markets:
It’ll have bounces along the way, and we’re currently in one of those bounces, but it’ll be key to watch the multi-quarter and multi-year trends here.
Besides the dollar specifically, most fiat currencies are debasing vs hard assets, due to interest rates that are below the prevailing inflation rate, along with rapid growth in the broad money supply.
Commodities have been in a bear market period of oversupply during the past 12 years, due to a combination of emerging markets slowing down, the dollar strengthening, and the rise in production of unprofitable shale oil. However, the commodities cycle may have bottomed in 2020, particularly when the price of WTI crude went briefly negative.
The investment bank Stifel, with a chart shown in this MarketWatch article from several months ago, directly links populism and reflationary commodity bull markets over the past two centuries:
Besides the sociopolitical outlook, I think that both the monetary/fiscal outlook and the commodity capex cycle support this bullish commodities outcome in the 2020s decade.
It has already been showing up in some areas first, like gold, silver, copper, iron, and uranium, but when it spreads to energy, which has had the most oversupply and is the biggest commodity market, that’s when it starts to be rather inflationary for consumer goods.
I also continue to be bullish on Bitcoin from current levels with an 8-month forward view, despite being up more than 5x from my initial entry price in April 2020. However, by many metrics, Bitcoin is overbought in the near-term. After such a strong run-up, it’s a good time for folks to check and ensure that their position size is appropriate for their unique financial situation and risk tolerance. There’s a difference between trying to actively trade it, and making sure your position size makes sense for your portfolio’s volatility budget.
I have several investment accounts, and I provide updates on my asset allocation and investment selections for some of the portfolios in each newsletter issue every six weeks.
These portfolios include the model portfolio account specifically for this newsletter and my relatively passive indexed retirement account. Members of my premium research service also have access to three additional model portfolios and my other holdings, with more frequent updates.
I use a free account at Personal Capital to easily keep track of all my accounts and monitor my net worth.
M1 Finance Newsletter Portfolio
I started this account in September 2018 with $10k of new capital, and I put new money in regularly. Currently I put in $1,000 per month.
It’s one of my smallest accounts, but the goal is for the portfolio to be accessible and to show newsletter readers my best representation of where I think value is in the market. It’s a low-turnover multi-asset globally diversified portfolio that focuses on liquid investments and is scalable to virtually any size.
I chose M1 Finance because their platform is commission-free and allows for a combo of ETF and individual stock selection with automatic and/or manual rebalancing. It makes for a great model portfolio with high flexibility, and it’s the investment platform I recommend to most people. (See my disclosure policy here regarding my affiliation with M1.)
And here’s the breakdown of the holdings in those slices:
Changes since the previous issue:
I made rather few changes since the November newsletter. The coal ETF “KOL” was delisted, so I sold that and shifted the funds into other industrial commodity producers. I also slightly increased the allocations to ex-China emerging markets (RSX, INDA, ASEA, ILF) in the international section.
Some folks ask me about Bitcoin as it relates to this portfolio. M1 Finance doesn’t have a way to hold Bitcoin, but I hold it elsewhere. I do have MicroStrategy (MSTR) in the portfolio as a small Bitcoin proxy. MSTR has more than tripled in price since it was added to the portfolio this summer.
Primary Retirement Portfolio
My retirement portfolio consists of index funds that automatically rebalance themselves regularly, and I rarely make changes.
Here’s the allocation today:
From 2010 through 2016, this account was aggressively positioned with 90% in equities and enjoyed the long bull market.
Starting in 2017, in order to preserve capital, I dialed my equity allocation down to 60% (40% domestic, 20% foreign) and increased allocations to short-term bonds and cash to 40%. This was due to higher stock valuations and being later in the market cycle more generally.
After equities took a big hit in Q1 2020, I shifted some of the bonds back to equities, and it is now 71% equities (46% domestic, 25% foreign), and short-term bonds and cash is now down to 29%. For my TSP readers, this is equivalent to the 2040 Lifecycle Fund.
This is an example of a portfolio strategy that takes a rather hands-off approach but that still makes a tactical adjustment every few years if needed, based on market conditions, which reduces volatility and makes the retirement account feel less like a casino than many indices these days.
This employer-based retirement account is limited to a very small number of funds to invest in, so my flexibility is limited compared to my other accounts. I would, for example, have more exposure to precious metals, commodities, and digital assets in that account if it were an option.
Other Model Portfolios and Accounts
I have three other real-money model portfolios that I share within my premium research service, including:
- Fortress Income Portfolio
- ETF-Only Portfolio
- No Limits Portfolio
Plus I have larger personal accounts at Fidelity and Schwab, and I share those within the service as well.
The best-performing portfolio recently has been the No Limits portfolio, which I began in June 2020 and is up about 42% since then despite relatively low turnover (mostly long-term positions). As a normal brokerage account, I can include OTC securities in that portfolio unlike M1 Finance, which gives it flexibility to hold things like the Grayscale Bitcoin Trust (GBTC), which has been a nice source of alpha:
There’s an old saying that goes, “may you live in interesting times”.
It’s a subtly ironic statement; on the surface expressing a blessing, but in reality expressing a curse. Uninteresting times tend to be the peaceful ones, while interesting times tend to be periods of turmoil and strife.
The year 2020 was unfortunately a very interesting one, and 2021 is shaping up to be so as well.
Investors can reduce how “interesting” their portfolio action is by maintaining some degree of diversification. Geographic diversification in equity exposure reduces jurisdictional risks within any given country. Multiple asset classes give you a buffer against rising and falling growth rates and inflation rates. Some spicy kickers, like Bitcoin or uranium, can give you tail exposure to big moves without necessarily requiring large positions.
From there, investors can choose how active to be. Some people prefer frequent trading, while others prefer long-duration holding periods and more subtle tactical shifts when needed around big trends.