Paraphrasing, a friend wrote to me last night and asked, “Hey Joe, is it time to invest?” I polished me crystal ball, gazed inside and saw the charts below magically appeared:
Pay attention to the shaded areas. The shaded areas are recessions, destroyers of capital. Do you see how the velocity line decreases in the shaded areas in the top chart? What this shows is that a decrease in velocity predicts a recession. PREDICTS a recession. That’s an important verb, predicts. It is not often in the life of a practitioner in the financial markets (or business manager or investor…) that you can see with clarity what is going to happen next. And the exact timing of an event is always the most difficult part of the game.
In the top chart we have an exception to the rule. The line bends straight down since 2011 yet no recession because of what is happening in the bottom chart. The bottom chart shows that we printed $4.4 trillion since 2011 to prevent a recession. PREVENT a recession. That’s a mighty hard thing to do. Prevent a recession. But money supply is the only input the government controls. So it is the only tool they have to “fix” the
economy. And it is a binary tool – either it is on and they are pumping money into the economy or it is off and they are drawing liquidity out of the market. This month we learned that the Fed is actually drawing money out of the system. This will accelerate the next recession. That is government interference in the markets in action and the price we will pay is pain – material pain in the financial markets. Great Depression-magnitude pain? Possibly.
We should have been in a recession since 2011 based on the declining velocity of money. If you remember the pain of the 2008-2010 recession and you can see the magnitude of the downward trajectory in the velocity of money since 2011 in the top chart, you can see that the next recession will be every bit as painful as the last recession, and, I predict, actually much worse.
As we have blogged a couple of times, the slowing velocity of money indicates that capital is being trapped or logjammed inside the financial system. So I wrote to my friend:
When money slows, it indicates it is not being invested in productive, growing enterprises. And if money is not being invested in productive assets, it is being invested in idle assets (read: financial engineering or speculation). And this is a predictor of a recession (or more precisely, a bubble before a recession). I think the drop could be 70% across the board – investment real estate included.
Today we have twin destroyers of capital working in collusion: The Fed mainlining money directly into the markets (Increasing Money Supply) and the markets plowing it into non-productive assets (Slowing Velocity of Money). This dual action is driving prices of financial assets higher while generating no (or very little) new production of goods and services. The twin destroyers of capital.
Be patient. Soon you should be able to buy assets at 2008 prices. The NASDAQ today is over 5,300. In November 2008 it dropped below 1,500. That would be a decline of over 70% from today’s figure! It could get close to that number in the next downturn and while that would wipe out trillions of dollars of net worth, it will only send us back to 2008. And somehow we all survived that setback.
Have some cash in hand but don’t rush in. You may have an opportunity to create dynastic wealth that will transform the lives of several future generations if you can be disciplined in your approach to the market.
Business owners and capital allocators, you would do well to dust off the worst case scenario plan and focus on cash generation. And if the storm hits as it looks like it will, give us a call. We are experts at navigating such waters. We can help stabilize the ship, pare back to the key drivers and help you maximize the value of your assets. That’s how we create tangible value.
ABOUT VERTICAL CAPITAL ADVISORS
Based in Atlanta, GA and created to help businesses survive the devastation of the Great Recession, Vertical Capital Advisors is a firm built on creating tangible value for our clients. We work with clients in just about every industry and we work with both capital growers and capital allocators..
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Sources: https://fred.stlouisfed.org/series/M2, https://fred.stlouisfed.org/series/M2V