2012: The Lessons of Endless Stimulus

Harry S. Dent | Friday, December 28, 2012 >>

When 2012 arrived, we had just published our book, The Great Crash Ahead. Our research on cycles was pointing to a stock-market crash, most likely in the summer or fall of 2012. We thought the stock market would retest its lows of early 2009, with the Dow around 6,440 and the S&P 500 Index around 667. At the time, we believed there was a limit to how much the Fed could stimulate the economy without inviting severe criticism.

It now appears that sanity was in short supply in 2012.

The Fed and central banks around the world have clearly demonstrated a willingness to stimulate without limits to prevent another severe economic downturnrn and debt deleveraging. Why? They witnessed the pain of 2008, and learnrned the lessons of the early 1930s, when governrnments failed to adequately respond to economic turmoil.

Politicians and central bankers don’t want a repeat performance on their watch. That’s understandable. What we didn’t expect was the tepid reaction of the general public and many economists. Even Warren Buffet sides with the Fed!

In Denial

Ten years ago, printing trillions of dollars out of thin air to apply a band-aid to massive debt problems would have been considered incredibly irresponsible. But now, with all of us in hot water and its temperature reaching the boiling point, it seems as if no one thinks we will get burnrned.

Our cycle research projected a major low coming in the second half of 2012. All we ended up with was a correction back to 12,000 on the Dow by early June. The European Central Bank came up with a surprising $1.3 trillion of Long-Term Refinancing Operations (its version of quantitative easing) in December 2011 and February 2012. In February, we pushed back our crash forecast, assuming that such massive stimulus would buy Europe another year. But it didn’t.

The two major surprises of 2012 were:

1) Europe implemented such a massive QE2 to follow the U.S.

2) How little impact QE2 had as Europe still slipped into a recession in 2012.


From Action Comes Reaction

In September 2012, the Fed came up with a $500 billion QE3 on top of the continuing Operation Twist when markets began correcting again. It then extended that to $1 trillion in December 2012. The markets had little response to such an aggressive move, in part due to the uncertainty over “fiscal cliff” negotiations.

When the “fiscal cliff” is resolved, as it will very likely be just before or after the January 1, 2013 deadline, we will see how much the markets value QE3.

We are projecting a substantial surge in stocks into early 2013. After that, we see little to no further gains, more volatility and a crash starting mid-year. More on that in another issue!

We foresee the U.S. and Europe following Japan with near-endless stimulus. Under such policies, Japan’s markets kept crashing to new lows every several years, because stimulus only works so long before it fails.

Repeat Performance

Please see the chart below. It is the best chart we found related to our 2012 lesson on endless governrnment stimulus. The S&P 500 Index in red and the Euro Stoxx 50 in blue are following Japan’s Nikkei stock index on an 11-year lag for the difference in the peak of our Baby Boom vs. Japan’s (1961 vs. 1950). This chart shows that despite endless QE in Japan, both stocks and the economy continued to crash to slight new lows.

See larger image

Japan’s first crash went from late 1989 into late 1992. That was followed by a 4-year rally until demographic and debt trends again weighed on the economy. Our recovery is now 4 years old and is due to crash in 2013 and 2014. We’ll see another rally into 2017 or 2018, then a final crash into 2019 or 2020. We will then see a move sideways into 2022 or so until the next demographic boom.

Therefore, we believe that we will see a peak in early to mid-2013 at the latest, then a crash down to slight new lows of around 6,000 on the Dow by early 2015. Another grand stimulus plan and another strong bounce will follow.

The roller coaster and never-ending stimulus continues!

It is still possible for governrnments to lose control of the global economy, resulting in a deeper downturnrn and crash. But for now, we assume that we will follow Japan’s scenario until proven otherwise.

On the Money

Our best forecast for 2012 was our belief that 10-Year Treasury bond yields would fall to between 1.2% to 1.3% before bouncing back up. We were using our longstanding Treasury-bond channel dating back to 1989, the same one that gave us a warnrning to sell bonds in December of 2008.

Yields hit 1.38% in 2012, so that’s where we got it right. We anticipate providing a major warnrning on bonds in the near future, as prices will fall if yields rise sharply as they did in 2009.

We also forecasted that gold would rise to $1,800 and then fall. The $1,800 forecast was dead on. However, we believe that gold will likely rise to a new high of over $2,000 before falling big-time in 2013 and 2014.

A Look Ahead

Governrnments continue to kick the can down the road. But Japan’s experience tells us that even endless stimulus cannot prevent alternrnating crashes and downturnrns. We have learnrned that our most reliable cycle-indicators don’t matter much in a Fed-manipulated economy and with markets “on crack.” However, the last strong configuration of cycles show late 2104 as the most likely time for the next crash to bottom, with mid-2013 as the most likely time for it to start.




Ahead of the Curve with Adam O’Dell

Rallies and Pullbacks of 2012

While the U.S. stock market has returnrned an average of about 8% annually over the past several decades, that does not guarantee an 8% returnrn each year. Long-term investors know that the timing, or sequence, of the returnrns is everything.