Jeff Seymour is a CFP, engineer, and investment adviser. His practice – Triangle Wealth Management – does financial planning and investment management on a fee-only fiduciary basis. His research focuses on global macroeconomic data.

RALEIGH, N.C. — In Part 1 yesterday, we discussed:

  • What a balance-sheet recession is, how we’re in one now and the fact that few of the brightest minds in academia recognized it
  • The similarities between the record-setting periods of prosperity in 1920-1929 and 1982–2000

In part 2, let’s look at the ride down – the unwinding of the great credit bubble of 1982-2000.

The only other time the U.S. experienced a balance-sheet recession was 1929-1948. Arguably, the worst part was the 1930s (the Great Depression). There are many similarities between the Depression and what we’re seeing in the U.S. today, and will see over the next year:

  • an unmatched bill (debt) to be paid
  • banking system brought to its knees
  • unmatched losses on real estate
  • unmatched levels of paper wealth destroyed
  • unmatched real unemployment (U6) levels
  • unmatched drops in stock market
  • unmatched drops in price/earnings (P/E) ratio on U.S. stocks
  • unmatched levels of homelessness, food stamps, desperation and despair

How long do I think it will take to stabilize the U.S. debt-to-GDP ratio? 2025 looks about right. Our current debt problem will take years to fix, regardless of who controls the White House or Congress.

Last time I checked, both parties had contributed to the debt. And as yet ,neither has been telling the American public that we’ve painted ourselves into a corner and that it will take several years of hard slogging, sacrifice and ultimately a slightly lower standard of living to repair the damage.

(Do you suppose one of next year’s presidential candidates will eventually come clean? He’s the slogan: “Vote for me. I’ll put you and everyone else through 5-10 years of hard times. But at the end of it the country will prosper again.”)

The implication for the stock market is dire (to be polite). If we follow the same recipe now as the only other balance-sheet recession (1929-1948), the Dow would easily drop to the 5000s in 2012. That would represent an ultimate secular (long-term) stock market bottom for this cycle and the point from which the next great long-term bull market for stocks may be launched.

The March 2009 lows (Dow in the 6400s) was not the bottom. The P/E only dropped to 15. More than a century of U.S. stock market history shows secular stock market bottoms always drop to levels where the Shiller P/E is 10 or lower.

It is not a slam dunk that the Dow will drop to 5000 (or something equally unnerving from a Dow 13,000 perspective) next year. The Fed, Congress, the European Central Bank and the International Monetary Fund might succeed in pulling yet another rabbit out of a hat and stalling the collapse like they have many times over the past 11 years. But reality can only be stalled, not stopped.

Stalling is only accomplished via more debt, and we’re quickly reaching the outer limits of that process (the U.S., Europe, and Japan). Ultimately, stalling will only make the economic and stock market collapse larger because there will be more debt to pay back. It’s true: the solution to having too much debt is not more debt.

The Fed and Congress have stalled magnificently for the past 11 years whenever a recession came around:

  • A recession in 2000. Eighteen years of overspending and irresponsible, myopic fiscal policy were beginning to take a toll. Arguably, we should have taken our medicine then. But no. More monetary and fiscal steroids. The S&P 500 lost 47 percent as demand collapsed. The Fed dropped short term rates to 1 percent in response. Congress gave unfunded tax cuts for another decade and introduced a massive new unfunded healthcare liability. The result was as expected: an artificial housing and stock market bubble. It was a colossal misallocation of resources and a waste of several years. The problem was made larger and delayed for someone else to deal with.
  • A recession recurred in 2008-2009, when the eventual housing and stock market bubble burst. The S&P 500 lost 57 percent. This time it took zero percent interest rates, QE1, QE2, trillions in U.S. bailouts and Keynesian fiscal policy stimulus (spending beyond our means), and a stream of sovereign bailouts in Europe that remains unresolved. Pause button again.
  • Another recession will likely begin in 3Q or 4Q this year. The S&P500 is back where it was 12 years ago. Worse, there is a very good chance stock markets will re-test the March 2009 lows (and drop through them) next year. Why shouldn’t they? Have we managed to address any of the systemic economic issues in our economy? What will the Fed and Congress be able to do to stop the stock market collapse this time? QE3 isn’t it. That would only cause more global inflation, potentially another war, and perhaps a mini “sugar-rush” stock market rally that would later be given up in spades.

In part 1 of this article, I mentioned that Wall Street failed to warn before the stock market was cut in half last time. Let me leave you with this story as to why that might be.

Let’s say you are paid to manage money for a living and work for a large bank or brokerage. You’re married with kids, have a mortgage and responsibilities. You really don’t want to lose your job. The last thing you want to be is alone and wrong.

If you invest client money differently than most others do (you’re alone) and lose a lot of money while most others lose a lot less or make money (you’re wrong), you’re going to lose clients and potentially your job. A great way to avoid that is to never be wrong and alone. Don’t make any decisions that are boldly different from what the masses do.

Now, enter 2007-2009. It is painfully obvious that this is not a garden-variety economic recession and not a garden-variety stock market correction. Are you going to sell all your clients’ stocks and avoid the loss? If you’re wrong and the stock market bounces back, they’re going to be plenty upset with you. It is safer for your career to do nothing and counsel to “stay the course.”

I assert this is one reason why so many lost so much last time (2007-2009). Nobody saw this coming. Really? I wonder how some of the insiders at the large investment banks were invested?

So, where does this leave us?
• awaiting the perfect economic storm 
• invested as conservatively and defensively as ever
• keeping a watchful eye out for more fiscal or monetary steroids from  Congress and the Fed (and the ECB and IMF)

It is as important to not lose big when times are bad as it is to make gains when times are good. At least, that’s what I think. But then again, I like boring.

Get the latest news alerts: Follow WRAL Tech Wire at Twitter.