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Photographs: N Mahalakshmi

Interview

"When China falls, investors will ask, what is the next big thing?"
Economist Harry Dent talks about The Demographic Cliff and why he thinks the party is not going to last for long

N Mahalakshmi & Rajesh Padmashali

Sunny state Florida is the last place you would expect to find a modern-day Cassandra. But find you will, if you look hard enough. Utter the name Harry Dent and most optimists cannot help but suppress a smirk. A good part of success in the stock market is showing up and Dent sure has had his moments in the sun. He was the first to predict Japan’s downtrend from its giddy highs in the early ’90s and that the Dow Jones would hit 10,000 by the turn of the century. Soon after, he also predicted that the Dow would go as high as 35,000 by 2007 or 2008. That not having materialised got him dollops of criticism and now his ultra-bearish target of Dow 6,000 by late 2016 in his latest book, The Demographic Cliff, has those very critics dismissing his forecast as a self-promotion stunt. Dent is unfazed and despite the bright sunshine in Florida, is feeling rather gloomy. If gloominess were contagious and if being cautionary was a crime, Dent would have been locked up a long time ago. Thankfully, it isn’t… yet. Alan Shore, in one of his many eloquent moments on Boston Legal, once said about the United States, “I don’t know who the hell came up with the notion that one can’t criticise this country and still be patriotic.” Dent would agree and in this interview says that his demographic forecasts show not everybody is in for a good time.

Let’s begin with your greatest hits and biggest misses. Why did the hits work out, what did you miss out on and what is your market call now? 

The first indicator I came up with was demographic because we could project inflation and spending, booms and busts cycles, for out decades. Our biggest hit was in 1989 when we said Japan is going to fall in the ’90s and beyond, and the US and Europe are going to have their greatest boom in history with the Dow hitting 10,000 by the end of the decade. People thought I was a nut. They thought the US was faring horribly and Japan was going to take over. Those demographic tools worked beautifully during the entire ’90s decade.

We also predicted in the roaring 2000s that the Dow was going to hit 30,000-35,000. Most people thought it was over after 2000. We said, “No, it is not. Baby boomers are not done spending, and technology is yet to move into 90% of households.” We did get investors back in October 2002 and predicted that the Dow will quadruple. It only doubled. I have never heard the end of that from my detractors. I had to say, “I am wrong here, I expected a much bigger bubble. Why didn’t things bubble as expected?” I dug deeper and discovered two new cycles.

Commodity prices were going down in the roaring 1920s and that was favourable for stocks, and in the 2007 boom they were going straight up, which was unfavorable for stocks. The second thing I found out was an 18-year alternating geopolitical cycle [every 18 years, stocks and the general economic environment wax and wane] that overlapped my demographics by 89% but I hadn’t paid much heed to. The geopolitical cycle has been trending down since 2001 and stocks have made little progress after that. When I put these two aspects together, I noticed that during unfavourable cycles with high geopolitical risk, stock valuations tend to be 50% lower. Had I been aware of these two cycles, my Dow prediction would have been 16,000 and not 32,000. That was my biggest miss by far. We also called the top of the US housing market in 2005 around the time I moved from Miami to Tampa — I have been renting ever since.

I am now looking at technical indicators and, I think, we are getting close to a top in equities. But there are some indicators that aren’t flashing and rightly so since the recovery is driven by money and speculation and not by consumers and businesses. It is a lot harder when the government manipulates the economy. Every time the stock market goes down, they pump in more money. They are not letting the economy go through its normal course of rebalancing of debt (See: Leveraged to the hilt) and business efficiency.

 

Leveraged to the hilt

Among the major powers, Russia is the least indebted

Right now, I am like, “Oh my gosh, I have to tell people when to get out of stocks and it is not going to be easy.” A lot of people who think like me have given the signal five or 10 times, I haven’t given the signal yet. We keep saying, “I think it is coming, but oops no, not yet, the bubble is still inflating.” But we do think a top is coming, could be this August at the latest.

What indicators that you monitor are not yet flashing?

Well, there are two important ones. First is an indicator that I didn’t have in 2007. I subscribe to a newsletter called Lowry’s. They have an indicator of buying power and selling pressure. It is a way of measuring the key turning points when the smart money is exiting.

The dumb money piles in at the end when everybody thinks, “The stock market has gone up five years, can’t lose money in stocks.” So, if in a rally that hits a new high,buying power does not hit a new high and, more importantly, selling pressure rises instead of falling, it clearly signals that the smart money is getting out. That was one indicator that would have called the top closer in late 2007. That’s not flashing yet. It is weakening but is yet to give a clear sign.

The second one is the advance-decline line. As the bull market comes to a close, people get increasingly selective and buy more of large caps and less of small caps. Fewer and fewer stocks join the rally. Small caps, of late, have greatly under-performed large caps, which could be a sign of an actual decline.

So, those are the two big things that are not flashing very clearly for me. Maybe, the smart money is thinking the Yellen Put [unstated assurance that the central bank will bail you out] won’t let the market go down. They are like, “We don’t have to exit because the Fed’s got our back.” Maybe, that is why we don’t get a selling pressure signal or a clear advance-decline line.

In late 2007, when the Dow hit a new high, the advance-decline line did not. Those two signals did catch that. Now, I don’t know if they will work this time. I would love to have those indicators join in. We have got extreme asset prices, margin debt and all the other stuff. Robert Shiller has a valuation model that adjusts 10-year average earnings. That indicator, which is right now above 25-27 P/E, is showing a top. Every other indicator suggests that we are at the top or close to it, but these two indicators, for now, say, “No”.

When you put out a target — for example, Dow 10,000 and then Dow 35,000 and now when you predict Dow 6,000 — how are those targets derived?

There are some short-term tools that I use. However, in this manipulative market a lot of these tools don’t work. The leading indicators are totally useless, they don’t work at all. They are coincident now, not leading. But in terms of a chart pattern, we have what is called a megaphone (higher highs and lower lows). The same pattern was evident from 1965 to 1972. In 1965, there was a small decline, in 1968 the top was a little higher and the 1972 top led to the bigger crash.

So, we have drawn a megaphone through the Dow in 2000, 2007 and now around 2014. I go on CNBC and say the Dow is going to go to about 17,000 and then a few years from now it is going to test the bottom at about 5,800. People look at me like I am crazy. Stocks are clearly, to us, edging in at the top. The question is does it top at 17,000 or 17,400. We think the second half of August could be a big turn date.

 

Clarion call

Megaphone pattern on the Dow points to ominous times

I am looking at all four cycle indicators pointing down in the next six years. Our demographic cycle turned down in late 2007, geopolitical in 2001, commodity cycle peaked in 2008 and is pointing down for years.

Then, the sunspot cycle [according to the Institute for Solar Studies on Behavior and Human Health, Santa Monica, California, stock markets usually peak at sunspot maximums and crash during sunspot minimums. The next decreasing sunspot cycle is due to arrive between late 2014 and 2016] points down from around now to late 2019 to early 1920. If we are going to have a major crisis, it is going to happen in the next six years.

If it doesn’t happen in the next six years I am going to say, “Ok, I was wrong because our cycles will one by one start to turn up.” In the sunspot cycle, the worst crashes and the highest probability of crashes are in the first 2.5 years after that cycle. The first 2.5 years of every decade, you can expect a recession and at least a 20% stock crash, if not bigger. It worked in the early ’60s, early ’70s, early ’80s, early ’90s, and early 2000s. That was my best cycle. It just didn’t really happen in 2010 to 2012.

Given that we have a distorted market, are you looking for any particular tipping point?

I see three triggers now. We have been saying for years that China is the biggest bubble in the world. While India under-invests in everything, China over-invests in everything. China is forcing people out from rural areas to urban ones at a rate no emerging country has ever done. It is on steroids. It is disrupting cultures and creating a giant underclass in cities. 27% of condos and homes in cities in China are vacant. They are just building stuff to employ people from the countryside and then just building on that like a Ponzi scheme.

Well, they are starting to crack. You have had a major developer go under. Multi-billionaire tycoon Li Ka-shing and his son are both dumping their major commercial properties worth billions of dollars. That is the smart money exiting. 

60% of the top 10% are thinking about moving out of the country. They have three reasons. One, they think the bubble is going to burst. They are scared that the government is going to impose an exit tax on them while the bubble bursts. Number two, pollution there is absolutely off the charts. Number three, most rich Chinese want their kids to get an English education. They want to be in San Francisco or Los Angeles or New York or London or Singapore or Sydney or Melbourne or Auckland. These cities are all being bid up. The Chinese are buying properties in these English speaking cities and keeping those bubbles going. The top 10% of the Chinese account for 60% of the income, 50% of the spending and own 85% or more of the financial assets, including real estate. If they leave, that economy is dead.

But more importantly, the Chinese, more than anybody on this earth, buy real estate. They either have money in the bank or in real estate. They don’t put much money in stocks and bonds. They don’t rent in China. If you are a man living in a rented house, you are never going to get a date or get married. They have 89% ownership versus some 60% in the US (See: A house of my own) but we are five times richer than they are, on average, even adjusted for purchasing power parity.

 

A house of my own

China tops the world when it comes to home ownership

I do look closely at price-to-rent, but the best universal indicator is home prices-to-average income. When the bubble in California burst, it was at 10 times. That is where it is in Vancouver, Sydney or Melbourne. When I go to these places they tell me, “We don’t have a bubble,” and I am like, “Forget it… just lose your money.” London is the worst at 15. In Bangkok and Singapore it is 20-something (See: Irrational exuberance).

In Shanghai, it is 28-35 times income. That means most people who live there can’t buy anything near downtown. When I was there, I spoke to drivers and workers in the hotel. They are living an hour and a half to two hours away in small condos with five families.

It is owned but there are five families. I looked in some and there were mattresses on the wall. At night, the mattresses come down and 15 people sleep on the floor. So, they have got the greatest bubble going and the government has heavily encouraged it.

The government encourages local communist leaders to borrow money and invest in construction projects. They have overbuilt industry, infrastructure, houses and malls. They have the largest mall in the world which is twice the size of the biggest malls in America. It is almost totally empty and now they have turned it into a tourist destination with pools and rides to entertain potential shoppers.

 

Irrational exuberance

Chinese house prices are clearly off the charts

They have overbuilt office property. They have got cities built for a million people. Chinese investors are buying these things and just sitting on them, not renting or using them. This is insanity. China is the growth engine of the world, the largest manufacturer.

Its manufacturing exports are already slowing. The China bubble bursting means game over. That is my number one trigger. People say the government can manage this and we will have a soft landing. When you hear ‘soft landing’ run. There is no soft landing for a bubble.

The second, in the late ’80s, I said two opposite things: Japan is going to have the biggest crash in history and the US and Europe are going to have their greatest boom in history. People said it doesn’t connect, but that is demographics for you. Most of Europe, but Germany, in particular, had its demographics peaking in late 2011.

From 2014 to 2022, it will drop steeper than Japan. Everybody is looking at Germany to hold the Eurozone together but it is experiencing near-zero growth and its exports have already turned negative (See: Last bastion standing). They will keep surprising on the downside.

 

Last bastion standing

German export growth is showing signs of slowing down

The third is the US real estate recovery is faltering. The ‘Buyers vs Dyers’ trend is pointing down from 2014 to 2039. Housing is going to grow slower and slower and it is going to get negative at some point. 50% of the sales are cash buyers and is speculative.

People buying foreclosures and renting them out is not a recovery. Real people buying homes actually get a mortgage. Mortgage originations have crashed and have been sideways for years. Young people don’t qualify and they are living with their parents or renting. We think that the weak leg of the US recovery, even with stimulus, is housing. The economy is going to be slower later this year than most people think. These are our three triggers and they all look set to hit sooner rather than later.

Have you looked at India? Because we make a big deal about our demographic dividend.

You should. India is my number one country for the future. The number one driver for developed countries, as we are already urban, is the demographic factor. The biggest driver for emerging countries is urbanisation and this is true for India, Brazil and China. You move a person, no change in skills or education, from a farm or a rural area into a city, their income goes up. If you plot this long term, you will find a linear relationship. India is a little early to judge but its curve does looks steeper. China is much steeper having moved 220 million people with no skills over the last 12 years into tier two and three cities.

But, do we want to own the Sensex now? No. Just like in 2008, everything is going to crash. If the world goes down due to a global financial crisis, emerging markets tend to go down more than developed. India has been one of the strongest emerging markets, so it will crash the most. But after the crash, the first place to buy is India. There are four reasons, demographics and urbanisation are two. Third, when China falls, investors around the world will ask, “What is the next big thing?” They are going to come to the conclusion, it is India.

That will benefit in attracting investment because India doesn’t have enough foreign or government investment. The fourth reason is unlike almost all emerging countries, which are commodity exporters, India is an importer. We have a commodity cycle that is pointing down into the early 2020s for the next decade. So, I want to buy an emerging country that has really good demographics and potential for urbanisation such as India or Turkey and even Mexico but does not have high export exposure. If I were to buy just one emerging country, I would buy an India ETF because everything is there.

Your theory says that an aging population will lead to less spending and the resulting lower economic growth will lead to a stock market slump. To begin with, is there a correlation between consumer spending and stock market return?

Yes, and I discovered this in 1988. Stock markets rise when an economy is growing and a generation is spending, and fall when they stop spending. 1983 to 2007 is an exact 46-year lag on the rising Baby Boomers birth index compared to today. If you had looked at demographics alone and nothing else, it would have said the US is going to boom from 1983 to 2007. Ever since the sub-prime crisis in 2008, we haven’t had the recovery we were supposed to because the demographics are pointing down and governments are providing unprecedented levels of stimulus just to grow at 2% here and 0% to 1% in Europe and Japan.

One of the things that is going to change, and we are going to have to adjust for this when it does, is people are going to have to work longer in developed countries. We should be retiring at 75 and not 65 in order to make it easy for unfunded entitlements to be paid. We are projecting a US population of 360 million in 2050 compared with 317 million, at present. Government projections are 420 million. They are projecting births will go up like they have and there will be immigration. I say, “No, immigration in a downturn goes down and the more society ages, births go down. In a downturn, births go down.”

When I calculate with reasonable assumption, we can barely grow. The real decline in spending comes from age 54 to death (See: The point of no-return). In the US, peak number Baby Boomers turn 54 next year. Even if they live and work a little longer that work is going to fund their retirement and investments. It is not going to mean they are going to spend substantially more money. I think you can only stimulate so much and the government has now stretched the economy far more than they would have wanted to.

Why can’t immigration be an answer to unfavorable demographics? The US is a very desirable destination for those wanting to immigrate.

The only thing that is going to have the US growing in the future is strong immigration. And that is not the mood of this country. The mood in the country is that “We let too many in”. In a slowing economy, we do care about all kinds of jobs. We used to say, “We don’t want to pick lettuce, we don’t want to baby sit, we don’t want to clean houses.” Now, people say, “I will take that job because there aren’t good jobs going”. It is the best thing to do, but I don’t think immigration is going to come back strongly. What all developed countries need to do is, over the next 10 or 20 years, sooner the better, transition from a retirement age of 65 to 75. That way people are going to earn more money and receive fewer benefits. They are going to pay into social security and health care longer and they are going to take out less.

 

The point of no return

In the United States, consumption peaks at the age of 46

Today, even though life expectancy in the US is 79.6 years, if somebody makes it to retirement age and the retirement age is 63, on average, you are going to live to be 85, not 79. In other words, 22 years of doing nothing. It makes sense, maybe, for the last ten years of your life to do nothing as you are more likely to have health problems and need to wind down, but 22 years is absurd. That was never the intention of Social Security or Medicare when they were introduced. If we make that transition, we would greatly reduce the entitlement burden on the young who never have a chance of paying it.

The other thing is encouraging people to have more kids. That is very hard to do because the one trend that is crystal clear in history: the more urban and more affluent households get, the less kids they have. That is why the demographic cycles eventually turn against you. Wealthy people in cities think: it costs a lot to raise a kid; I want to have one or two kids and give them the best education. If I have three to five kids, how am I going to get them all into Harvard? Individually, that makes sense. Collectively, it is demographic suicide.

There is a reason why Scandinavian countries and even the US have the best replacement rates. They treat their working women well. That is the big difference. The worst replacement rates are in East Asia (Japan, Korea and Taiwan) and southern Europe (Spain, Portugal, Italy and Greece). In those countries, women go in the workforce the first time but the men don’t budge. Women are in the workforce but still have to do the housework and take care of the kids. When women get that message they have one kid and say, “Screw you, I am not having any more.”

In Scandinavia, when a woman gets pregnant, she gets 12 months maternity leave and all the support from the company and the government. In the US, companies offer stronger support than the government. All these countries recognise that if women need to be in the workforce, then you have to help them with the kids. You got to give them more childcare services because you want those women in the workforce. They keep your demographics going. I look at the demographic charts of southern Europe and East Asia and I am like, “What are these people gonna do?” These economies are probably going to have negative growth even in the next global boom. That is scary.

You believe the US could go the Japan way if the Federal Reserve stops its QE?

That is what I am scared will happen because Japan has now pulled this off for over two decades. Their growth since 1997 has averaged zero or just below zero. Japan never had a great depression; they never had major bank failures as the government kept the banks alive. Real estate is down by 60%, they are not making them write-down the loans and they are making citizens pay underwater mortgages. You still got people, 20 years later, paying off a mortgage that is underwater. That shouldn’t happen. You have to restructure bad loans like we do under Chapter 11 in the US and write the loans down to market.

You have to clean out the debt and the excess capacity. I am afraid that the US is going to adopt the same policies and say we are just going to keep the economy on more and more QE. I would rather see the US go through the crisis. We could cut our entitlements and private debt in half. The US has $42 trillion in private debt and $22 trillion of that piled up between 2000 and 2008. We doubled our entire private debt in 8 years and government debt, too, is a lot higher in most countries.

Successive QEs have had less and less effect. Have we reached a point where the Fed is pushing on a string?

I get on these TV shows where people argue, “We are getting into launch velocity. We are getting into a sustainable recovery.” What are they talking about? If we were in a sustainable recovery we wouldn’t have been upping QE 1, QE 2, QE 3, QE 4... In 2008, we have this collapse, so we have a big QE 1. We grow for three to four quarters. Up to 4% is where we get and then the stimulus doesn’t work, it wears off and we are back in recession three or four quarters later. It is what I call a seven-quarter cycle. That is where we have got now. They did QE 3 in the first quarter of 2013, up second and third quarter. We are down a little in the fourth quarter, weather and stuff, but we are already trending down. This cycle says the economy is likely to keep slowing at least into the third quarter of this year. So the stimulus doesn’t get to launch velocity.

I am just waiting for something to go wrong like the sub-prime crisis, and then everything blows. Again, you have to look back. Four states (California, Florida, Arizona and Nevada) had a sub-prime crisis and the whole world went down, including India. That is what happens when bubbles burst and fundamentals fail. We are all interconnected, banks and trade are interconnected. Countries get defensive and protectionist when their economies fail and everybody tries to push their currency down at the same time.

Well, everybody can’t push their currency down at the same time without creating a mess. So, yes, this stimulus comes in surges and then it fails. It is like a cup of coffee that keeps you awake for a extra couple of hours and then wears off. That is what any stimulant or drug does. It makes you feel high or good, after it wears off, you feel worse. That is what QE is — a financial drug. 

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