The ‘Long-Term Stock Market Bear Argument,’ As Told By A Pro

[Editor’s note: As many readers are likely aware, fan-favorite Kevin Muir – formerly head of equity derivatives at RBC Dominion and better known for his exploits as “The Macro Tourist” –  recently transitioned his daily letter to a subscriber-only format. On Monday, I asked permission to republish his latest, which he granted on a one-off basis. Think of it as a “special occasion”. The following is available exclusively to his subscribers and mine.]

Don’t mistake this as a shift to the darkside, but investors should be aware of the long-term headwinds facing equity markets.

I was a little kid in his pajamas in the late 1970s, but I still remember staying up for the first intermission of Hockey Night in Canada to watch Peter the Puck.

Then, as I got a little older, I recall spending Saturday night watching hockey, hoping for a bench-clearing brawl. As an adult now, I recoil at thinking fighting was more entertaining that actual hockey, but so goes the mind of a young Canadian boy.

However, on May 24th, 1987, hockey changed forever. That night during a playoff game between the Montreal Canadiens and the Philadelphia Flyers, Claude Lemieux and Shayne Corson sneaked on the ice after the pre-game warmup to shoot the puck into the Boston goal when no one was looking. They had been warned by the Philly players not to do it, but they didn’t listen. The result was pandemonium. From the Globe and Mail:

It took only seconds for the Montreal-Philadelphia pregame spark to become a three-alarm blaze. Hospodar and backup goalie Chico Resch raced back onto the ice when they saw Lemieux and Corson. Hospodar said of Resch: “Chico was an innocent bystander; a nice reborn Christian guy and I took him to the dark side.”

Soon players from both teams poured out of the dressing rooms. Overlooked at the time was how Flyers’ coach Mike Keenan had dressed 24 skaters for the warm-ups. Montreal had 18 and two goalies. Again, those were the days.

“We dressed a lot of guys,” Brown acknowledged. “[Lemieux’s pregame ritual]was a silly thing. But if he was going to do it, we weren’t going to put up with it.”

Nilan recalled fighting Brown for eight to 10 minutes then having to play the game. “I was basically spent before it even began. And there was Dave sitting on the bench the whole game,” he said. “Looking back at it, it was kind of stupid.”

Others have their lasting memories.

“Someone sucker punched Larry Robinson,” said Montreal defenceman Chris Chelios. “What I remember was nothing happened because there was no referee to make any calls. It was out of control.”

“I remember hanging on to Mike Stothers and seeing [Philadelphia’s] Don Nachbaur punch Larry Robinson,” said Canadiens’ forward Brian Skrudland. “I went, ‘Oh my goodness.’ That night was crazy.”

That night was over thirty years ago, but it forever changed hockey. The NHL instituted harsh new rules against bench-clearing brawls and they became a thing of the past.

It’s amazing how something that was once so ingrained into hockey was removed overnight. Canadian kids growing up today have no idea that bench-clearing brawls were once a semi-regular occurrence.

It’s funny how quickly humans adapt to new realities.

Which brings me to the point of today’s post. Although few realized it at the time, in the summer of 1982, when I was a young twelve-year-old more interested in checking out the new E.T. movie than learning anything about finance, the greatest bull market in modern financial history was born.

Here is a log chart of the S&P 500 with the August 5th, 1982 date denoting the start of the trend:

I have spent my entire career immersed in a giant bull market. I know nothing different.

Green upticks are as an inherent part of stock market trading as bench clearing brawls were to hockey in the 1970s.

However, as we saw in hockey, the world can change. Almost overnight.

I was reminded of the long-term bear argument this weekend when I interviewed Chris Sommers from for the MarketHuddle podcast. Chris was the hedge fund manager responsible for some of Greenlight’s most high profile short campaigns like St. Joe’s and Lehman. During our talk, he articulated the monster tailwinds that have fueled this almost four decade long bull market in stocks.

Although neither he nor I am predicting these trends are about to end tomorrow, investors should be aware that they will eventually exhaust themselves. And when they do, it will change investing forever.

Stock market bulls will tell you that stocks rise over the long-run at 8%, 10% or 12% per year. The reason for all the different numbers? It depends on how you pick your periods.

However, the one thing they often conveniently forget to highlight is that over the past four decades, conditions have been perfect for stock market returns.

What do I mean by that?

The backs of unions were broken during the 1970s, and since then, labour’s power has been dwindling. When you combine that with the huge labour supply shock released when the Iron Curtain fell and China was admitted into the WTO, the average worker’s compensation has been steadily falling.

This trend is obvious when you look at wages and compensation as a percentage of GDP over the past seventy years.

If labour’s slice of the pie is falling, then someone else’s must be increasing.

And the other side of that equation is corporate profits.

Since a low of under 4% of GDP in the mid-1980s, corporate profits have exploded higher to almost 12% in late 2010s.

Not only has capital been gaining over labour, but government’s attitude towards taxing these profits has only helped the trend. Here is a chart of Federal Tax Receipts as a percentage of GDP:

So let’s review. Labour earning less while corporate profits are increasing with the added benefit of being taxed at lower rates.

No wonder stocks have risen.

But there’s another part of this story.

We know that capital has been earning a larger piece of the pie, but how do you determine what that piece is worth? Well, the largest determinant of valuing future cash flows is the long-term risk-free interest rate.

What does that look like over this period?

Not only has capital being winning over labour, but the rate at which you value those future cash flows has fallen from 15% to under 1%!

It’s been the perfect world for equity investors.

When you think about the next forty years you need to ask yourself – do you think capital will continue gaining over labour at the same rate as the past four decades? And do you think the same compression in interest rates can occur?

Although this post is not meant to sway anyone’s attitude about stock market returns over the next month, quarter or even year, I wanted to bring it to everyone’s attention.

I know that most investors believe stocks always go up in the long-run. But they are being swayed by the absolute best investing environment for stocks that an investor could dream up.

Don’t mistake this post as my converting to the gloom crew that’s constantly predicting the next collapse in the stock market. However, in real terms, stocks will have difficulty repeating the performance of the past forty years. But remember – real terms are much different than nominal.

The world changes. At some point we might think the idea that stocks always go up with the certainty of the past four decades just as strange as the idea that two entire hockey teams fighting each other was somehow appropriate.


NEWSROOM crewneck & prints