Pam in New Orleans asks:

Harry Dent recently published a view that says

“The Biggest Stock Market Bubble In History Set To Crash.” What are your thoughts on what Harry has to say?

Pam, this is a great question. Harry Dent is an economist who specializes in using demographics to predict economic behaviour. He is also known for having some controversial views. All controversy aside, I agree mostly with Harry Dent’s perspective that the market is going to face some significant headwinds.

If you think about what drives up prices in the stock market, it’s more buyers than sellers. Buyers of stock are people who are in the workforce who put some money aside and invest some of those savings in the stock market, the bond market or in real estate.

People who are of retirement age take their life savings out of the stock market and put them into more fixed income securities and use the income to fund their retirement.

When you look at the number of people in the workforce compared with the number of people in retirement, we see an inversion. When the baby boomers were all in the workforce, they were saving for retirement and investing in the stock market. With about half of the baby boomers now retired, and the remainder to retire over the next decade, that large generation will be pulling money out of retirement accounts and out of the stock market for the next 30 years. The generation of people who came behind the baby boomers, the so-called Generation X is a much smaller population who are still in the workforce. All other things being equal, we’ve gone from a period where there were more investors in the stock market to a period where there are now more people withdrawing form the stock market. All other things being equal, this redemption of funds form the stock market is putting downward pressure on the stock market. It’s hard to see that right now because we’ve just gone through a few years of asset price inflation in the stock market. The valuations we are seeing in the market don’t make sense on a fundamentals basis.

We’ve seen insane valuations being attached to companies that are losing money. The examples are rampant from WeWork to Uber, Lyft, Tesla and Netflix. The valuation multiples being attached to these companies are decidedly in bubble territory. So at some point, when the markets wake up and sanity prevails, we can expect to see a dramatic drop in stock prices. I think we’re starting to see the tip of that iceberg with the failed IPO of WeWork.

So when will this happen? I’m not sure about the timing. The difficult thing to predict is how much longer governments can inflate the bubble by printing more money. These hits of heroin (cash) being injected into the economy do have a stimulative effect (less and less), and they definitely inflate asset prices. The patient is now resistant to the drug. That’s why negative interest rates in Europe for over a decade have done nothing to stimulate the economy there.

You want to get your money into assets that are an effective hedge and you want to do it before the precipitous fall in prices. Harry also predicted a precipitous fall in real estate prices. When he says that, I believe he is talking about residential real estate. There is no question that demand for 5 bedroom houses in the suburbs is falling. Demographics says that the demand isn’t there at those price points. So we will definitely see homes at the top end of the market fall in price, even as homes at the bottom end of the market increase in price.

He did say that cash flow positive real estate is a good hedge (I agree). He said long bonds are a good hedge, but I don’t agree. Paper assets get devalued too much over the long haul. Savings get wiped out. Debt gets wiped out, and people on fixed income get wiped out.

A destruction of wealth in the stock market will make less equity available for investment.