Financial Repression and Stock Bubbles: The Future Ain't What it Used to Be

April 28, 2025

Although Millennials seem to love nothing more than complaining, they have actually had it great from an investing point of view. When that’s pointed out to them, their next go to argument in their “whoa-is-me” narrative is to point out that they aren’t making enough money to cope with daily life and that their perceived incomes are below those of their parents generation. Their incomes are not so low as to prevent them from spending weekends at Coachella, buying $5 lattes, and smoking large quantities of weed. This pessimistic worldview does not stand up to empirical analysis. Since the recovery from the 2008 Great Financial Crisis, U.S. real (inflation adjusted) median household income has increased from $65,470 in 2012 to $80,610, an increase of 23%, or about 2% annualized. Americans not only kept up with inflation, they were slaying it. Millennials are defined by those born in the years between 1981 and 1996, making them 29 to 44 years old. Arguably, they have been a blessed generation despite their protestations.

Here’s some really bad news for them. Things are going to get a lot worse in terms of inflation adjusted investment returns on stocks. The prospect for a significantly higher standard of living does not look much better. In fact, with respect to stock returns, the chances that the next sixteen years will be as good as the last sixteen years is effectively zero.

On the plus side, government bonds returns will very probably be higher. Frankly they couldn’t be much worse than the period between 2008 to 2024. The return on U.S. Treasury bonds during that period has been 1.1% annualized, and -1.5% adjusted for inflation. That’s a lot of buying power to lose over sixteen years. This is called financial repression. It is a period where governments artificially set interest rates below inflation and effectively deflate the value of their debt at the expense of bondholders. The last sixteen years has seen older investors and foreign bondholders robbed to the benefit of hedge fund and private equity managers, investment banks and younger investors who can have larger equity weights in their investment portfolios. Major beneficiaries have been the U.S. government, and U.S. consumers as cheap foreign goods flooded the U.S. and were paid for with a declining fiat currency.

Equity investors did astonishing well from the end of 2008. Over that sixteen year period, the S&P 500 Index returned 14.5% annualized. Adjusting for inflation, returns were 11.9%, annualized. These levels are far above the nominal and real returns from 1928 to 2008. In contrast, in the sixteen year period from the end of 1965 to the end of 1981, the S&P 500 returned 6.7% annualized nominally and a big fat zero after inflation. That’s correct. Sixteen years and zero real returns. Most investors actually lost money through market timing and fees. The illustration we provided indicates how negative investors became by the late 1970’s. Nor was that period the only time stock investors struggled. It took until the end of the 1950’s for stocks to return to the same value they had just before the 1929 Crash.

As I have written about many times, stocks are at valuation levels that historically have always preceded long periods of poor returns. We are already beginning to see this as real returns from October 2021 are below the previous post 2008 period. We have been in a stock bubble which hasn’t popped as much as it’s deflating like a punctured tire.. Real equity returns will be poor going forward. However, there will be cyclical bull markets and bear markets just as in previous poor periods. Individual market sectors will outperform and do well at times. Market timing may make a comeback.

Bond yields have adjusted to about 4.5% which is a solid yield relative to current inflation. U.S. debt to G.D.P. effectively doubled from about 62% before the G.F.C. to 123% currently with the real possibility it could soar from here. Debt may seem like a great idea when rates are less than 1% , the economy is growing and your debt is manageable. Not so much when rates are 5%, your economy is slowing down secularly, and your debt has doubled. Your bankers have their own issues and will eventually have had enough of your crap. America’s credit rating is declining faster than a divorced father with a crazy ex. Basic math: a 2% interest cost on a debt of 62% of G.D.P. results in having to pay about 1 1/4% of G.D.P. to creditors in interest. A 4.5% interest cost on a debt of 123% results in annual interest payments of about 5 1/2%. Thanks Obama-Biden!

The U.S. government will soon be obligated to allocate about one-third of tax receipts to interest payments. This will put pressure on the U.S. to engage in financial repression and try to keep U.S. Treasury yields well below inflation. Hopefully, for fixed income investors, that game is up as investors dump Treasuries and the U.S. dollar loses its pre-eminence. However, the U.S. may attempt some form of effective default by renegotiating the terms of its existing debt by lowering coupon payments and lengthening terms to maturity. That will be met with as much enthusiasm by bondholders as Jeffrey Epstein at a all-girls high school. The remaining alternative is to inflate the debt away. Although, I am an outlier on this, I believe the long-term outlook for inflation is higher over the next decade or two. Do not be mislead by middle-term lower inflation figures due to lower consumer demand. The price hikes coming due to tariffs are not inflationary in the true sense of the term. They are price shocks that immediately lower living standards. When they make their way through the annual C.P.I. number, inflation will fall if we are in a downturn but will head back up.

This type of environment necessitates an active fixed income strategy. Keep average term short and avoid bonds with terms to maturity over seven years, unless long rates are above 2% over inflation. Offshore government and corporate bonds are preferable as the U.S. dollar crashes and America enters a debt crisis. Canada is in an even worse situation than the U.S. The Great White North has almost all of Americas weaknesses, some of its own and fewer strengths. Canada’s government debt to G.D.P. is somewhat lower and it wisely funds its government pensions with assets instead of out of current tax revenue. Strong cash flow and large debt is sustainable. Poor cash flow is unsustainable even at moderate debt levels. As an old bond rating analyst, I can safely say debt is not a problem for a government if cash flow is strong. Canada’s cash flow or income outlook is crashing as the standard of living of Canadians seem to rank lower on the global scale each year. But hey, Canada is doing its part fighting climate change.