Where The Heck Is The Stock Market Bottom?
Stock-Markets / Stocks Bear Market Oct 20, 2008 - 01:08 PMBy: Ronald_R_Cooke
A Logical Conclusion - One can make a case that sometime in 2010 our stock markets will “bottom out”. In this scenario, the DOW will decline below 5700 and the NASDAQ will fall under 430, after 33 to 35 months of highly volatile trading.
How did I reach this conclusion? Read on.
According to this morning's stock market news on CNN, most economists believe this will be a relatively short and shallow recession. This conclusion is apparently based on an extrapolation of past economic performance in comparison with currently available data. To construct this scenario, one merely needs to look at the “usual” market direction indicators. Corporate profits, GNP, auto sales, the Purchasing Manager's Index, payroll employment, personal income, public consumption, retail and durable goods sales, housing starts, and the value of the dollar are all negative. Unemployment is up, along with the rate of inflation. By themselves, the data underlying these factors would indicate a mild to moderate recession lasting into 2010.
If you watch to CNN or FOX, however, three factors could derail this conclusion. Economists appear to be unsure how to measure the impact of the mortgage crisis, the rash of financial institution failures, or the sudden decline of available credit. No one seems to know how to include these three “challenges” in the recession calculation.
No matter. If we ignore them – goes the thinking - perhaps these factors will not have a long term impact on the direction of the stock market.
But. I do protest this shallow and incomplete analysis. This stock market is unlike anything we have experienced in our lifetime. Extreme volatility has thus far been the norm. The markets have been in a virtual free-fall since mid- September. Last Friday the DOW closed below 8500 (down 40% in 12 months) and the NASDAQ came in under 1700 (down 42% in slightly less time). This week the DOW rocketed upward by 1300 points in less than 9 hours of trading, and then promptly lost almost 1200 points in the next 8 hours. Past performance has never been anything like this. Throw out the rule book. We are in new territory.
So. Where is the bottom?
Constructing An Alternative Scenario
I was watching Neil Cavuto on Fox News last weekend. Like many media personalities, he just doesn't comprehend the gravity of our precarious economic environment. For a business commentator, failure to understand the economic fundamentals is inexcusable. Let us see if we can help him out.
Neil: This isn't your usual economic contraction. If we want to construct a high probability scenario, we must develop a way to include all the probable economic factors in our recession equation, and then characterize the interaction of these factors with our culture. How will people, including governments, react to this crisis? And how will this reaction shape the probable outcome?
Let's summarize the “challenges” ahead ….
• Home loans. Additional Option ARMs and Interest Only loans are scheduled to reset through 2012. Almost a trillion dollars of debt to roll over, and most of the original loans are “under water”. Many home owners will chose to walk. It could be long into 2010 before we know the true value of our banking system's housing portfolio.
• Housing. In some areas, it will take several years for the market to recover. Start with excess inventory, factor in higher unemployment, and we have a recipe for sluggish sales.
• Retail shops. Landlords are currently working with retail tenants to keep the doors open through Christmas. Both struggle to make a buck. But in January, many retailers will throw in the towel. Look for a sharp increase in retail store vacancy signs, accompanied by higher unemployment. Building owners take a revenue hit. More questionable bank loans.
• Office and Industrial space. Escalating unemployment means increased vacancies. Corporate contraction is inevitable. “Downsizing” becomes a verb. Building owners take a revenue hit. Bankers buy TUMS by the barrel.
• Commercial loans. This will be an all-to-typical situation. The money has been loaned, and the construction has been completed. But there aren't enough tenants to carry the paper on a take out loan. Does that spell default? More bad debt on the books of our banking system?
• Small businesses. Typically undercapitalized, and unable to borrow enough money to meet payroll, small business failures will increase. More bad debt. Thousands of people out of work.
• Debt defaults. Look for a sharp increase in credit card and auto loan defaults through 2010. Not only will this add to the load of non-performing debt, it will change the economics of the Credit Card industry .
• Credit. We are in a cycle where a lack of credit triggers loan defaults, leading to even tighter credit markets. Without access to credit, businesses (large and small) are forced to curtail operations, leading to layoffs, expense reduction, and reduced capital investment.
• Derivatives. The $60 trillion Credit Default Swap mess is starting to unravel. The worst will hit in 2009. And we do not have adequate visibility as to how much other derivative junk will crash.
• Hedge funds. Redemptions are up, forcing asset sales. Unfortunately, many of these assets are worth less than their original book value.
• Dollar. Look for a further devaluation of the dollar. This will increase the cost of goods purchased from other nations, increase the cost of manufacturing in the United States, and increase the cost of goods distribution. Fixed asset depreciation in an era of soft goods inflation promises to be an economic disaster for low to middle income Americans.
• Government response. People are becoming really frustrated with the failure of our dysfunctional government institutions. There is a clash of political philosophies. Add in a tough job market and one has a recipe for political turmoil. Generally speaking, conflict is not good for the stock market.
• Globalization. This crisis is global in nature. If this were a sane world, the response would also be global in nature as governments worked together to resolve the crisis. Instead, look for self serving, politically expedient, and ultimately ineffective nationalistic responses.
I could add three more critical factors to this list. But I will not. They take a lot of explanation and I am running out of space. Suffice it to say, these factors make an ugly contraction highly likely.
A Look At History
Do we have a historical model that gives us a clue as to what lies ahead? Yes. The panic of 1873. And I do mean panic. There was a v shaped stock market contraction. It took several years to reconstruct an over-extended banking system. Bankruptcies skyrocketed. Corporate profits were miserable. Real estate values fell. Credit dried up. Wages were cut. By 1876, unemployment had risen to 14%, sending tens of thousands into the streets. There were bloody riots. Employment frustration and lousy policy led to labor conflict. Crime increased. The panic of 1873 was accompanied by industrial consolidation, politically motivated violence, and a call for institutional nationalization. Welfare systems were overwhelmed. Millions took solace in the practice of fundamental religious beliefs. Aliens and Jews became scapegoats for a failed economy. Political systems were destabilized.
Yes, Neil. This is what happens in a depression.
Conclusion
It is hard to construct an optimistic scenario. It is far more likely this crisis will not be resolved until 2012 – or later. Look for economic destitution accompanied by political conflict. Given the acceleration of this contraction, and the challenges listed above, a DOW under 5700 and a NASDAQ below 430 are perfectly feasible. These economic events will exacerbate the already deep philosophical divide between “Red” and “Blue” Americans. Debilitating cultural turmoil and bitter political confrontation are in the wind. No matter who wins the American elections, the next four years are going to be brutal.
But don't believe me. I could be wrong. Do your own homework.
And pray I am not being overly optimistic when I say – “We can get through this.”
Ronald R. Cooke
The Cultural Economist
Author: Detensive Nation
www.tce.name
Cultural economics is the study of how we interact with economic events and conditions. Culture, in this sense, includes our political systems, religious beliefs, psychology, history, customs, arts, sciences, and education. The term "Economics" refers to the extent and process of how we employ capital, labor and materials. If human existence is dynamic, then economics – as a science – must be able to characterize the interaction of culture and economics in contemporaneous terms.
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