	Generational Dynamics
	Forecasting America's Destiny ... and the World's

\| HOME \| WEB LOG \| COUNTRY WIKI \| COMMENT \| FORUM \| DOWNLOADS \| ABOUT \|

Generational Dynamics Web Log for 24-Oct-07
Investor anxiety is palpably increasing on housing and earnings news

Web Log - October, 2007

Investor anxiety is palpably increasing on housing and earnings news

As credit crunch returns, will the Fed save the world again next week?

There's very little left of the bubbly optimism that you used to hear on CNBC. The anchors keep asking the same questions -- of each other and of the pundits they invite as guests: Should investors pay attention to the economy, to earnings, or to the Fed?

The economy. The thing that triggered the sharp selloff last Friday was an earnings report from Caterpillar. It included poor results and, more important, it predicted a slow economy in the future because of the collapse of the housing bubble. There was other bad news about the economy, including the increasing expectation that it will be a slow holiday season this year. This spooked investors on Friday, resulting in a 2.5+% stock selloff.
The main concerns about the economy center around the housing bubble collapse. Housing starts have been falling sharply, meaning increasing unemployment; foreclosures have been surging, meaning that banks and financial institutions will be losing money; home prices are falling, preventing people from borrowing money against their homes, as they've done in past years, so they can't use money from their homes to make large holiday purchases.
Last week I wrote an article, "Big banks discuss mind-boggling "M-LEC" superfund to bail themselves out." This article discussed how Citibank has set up an independent corporation, called a "Master-Liquidity Enhancement Conduit," that it and other banks could use to launder money, so that they could sell worthless mortgage-based securities to one another at artificially inflated prices. Citibank's M-LEC, also called a "Super-SIV" or "Super Structured Investment Vehicle" apparently didn't fool investors, much to my surprise, since investors seem willing to be fooled by anything. The financial community is extremely suspicious of the M-LEC, as well they should be.
This is all bad news. For some reason, investors panicked on Friday, and bad news was interpreted as (gasp!) bad news, and they sold off. By Monday, bad news was good news again, and the market rallied, even though there was an obvious level of anxiety.

Earnings. As I wrote in my 2005 article, "The 11% Solution," corporate earnings have historically grown at an average rate of 11% per year, but since the 1995 dot-com bubble started, corporate earnings have been growing at an average of 18% per year.
By the Principle of Mean Reversion, corporate earnings would have to reestablish the long term average. Since they'd been ABOVE 11% for over ten years, then have to be BELOW 11% for over ten years.
I've been waiting for something like that to happen since 2005, since it HAD to happen. Finally, third quarter results are in, and here's a summary from CNBC Earnings Central:

"As of Tuesday, October 23rd: 185 companies in the S&P 500 have reported earnings for third-quarter, 67.03% have beaten estimates, 10.27% were in-line, and 22.70% have missed. ... As of Friday, October 19th, the blended earnings growth rate for the S&P 500 in third-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, remains at -0.1%, below the 3.6% estimate from October 1st. On July 1st, the estimated growth rate was 6.2%. (Data provided by Thomson Financial)"

So third quarter earnings had been expected to grow 6.2% as of July, and 3.6% as of October. But now that actual results have been pouring in, earnings growth has been NEGATIVE: -0.1%.

Quarterly S&P 500 earnings growth, 2000-present, with estimates for Q4 and for 2008.

There is something VERY PECULIAR going on with earnings, as you can see from the adjoining graph. This is one more mind-boggling thing in an increasingly mind-boggling world.
Thomson Financial is the firm that provides these earnings growth figures. The adjoining graph shows the -0.1% growth in Q3 2007, but look at what comes after that: They're showing 10% earnings growth in Q4 and Q1!!
There's no way that they could have reached that conclusion, and I'm not the only person who's noticed this. Many financial pundits on CNBC have been wondering, "When is Thomson going to reduce those 10% earnings growth estimates for Q4 and Q1? Those rates will NEVER happen."
There's only one possibility: Thomson is purposely inflating its estimates to 10% so that investors will still be thinking in terms of "double digit earnings growth." In other words, it's another fraud, just like the M-LEC.
We've seen one example after another of these coverups and frauds this year. Bear Stearns purchased its own hedge funds' securities at artificial prices, in order to cover up the fact that they were worthless. Ratings agencies S&P, Moody's and Fitch deliberately overrated worthless mortgage-based securities in order to collect commissions from their customers.
This Thomson thing with the phony earnings growth estimates is just mind-blowing to me. These financial firms are defrauding the public in full view of the public. I'm almost tempted to say that I just can't get over this.
What's their excuse? I'm sure it would be, "If we told the truth, then investors would panic." Indeed.

The Fed. As I heard one pundit put it, "Investors believe that everything is going to be OK because the Fed will cut interest rates. Everyone knows that the Fed is on their side."
Last month, there was a surprise monetary loosening by the Fed and Bank of England. In particular, the Fed reduced interest rates by a full ˝%. This had an enormous psychological effect on investors. They hadn't been sure that the Fed would reduce interest rates at all, and were sure that if there were any reduction, it would be only Ľ%. The ˝% reduction caused an almost erotic euphoria among investors, and they pushed the stock market to new highs.
The Fed Open Market Committee (FOMC) will be meeting again on October 31. Expectations this time are much different. One pundit after another has said something to the effect that, "The Fed will, WITHOUT DOUBT, reduce interest rates by at least Ľ%."
The "credit crunch" that almost crashed the markets in August was averted by aggressive action by the Fed and by the Bank of England.
But the credit crunch isn't over. Apparently the Europeans are more aware of this than we are, as an article from the Telegraph entitled "New credit crunch looms" describes.
The Fed is in a difficult place. If the FOMC doesn't cut the interest rate at all, then investors, who have been counting on a cut, will immediately initiate a stock selloff, and the credit crunch will worsen.
If the Fed does a Ľ% reduction, then they won't give the economy any psychological boost at all, the kind of psychological boost that drove stock prices up last month.
And if the Fed does a ˝% reduction, then investors will be slightly surprised, though not nearly as much as last month. But more significantly, a ˝% reduction will cause the value of the dollar to fall even further on international markets, causing a whole new set of dangers and problems that we haven't even discussed.
So it will be interesting to see what the Fed does on October 31, and whether the Fed can "save the world" again, for the second time in two months.

From the point of view of Generational Dynamics, we're headed for a new 1930s Great Depression, as I've been saying since 2002, based on the stock market bubble. In 2002 I had no idea how it would unfold, but now we're seeing it.

What's amazing is how the financial community is using one artifice after another, many of them simply fraudulent, to postpone the inevitable, making the situation worse with each new artifice.

That's exactly what happened in 1929, as described by John Kenneth Galbraith in his 1954 book, The Great Crash - 1929, as follows:

"A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-21.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market." (p. 25)

This is exactly what's happening today.

I had to laugh on Tuesday morning, listening to Steve Liesman on CNBC talk about the M-LEC or Super-SIV. He said that an unnamed senior Fed official offers conditional support to the Super-SIV, provided that it's completely transparent, and that the securities being sold are at true market prices. So first off we can laugh at the fact that the Fed wants to support the project so much that they're willing to have an unnamed official say so on condition that his name isn't mentioned. Some support.

And what's the nature of the support? It's conditional, and depends on the securities being sold at true market prices, which of course everyone knows they won't be, because the whole purpose of the Super-SIV is to fraudulently sell them at unrealistically inflated prices.

So the Fed gets to eat its cake and have it too. They can support the Super-SIV at the present time, when it's expedient to do so, but only with an unnamed official; and later, when the whole thing blows up, they can say, "Well, yeah, we said it was OK, but ONLY if they sold the securities at market prices. We NEVER meant to support these fraudulent sales."

All these financial officials are covering their asses now, waiting until the inevitable crash occurs, and hoping that SOMEONE ELSE will be blamed. This would be fun to watch, if only the consequences weren't so disastrous. (24-Oct-07) Permanent Link
Receive daily World View columns by e-mail
Donate to Generational Dynamics via PayPal

Web Log Pages

Current Web Log

Generational Dynamics Web Log for 24-Oct-07 Investor anxiety is palpably increasing on housing and earnings news

Web Log Pages

Generational Dynamics Web Log for 24-Oct-07
Investor anxiety is palpably increasing on housing and earnings news