Markets fall as investors are increasingly unsettled by bad economic news - 21-Nov-07 - Generational Dynamics

Generational Dynamics Web Log for 21-Nov-07

Markets fall as investors are increasingly unsettled by bad economic news

Hopes for quick return to "normal" bubble growth are fading.

A strong signal that investors and pundits are becoming increasingly pessimistic is what might be called the "time horizon" effect -- when do pundits think that things will return to "normal"? Usually the pundits give a time horizon of a day or, at most, a week.

But listening to the pundits on CNBC on Tuesday and Wednesday gave a very different picture. I heard one and only one pundit say that he expects a "year-end rally." The rest were unanimous: People are not going to be buying stocks for the rest of year -- and that includes large institutional investors, as well as small investors with 401K's -- because they want to wait until things have "settled down" again.

One pundit said that he's hearing that investors won't buy again until the Dow Industrials index is below 12,000 -- 1,000 points below where it is now. He also said that it might happen within the next week.

Asian stocks fell sharply on Tuesday night / Wednesday:

    Australia All Ordinaries     6450.20     - 0.62%
    Bombay Sensex               18602.62     - 3.52%
    Hong Kong Hang Seng         26618.19     - 4.15%
    Japan Nikkei                14837.66     - 2.46%
    Shanghai Composite           5214.22     - 1.50%
    Singapore STI                3347.20     - 2.65%
    South Korea Composite        1806.99     - 3.49%
    Taiwan Weighted              8484.11     - 2.27%

According to the Wall Street Journal, Asian investors were concerned that the U.S. economy, the most important export market for many of the region's companies, would continue to weaken. It said that "the region took its cue from unsettled trading" on Wall Street on Tuesday, when the market closed slightly higher, but only after turbulent 250 point swings. The article quotes a Tokyo trader as asking, "What the heck were the wild ups and downs in New York?" saying that the trading pattern reflected the unsettled prospects for the market.

European stocks on Wednesday similarly fell sharply.

As I've said many times before, from the point of view of Generational Dynamics, what's important is changes in behaviors and attitudes of large masses of investors, entire generations of people. The ups and downs of the markets are not per se of concern, except insofar as the indicate changes in behaviors and attitudes.

What we're seeing now is what I had been expecting to see when I wrote my August 17 article entitled "The nightmare is finally beginning." I indicated that we were now on the road to a stock market crash in the near future. The exact timing couldn't be predicted, but the speculation was that it would happen by the end of September. However, unexpectedly aggressive Fed interest rate cuts caused a period of drunken euphoria among investors, and postponed the inevitable results.

The markets in the last few days have been following the 1929-like pattern that I was expecting in September, before it was redirected by the Fed interest rate cuts. The one major thing that we haven't seen yet is a large "crash upward" such the 6.9% Dow increase that occurred on October 7, 1929, two weeks before the crash. (See Dow Jones historical page.) At any rate, extreme caution is called for.

Something else that's becoming increasingly clear is that faith in the Fed is collapsing. In fact, faith in any "easy solutions" is collapsing. On October 15, the mind-boggling "M-LEC" announcement, which was supposed to calm jitters, only increased them. The October 31 Fed interest rate cut only caused investors to become more sober, instead of returning to drunken euphoria.

On October 24, I quoted a pundit as saying, "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."

No one says anything like that any more. The discussion about the Fed on CNBC on Wednesday morning was extremely negative. CNBC anchor Steve Lieseman expressed great concern that the Fed was contradicting itself on inflation, sometimes indicating that there's no problem, other times expressing concern. Another pundit described as "scary" the impression that the Fed was no longer setting policy, but was simply reacting to day by day events.

So, within the last 4-8 weeks, there has been enormous loss of hope in every direction. I can't recall hearing anyone describe any scenario that's going to make things better, except "waiting."

Before going on, I want to take a quick digression about the inflation rate, because I get a lot of questions about this.

There's a lot of obsessive fixation on the inflation rate because it's thought by many to be the key to the future. If the inflation rate is low, then the Fed can lower interest rates and "save the world" again; if the inflation rate is high, then the Fed can't risk lowering interest rates because that would raise inflation even more.

It's important to remember that there are two separate measures of inflation. They usually track each other closely, but they've been diverging in recent years.

The internal inflation rate is measured by the CPI (consumer price index). This measures how much your dollar is worth when you visit the grocery store or the clothing store.
I've been saying for several years that the CPI is on a long-term deflationary trend, and I expect the CPI to fall 30% or so by 2010. That's still my expectation. That means that your dollars will be increasingly valuable in the next few years. People who say "Get rid of all your dollars because they'll be worthless" are talking nonsense. Remember, you're still going to have to purchase groceries and stuff, so you're going to need cash.
(I apologize for being so America-centric in the above paragraph. However, the internal inflation rate will trend down just as sharply in most other countries, and for similar reasons. So the same remarks apply in other countries.)

The external inflation rate is measured by the foreign exchange markets. For example, the fall of the dollar against the euro has been dramatic. It was at 82 cents per euro a few years ago, and today a euro costs almost $1.50. The fall in the value of the dollar has been an important factor in the increases in commodity prices, particularly the cost of oil.
I've made no predictions about the external value of the dollar, or on the claim that the dollar will become "worthless" in international markets, since it depends at least partially on political factors, in America and in other countries.
However, writing about "The bubble that broke the world" has led me more and more to believe that even if the dollar weakens further, it will remain strong during the crisis. One web site reader pointed out to me that it took 50 years for the British pound to lose 80% of its value and status as the world's reserve currency.

The problem that the Fed has these days is because the dollar is internally deflationary, but is externally inflationary. That's why nobody understands the Fed's message on inflation. For those of you who are concerned about the value of the dollar, it's worthwhile keeping these considerations in mind.

That ends the inflation digression.

The 1929 stock market crash was not a one-day event. The stock market kept falling, month after month after month, for three years, until 1932, when it had fallen 90% of its peak value. (Paragraph corrected - 7-Apr-09)

One question that I've wondered about is the "mood" of investors during those years. During the last few years, we've seen the "euphoric" mood of bubblehead investors for whom every bit of bad news was good news, and every bit of good news was cause for chirps of joy.

Well, what was it like during the downturn years?

It may be what we're seeing now -- an increasing expectation of more and more bad news, a lengthening time horizon before the masses of investors expect good news to start again.

This is certainly something that pundits and investors and journalists are completelly oblivious to. The whole concept of investor mood is foreign to them, especially when it's related to generational concepts.

And yet, it's the key to understanding what's going on and what's coming.

In order to advance this a little farther, here's a graph of the Dow Industrials since 1950:

Generational 'moods' overlaying Dow Industrials since 1950

Generational 'moods' overlaying Dow Industrials since 1950

In the above graph, the red line is the Dow Industrials. The blue line is the exponential growth trend, computed since 1896, and represents the "real value" of the stock market. This provides a reference to whether the market is overpriced or underpriced at any given time.

What I would like to do is speculate on how investor "moods" change as generational changes occur.

What I especially want to focus on is the two "inflection points" on the DJIA graph. At each of these two points, the graph turns a sharp corner to the left, forming the letter "V". Mathematically, these are the points in 1995 and 2003 where the second derivative is discontinuous (or infinite, depending on how you look at it).

Things in nature tend to be continuous, unless affected violently by some external force. A rolling ball may slow down or speed up, but the change in speed will be continuous unless the ball hits a rock or a tree.

Similarly, we would expect the DJIA curve to continue in the same direction, perhaps gradually rising or lowering, but a sharp "V" cannot occur unless affected violently by some external force. And the most obvious choice of an external force is a generational change.

Thus, we provide theoretically the following generational investor "moods" from 1950 to the present:

Depression survivor mood: 1950 to 1995. The leaders in the nation's public and private organizations were survivors of the crash of 1929 and the Great Depression of the 1930s. They were very cautious, and very suspicious of credit. During this period, the DJIA oscillated fairly close to the long-term trend line.
The Depression era survivors exerted leadership in global financial institutions. These leaders included those in the Silent Generation, the "depression babies" and "war babies" who grew up during the horrors of the Great Depression and World War II. They were in charge until the early 1990s, when they all disappeared (retired or died), all at once, leaving behind a new generation of younger leaders with little or no fear of credit.

Boomer Euphoria: 1995 to 2000. The Baby Boomers were the first generation born after WW II. In common parlance, the Boomer generation starts with those born in 1946, but in generational theory it starts in 1942, because anyone born after that time has no personal memory of WW II.
The phrase that I'm going to apply to Boomers is: "passively destructive."
As I've described many times on this web site, Boomers have no ability to govern or lead. Their parents had been taking care of them their whole lives. All that the Boomers ever did was argue with and humiliate their parents, as happened in the 1960s with the "generation gap."
This is the explanation for the dot-com bubble in the 1990s. Boomers didn't actively create the bubble; they passively let it happen by removing decades-old restrictions, imposed by their parents, on the types of investments that they'd allow themselves to make. There was no destructive intent to harm other people. The destruction was passive.

Boomer Panic: 2000-2002. The bursting of the dot-com bubble changed the Boomers' euphoria to panic.
There's really little difference between euphoria and panic, since both are totally emotional. They correspond respectively to the manic and depressive phases of bipolar disease. The symptoms may be different, but it's the same disease.

Generation-X Euphoria: 2002 to September, 2007. There was a distinct change in 2002, and it was a generational change, but it appears to have been a different kind of generational change than the one that occurred in 1995.
There's little doubt that it was in 2002 that the real abuse of credit began. There had been things like credit derivatives around before, but it was in 2002 that the really explosive use of "structured credit" began.
The Boomers were still nominally the leaders, but, as before, they didn't want to lead. The Gen-Xers stepped up and took charge.
Here's what PIMCO's Bill Gross said recently in his monthly column:

"During times of market turmoil it helps to simplify and get basic � explain things to a public and even yourself in terms of what can be easily understood. Goodness knows it�s not a piece of cake for anyone over 40 these days to understand the maze of financial structures that now appear to be unwinding. They were created by youthful financial engineers trained to exploit cheap money and leverage who showed no fear and who have, until the last few weeks, never known the sting of the market�s lash. They are wizards of complexity. I, however, having just turned 63, am a professor of simplicity."

A web site reader put it a little differently. "Only Gen-Xers would have the technical sophistication to devise these complex, opaque and (consciously or not) dangerously deceptive models that the CDOs use. Few Boomer men can even type, let alone write software."
If the Boomers were "passively destructive," the Xers have been "actively destructive," creating these complex financial structures.
Much of what the Xers did was fraudulent, illegal, and contemptuous of the entire global financial system. I've pointed out several examples of fraud on this web site, especially fraudulent methods used to avoid having to apply "mark to market" to overpriced CDOs.
In fact, the number of legal actions is increasing. As time goes on, we're going to see more and more criminal prosecutions against everyone from individual homeowners who lied on their applications to mortgage brokers to major financial institutions.
Generation-Xers are the name for the generation born roughly between the early 1960s and the early 1980s. In generational theory, they belong to the Nomad archetype, the generation of people born during a generational Awakening era. Bill Strauss and Neil Howe, the founding fathers of generational theory, found that those in Nomad generations become disaffected and angry, growing up in the shadow of the favored Prophet generation (like America's Boomers).
In 2002, the first wave of Gen-Xers reached the age of 40, and were in sufficiently high leadership positions that they could influence and often control the financial decisions of many organizations, especially since their Boomer bosses just let them do what they want anyway.
I've spent a lot of time since the beginning of this year trying to figure out what's been going on. Once you really begin to understand what's going on with securitization of credit, credit derivatives and CDOs, you realize what a totally debauched, depraved and abusive design they are. This is no simple passive mistake -- that's what the dot-com bubble was. This was a massively destructive and self-destructive financial architecture, devised by nihilistic financial engineers on the edges of the Generation-X generation. This was active destruction at its most debauched and depraved, condoned by passively destructive Boomers. We're now about to pay a very, very expensive price.

Generation-X Panic: September, 2007, to ????. It appears now that Gen-Xers are just beginning to panic. The market is on a steady downward trend, and it appears that this will continue. There hasn't been a generational panic yet, but indications are that it's coming close.

Don't think that I'm saying that Boomers are good and Xers are bad. Both are pathetically bad, but it's their interaction, the way they complement each other, that results in the destruction we're headed for.

The above is a first pass at a generational explanation of what's going on. As time goes on, and as more information and more criminal prosecutions become known, I'll try to expand and refine it.

Finally, a web site reader has sent me, "for my reading pleasure," the address of a web page containing statements of journalists, pundits, financiers and politicians from the years 1927 to 1933.

Here's the list -- and remember that the crash began on October 24, 1929, and continued for three years, until mid-1932:

"We will not have any more crashes in our time." - John Maynard Keynes in 1927

"I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future." - E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928

"There will be no interruption of our permanent prosperity." - Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928

"No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment...and the highest record of years of prosperity. In the foreign field there is peace, the goodwill which comes from mutual understanding." - Calvin Coolidge December 4, 1928

"There may be a recession in stock prices, but not anything in the nature of a crash." - Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929

"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months." - Irving Fisher, Ph.D. in economics, Oct. 17, 1929

"This crash is not going to have much effect on business." - Arthur Reynolds, Chairman of Continental Illinois Bank of Chicago, October 24, 1929, Black Thursday.

"There will be no repetition of the break of yesterday... I have no fear of another comparable decline." - Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929

"We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices." - Goodbody and Company market-letter quoted in The New York Times, Friday, October 25, 1929

"This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan... that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years." - R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929, two days after Black Monday.

"Buying of sound, seasoned issues now will not be regretted" - E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

"Some pretty intelligent people are now buying stocks... Unless we are to have a panic -- which no one seriously believes, stocks have hit bottom." - R. W. McNeal, financial analyst in October 1929

"The decline is in paper values, not in tangible goods and services...America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin." - Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929

"Hysteria has now disappeared from Wall Street." - The Times of London, November 2, 1929

"The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before." - Business Week, November 2, 1929

"...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation..." - Harvard Economic Society (HES), November 2, 1929

"... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall." - HES, November 10, 1929

"The end of the decline of the Stock Market will probably not be long, only a few more days at most." - Irving Fisher, Professor of Economics at Yale University, November 14, 1929

"In most of the cities and towns of this country, this Wall Street panic will have no effect." - Paul Block (President of the Block newspaper chain), editorial, November 15, 1929

"Financial storm definitely passed." - Bernard Baruch, cablegram to Winston Churchill, November 15, 1929

"I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress." - Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929

"I am convinced that through these measures we have reestablished confidence." - Herbert Hoover, December 1929

"[1930 will be] a splendid employment year." - U.S. Dept. of Labor, New Year's Forecast, December 1929

"For the immediate future, at least, the outlook (stocks) is bright." - Irving Fisher, Ph.D. in Economics, in early 1930

"...there are indications that the severest phase of the recession is over..." - Harvard Economic Society (HES) Jan 18, 1930

"There is nothing in the situation to be disturbed about." - Secretary of the Treasury Andrew Mellon, Feb 1930

"The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity." - Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

"... the outlook continues favorable..." - HES Mar 29, 1930

"... the outlook is favorable..." - HES Apr 19, 1930

"While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us." - Herbert Hoover, President of the United States, May 1, 1930

"...by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..." - HES May 17, 1930

"Gentleman, you have come sixty days too late. The depression is over." - Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930

"... irregular and conflicting movements of business should soon give way to a sustained recovery..." - HES June 28, 1930

"... the present depression has about spent its force..." - HES, Aug 30, 1930

"We are now near the end of the declining phase of the depression." - HES Nov 15, 1930

"Stabilization at [present] levels is clearly possible." - HES Oct 31, 1931

"All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S." - President F.D. Roosevelt, 1933

It was only in mid-1932 that the stock market began to gain again, having fallen 90% from its 1929 peak. (21-Nov-07) Permanent Link
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Generational Dynamics Web Log for 21-Nov-07 Markets fall as investors are increasingly unsettled by bad economic news

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Generational Dynamics Web Log for 21-Nov-07
Markets fall as investors are increasingly unsettled by bad economic news