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Generational Dynamics Web Log for 8-Apr-08
Investors have gone beyond "Bad news is good news."

Web Log - April, 2008

Investors have gone beyond "Bad news is good news."

Now it's, "The news is so disastrous, the worst must be over."

The news this past week was indeed disastrous:

The Swiss banking giant UBS AG wrote down a staggering $19 billion in additional assets. Deutsche Bank announced an additional $4 billion writedown.

Bankruptcy filings are soaring, as the economy degrades.

Corporate earnings continue to fall rapidly. (See below).

The unemployment statistics released on Friday are devastating. The economy lost 80,000 jobs in February, the worst decline since 2002. During the fourth quarter of 2007, the economy GAINED 241,000 jobs. In the first quarter of 2008, the economy LOST 232,000 jobs.

The UBS writedown, announced early morning (Wall Street time) on Tuesday of last week, should have caused sensible investors to sell stocks and put the cash under their mattresses. But investors are not being sensible.

Most dramatic is what happened on Tuesday, April 1, right after the devastating UBS announcement: Wall Street markets rocketed up 3-4%.

The reasoning that I heard several times was this: "The UBS writedown was so big and so unexpected that it's clear it's a 'kitchen sink' writedown. They must have taken every possible writedown in the most conservative way. That means it's the end of it. The worst is over. In fact, the end of all the writedowns is in sight."

The implication of this bizarre reasoning is that if the UBS writedown had been less severe, then it would have been worse news, since it would have meant that there are more writedowns to come.

Instead, the news was SO bad that it can't possibly get any worse, and so the worst must be over.

Do you think I'm joking, Dear Reader? I assure you that I am not. The inmates are in control of the asylum.

Here's what Fritz Meyer, senior market strategist at AIM Investments, said on Monday morning on CNBC:

"I thought the market scored a very impressive victory last week, and that was because Tuesday's huge move was on what normally is considered to be very bad news for these financial institutions, UBS and Lehman. And when you finally see that, when you finally see the market trading higher on what should be bad news, it has typically marked a pretty important inflection, and so that's the way I viewed it."

Well, that's an interesting way to view it.

A similar view on Monday morning was that of contributor Jack Bouroudjian, CNBC's resident fanatic Pollyanna. He was asked whether he thought Friday was a good day for the stock market -- the Dow had lost only 16 points, despite the devastating unemployment report. His amazing response:

"It felt like a great day, didn't it? One thing that we said when that number came out, if you remember, that had this number come out a couple of months ago we would have seen those futures down significantly, it would have been a disaster, it would have been one of those 400 point down days for the Dow. But something seems to have happened -- there's been a shift over the course of the last week or so. We are starting to see money that's on the sidelines starting to come into market. And the real key for me is what happens with some of these European fund managers that I've been talking to."

Bouroudjian is stating the obvious: That all the bad news "felt like a great day." Why is that? Because the news was so bad, that the worst must be over. Since the worst is over, it feels good.

Now let me once again repeat a quote from John Kenneth Galbraith's 1954 book The Great Crash - 1929:

"A common feature of all these earlier troubles was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune." (p. 108)

This is EXACTLY what's happening now.

The first time that I read this paragraph several years ago, I didn't really grasp what was going on, but now we can see it day after day. "What looked one day like the end proved on the next day to have been only the beginning." It's almost as if Meyer and Bouroudjian, the two people quoted above, were just copying their lines from Galbraith. What an INCREDIBLE situation!! These people are following the 1929 script as if it had just been written!

If you have a few minutes, take a look at my Dow Jones historical page. Look at what happened around the time of the 1929 crash, some of which is extracted here:

    1929: Daily change in Dow Industrials
    --------------------
    Mon 10-07 ( +6.32%)
    Tue 10-08 ( -0.21%)
    Wed 10-09 ( +0.48%)
    Thu 10-10 ( +1.79%)
    Fri 10-11 ( -0.05%)
    -------------------
    Mon 10-14 ( -0.49%)
    Tue 10-15 ( -1.06%)
    Wed 10-16 ( -3.20%)
    Thu 10-17 ( +1.70%)
    Fri 10-18 ( -2.51%)
    ------------------ 
    Mon 10-21 ( -3.71%)
    Tue 10-22 ( +1.75%)
    Wed 10-23 ( -6.33%)
    Thu 10-24 ( -2.09%) Black Thursday
    Fri 10-25 ( +0.58%)
    -------------------
    Mon 10-28 (-13.47%) Black Monday
    Tue 10-29 (-11.73%)
    Wed 10-30 (+12.34%)
    Thu 10-31 ( +5.82%)
    Fri 11-01  (Closed)
    -------------------
    Mon 11-04 ( -5.79%)
    Tue 11-05  (Closed)
    Wed 11-06 ( -9.92%)
    Thu 11-07 ( +2.61%)
    Fri 11-08 ( -0.70%)
    -------------------
    Mon 11-11 ( -6.82%)
    Tue 11-12 ( -4.83%)
    Wed 11-13 ( -5.27%)
    Thu 11-14 ( +9.36%)
    Fri 11-15 ( +5.27%)
    -----------------

Notice that the crash didn't just happen, and then everything went down from there. Notice that instead, the market spiked +6.23% just two weeks before Black Thursday, and it spiked +12.34% just two days after Black Monday.

If you go to the Dow Jones historical page, you'll see that the market went down almost continually until mid-1932, until it was down to just 10% of its peak value (on 3-Sep-29). But along the way, there were many days when the market spiked upward.

That's what's already happening, and that's what's going to be happening for the next 3-4 years. And those are the days when people like Meyer and Bouroudjian are going to go on CNBC and say that we're seeing a "pretty important inflection," and that it "feels good." Those are the days that people will say, "The market's finally going up again. Let me pour more of my savings into the market so that I can make all my money back." That's when politicians will say, "Prosperity is just around the corner."

That's what I've been calling the Principle of Maximum Ruin. As Galbraith says, "Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune." As in 1929, the market will ruin the maximum number of people to the maximum extent possible.

Let's not fool around. The news last week was disastrous, and there's absolutely no reason, except in the minds of those with financial sexual fantasies, to believe that the news will get any better.

As I've been saying for years, and summarized in "How to compute the 'real value' of the stock market," the market is overpriced by almost 250%, same as in 1929. It has nowhere to go but down, and it will go down, to the Dow 3000 range or lower. If it spikes up for one day or for one week, it still has to go down because it's way overpriced.

Finally, let's update our table of corporate earnings estimates. Each week, we add a line to the table indicating the estimates of first quarter corporate earnings as of that week.

Here's the summary from Friday from CNBC Earnings Central:

"Earnings Central Stats, as of Friday, April 4th:

28 companies in the S&P 500 have reported earnings for Q1, 75.00% have beaten estimates, 10.71% were in-line, and 14.29% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in first-quarter 2008, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -12.2% from -9.3%.

On January 1st, the estimated growth rate for Q1 was 5.7%. (Data provided by Thomson Financial)"

This allows us to add one more line to our table, as follows:

  Date    1Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct 23:             +10.0%
  Jan  1:              +5.7%
  Feb  6:              +2.6%
  Feb 29:              -1.1%
  Mar  7:              -4.3%
  Mar 14:              -7.8%
  Mar 21:              -7.9%
  Mar 28:              -9.3%
  Apr  4:             -12.2%

And here's a late flash: Monday is the first big day for announcements of actual first quarter earnings, and Alcoa Corp. announced a 54% FALL in earnings, well below analysts' expectations.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (8-Apr-08) Permanent Link
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Generational Dynamics Web Log for 8-Apr-08 Investors have gone beyond "Bad news is good news."

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Generational Dynamics Web Log for 8-Apr-08
Investors have gone beyond "Bad news is good news."