A special strategy meeting for Tibetan exiles will occur in
mid-November.
This little-reported story that may have important significance in a
few weeks.
The Dalai Lama is changing his position from one of preaching
conciliation, compromise and tolerance with China into something
that's a lot more confrontational.
The Tibetan spiritual leader shocked observers last weekend for his
unusually blunt statement.
On Saturday, the Dalai Lama told a public function in his exile location, Dharmsala, India,
that he has "been sincerely pursuing the middle way approach in
dealing with China for a long time now but there hasn't been any
positive response from the Chinese side." He added: "As far as I'm
concerned I have given up."
In an interview on Thursday with the BBC, he made the following
bitter statement:
Dalai Lama describes his faith in China's government. (Source: BBC)
"My faith in China's government has become tiny,
tiny, tiny.
Our main aim has been to improve conditions inside Tibet. That
has not happened. Now the suppression is much, much increased -
very, very tight control, something like military occupation -
like that. Sometimes I feel like the Tibetan people are passing
through a death sentence - something like that."
He's called an extraordinary mid-November meeting of Tibetan exile
leaders to discuss future strategy. One possible outcome, though far
from certain, would be a call for full Tibetan independence.
Ironically, this call for independence would do little to stir up the
Tibetans, since the Tibetans are in a generational Unraveling era. The most you could expect from the
Tibetans would be a few demonstrations, and perhaps some scattered
violence.
But the Chinese have the most nationalistic, paranoid government on
earth. It's quite possible that the Chinese Communist Party (CCP)
will take this change of strategy as a major threat, and will
overreact.
The Chinese DID overreact last March, with an extremely violent crackdown on demonstrating Tibetan
monks. Worldwide attitudes towards the Chinese became increasing
angry and xenophobic until May, when a massive earthquake in Sichuan province created a period of
good will that lasted through the Olympics game in August.
The girls were all giggly today on CNBC and Bloomberg tv, as
investors poured money into the market, pushing the Dow Industrials
index back above 9,000 that really took off furiously in the last
hour of trading.
There was an 11% surge two Mondays ago, and since then there have
been several large falls. The volatility and wild swings seem to be
growing. I've been expecting these wild swings for some time, as
they occurred just prior to the 1929 crash.
There was plenty of bad news around on Tuesday.
According to one report, U.S. consumer confidence has dived to the lowest
reading since the survey was started in 1967. According to another report, housing prices fell at the fastest pace on
record, as foreclosures continue to climb.
There was one piece of news which some might interpret as very good
news: Sales of long-term commercial paper soared to a historic record
on Monday, as companies sold 1,511 issues totaling a record $67.1
billion of the debt due in more than 80 days, compared with a daily
average of 340 issues valued at $6.7 billion last week,
Commercial paper (CP) is the most common way for a corporation to lend
money to another corporation. The corporation issues CP notes,
and a purchaser loans money by purchasing the CP. Later, the
purchaser sells the CP back for cost plus interest.
Sales of commercial paper have plummeted since the credit crisis
began in August, 2007, since no one wanted to buy it. Thus, the Fed
began buying CP on Monday, as part of the $700 billion bailout. The
program was spectacularly successful, at least for one day, and
investors showed their pleasure on Tuesday. It remains to be see
whether the credit crisis continues to soften.
Crashing corporate earnings
However, the long-term trend that I've been reporting on for a long
time took a nose-dive on Tuesday.
As regular readers know, for the last few quarters I've been posting
the table of S&P 500 average corporate earnings estimates, based on
figures from CNBC Earnings Central supplied by Thomson Reuters. These tables
have shown sharp falls in corporate earnings estimates from week to
week.
Actual earnings have been pouring in since mid-October. For a while,
it seemed that third quarter earnings growth estimates were
stabilizing around -10% (that is, 10% lower than third quarter
earnings for last year).
However, the estimate posted on Tuesday suddenly fell off a cliff:
Date 3Q Earnings growth estimate as of that date
------- -------------------------------------------
Mar 3: 25.0%
Apr 1: 17.3% Start of previous (2nd) quarter
Jul 1: 12.6% Start of quarter
Sep 5: 0.8%
Sep 12: -1.6%
Sep 19: -0.3%
Sep 26: -1.7% End of quarter
Oct 3: -4.8%
Oct 10: -7.8%
Oct 15: -9.8% Wednesday
Oct 16: -10.3% Thursday
Oct 17: -9.1% Friday
Oct 20: -9.6% Monday
Oct 21: -9.9% Tuesday
Oct 22: -10.0% Wednesday
Oct 23: -10.9% Thursday
Oct 24: -11.0% Friday
Oct 27: -11.3% Monday
Oct 28: -23.8% Tuesday
Investors had been particularly hopeful that the third quarter would
be the end of the falling earnings. Third quarter earnings had
fallen in 2007, and so there was a lower base to build on this year.
Investors had hoped that, because of the lower base, earnings would
actually grow 25-50% above last year's depressed earnings.
But no such luck. In fact, earnings growth has been negative for
several quarters in a row now, and this quarter is turning out to be
among the worst.
As usual, a fall in earnings estimates means an increase of
price/earnings ratios estimates.
There's a price/earnings ratio chart at the bottom of this web site's
home page, and it gets updated automatically every Friday. Here's
last Friday's version of the chart:
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 24-Oct-2008. (Source: MarketGauge ® by DataView, LLC)
As you can see, the P/E ratio index was at 18 for several years,
which is well above the historical average of 14. In fact, the index
has been above average for 13 years, since 1995, and by the Law of
Mean Reversion, this means it has to be equally below average for
roughly the next 13 years.
Starting in March, however, the P/E index is spiked upward again, to
astronomical levels in the 20s. This was when first quarter actual
earnings were coming in. But investors believed that they should be
ignored; the common wisdom was that the credit crisis would be over
by the fall (i.e., now), and that earnings would grow in the third
and fourth quarter by 25% and 50%, respectively.
Because of that widely held belief, investors pushed the P/E index up
into the 20s. Finally,
It's only in the last three weeks that it came back down to 18. This
was thanks to the stock market losing 25% of its value in the last
three weeks.
Tuesday's events -- a 10.8% increase in the S&P index, and a fall in
earnings growth estimates to -23.8% -- will push the P/E index
temporarily into the astronomically high 20s again, until a new
collapse brings it down again.
The pundits don't see it that way, however. "This may be the sign of
a turnaround. Maybe people are coming out of the woodwork again, and
buying stocks." Idiots.
Why are the dollar and the yen getting stronger, while the euro is
getting weaker?
Investors and government officials worldwide are breathing easier
this weekend, because Wall Street didn't completely melt down on
Friday, as had been feared. Friday and Saturday may be the first
times they slept through the night for a week.
But they won't be sleeping well on Sunday night, or probably any
night this week.
Stock markets around the world have fallen very far from their recent
highs, most of which were reached late in 2007. Here's list compiled by the LA Times:
Iceland -88.7%
Russia -73.9%
Ireland -73.4%
Peru -73.2%
Vietnam -70.5%
China -69.8%
Poland -62.6%
Hong Kong -60.1%
Brazil -57.2%
Egypt -56.9%
Italy -55.2%
South Korea -54.5%
Turkey -58.5%
India -58.3%
Singapore -58.2%
Japan -58.1%
Mexico -48.3%
Germany -47.0%
Spain -46.4%
U.S.-S&P 500 -44.0%
Australia -43.3%
Great Britain -42.3%
There are other things going on, besides stock markets crashing all
around the world. Commodity prices are falling 50% or more, and the
Baltic Dry Index, which measures costs for shipping iron ore, copper,
and similar commodities, has fallen almost 90%.
To get a better picture of what's going on in the world, here's an
interview with Simon Rose, CEO Dahlman-Rose, who's been to
Singapore recently, and has had a view of international shipping
trade. This is my transcription from Bloomberg tv.
"Rose: I spent about a week in Singapore, a lot of
time in the port, no activity. No activity at all. They've ground
to a halt.
I can give you anecdotal information, and I can give you factual
information.
Q: Start with anecdotal information
Rose: Anecdotally, I spent two days driving around two of the
biggest ports in Asia, and saw very little activity. Very little.
Ships loading, unloading - very little activity.
Factually, the BDI [Baltic Dry Index] is down around 90% this
year, and it confirms what I saw with my own eyes.
It's really very simple. You can watch the BDI, you can watch
commodity prices, you can watch the stock market -- they all
depend on the credit market.
You cannot get credit to load a cargo and bring it from point A
to point B. Credit does not exist. 60 sovereign countries
cannot get a letter of credit to buy oil.
Q: Are we close to hitting bottom?
Rose: I think it's really simple. I take a leading economic
indicator from cab drivers. I asked the cab driver in Singapore
what the problem is. He said, "You don't lend money to people
who don't pay it back."
No one can buy anything, because there's no global trade right
now, and so until we unfreeze the credit markets, and people can
get a counterparty and help them buy oil, and deliver it from
point A to point B, there's not going to be a lot of commerce.
So, watch the credit market. A lot of people are focusing on
Libor.
I'm far less focused on Libor. You know why? The banks can
borrow from the central bank. They don't need to borrow from one
another.
So banks are borrowing from the central bank, but where's the new
credit? Banks are struggling to find the capacity to finance the
loans they've already promised, let alone new loans.
Q: Should investors be looking for bargains to buy shipping
stocks?
Rose: These companies have all been hit by a tsunami that was not
of their making. All of a sudden, they cannot get credit to load
ships. This is not the ship owners' fault. Our analyst
downgraded the group over the summer, based on the price of
commodities coming down, which was an indicator for him of ship
cargoes going down as well. He did a great job.
How do you figure out what the bottom is? Watch the credit
markets. When the credit markets open, there'll be enormous
buying opportunities. ... There's been huge wealth destruction,
as a result of the credit markets being seized. When the credit
markets open, then we'll have an idea of what real value is in
the marketplace."
We could point to many more individual national and global trends, in
areas like real estate and employment in countries around the world,
and generally they're all trending downward. All of them are
reinforcing each other, in a very broad picture of a worldwide economy
that's plunging downward with incredible momentum.
It's like a hundred-ton rock rolling downhill. There's nothing that
can stop it.
Certainly the $700 billion Washington bailout hasn't slowed it down
at all, and has had almost no noticeable effect whatsoever.
There's a very easy way to see this: If the bailout were easing the
credit crisis in any meaningful way, it would be touted by government
leaders around the globe, and it would be worldwide front page news.
Instead, all we've heard about is a barely significant fall in the
Libor interest rates, and even that's ending, as Libor is now inching
back up.
Why didn't the bailout work?
Starting in 1995 with the dot-com bubble, the world began creating
more money through the creation of bubbles. It's hard to measure
exactly how much money was created, but we can take some reasonable
guesses.
The dot-com bubble of the late 1990s probably created around $1
trillion in new money, through stock options, stock appreciation,
venture capital, and similar things. However, a lot of that $1
trillion was destroyed with the Nasdaq crash that began in the year
2000.
The dot-com bubble was an almost pure Boomer play. The major bubbles
formed when the Generation-Xers were filling middle-management
positions throughout the economy, in the early 2000s.
Fraud and deception took place at all levels. At the lowest level,
homebuyers lied on loan applications, builders, appraisers and
brokers lied about property values, and loan brokers lied about
verifying application claims. At upper levels, "financial engineers"
took the fraudulently created loans and securitized into
collateralized debt obligations (CDOs) and other securities that have
turned out to be worthless. They took fat commissions to sell these
worthless securities, and they received cooperation from ratings
agencies who took fat commissions to give them phony AAA ratings, and
from "monoline" insurance agencies who took fat commissions to give
them phony insurance.
We can make some reasonable guesses that the real estate bubble
created about $5 trillion in new money, through inflated real estate
prices. The securitization process created $25 trillion in CDOs and
other near-worthless mortgage-backed securities.
Then we have the insurance contracts, the credit default swaps, or
CDSs. There are about $60 trillion of those in portfolios around the
world.
Finally, we have other credit derivatives of various kinds. These
add up to about $1 quadrillion (1,000 trillion dollars), according to
the Bank of International Settlements (BIS).
And so, depending on what you count, the credit bubble has been
bloated with at least tens or hundreds of trillions of dollars in new
money, mostly in the form of bad securities.
Pieces of this credit bubble have been leaking. The real estate
bubble began deflating in 2005. CDOs and other mortgage-backed
securities began to be revalued early in 2007. By late 2007, the
stock market bubble began deflating. Early in 2008, there was the
Bear Stearns rescue, followed by a number of other financial services
bailouts, bankruptcies and mergers. In the last few months, the rate
of forced selling by hedge funds, and withdrawals from money market
and mutual funds has been increasing.
So we had a period of several years where the credit bubble grew to
hundreds of trillions of dollars, probably adding a few trillion
dollars per week, at the height of its growth.
Today, I would guess that the same credit bubble is deflating at the
rate of $1 trillion or more per week.
So now we have a $700 billion bailout, 7/10 of $1 trillion. That
amount of money disappears every three or four days.
So there isn't a snowflake's chance in hell that any bailout can
possibly keep up the leaking of the credit bubble. It is literally
impossible.
That's why every bailout must fail.
Bernanke will do whatever is necessary
A forum member claimed that there would be no stock market crash
because Fed Chairman Ben Bernanke would do whatever is necessary to
prevent it. He quoted from a 2002 Ben Bernanke speech to prove his point:
"Although a policy of intervening to affect the
exchange value of the dollar is nowhere on the horizon today,
it's worth noting that there have been times when exchange rate
policy has been an effective weapon against deflation. A striking
example from U.S. history is Franklin Roosevelt's 40 percent
devaluation of the dollar against gold in 1933-34, enforced by a
program of gold purchases and domestic money creation. The
devaluation and the rapid increase in money supply it permitted
ended the U.S. deflation remarkably quickly. Indeed, consumer
price inflation in the United States, year on year, went from
-10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in
1934.17 The economy grew strongly, and by the way, 1934 was one of
the best years of the century for the stock market. If nothing
else, the episode illustrates that monetary actions can have
powerful effects on the economy, even when the nominal interest
rate is at or near zero, as was the case at the time of
Roosevelt's devaluation."
It really depresses me to read this speech, because it exhibits such
a shallow understanding of the 1930s Great Depression from a man who
is theoretically the world's leading expert on it.
The 1920s stock market bubble was smaller, by several orders of
magnitude, than the credit bubble that we have today, and so the
deflationary spiral that followed the 1929 crash was not as big as
the one we're facing.
Bernanke talks about inflationary measures that were taken in
1933-34. Well, that was 4-5 years after the deflationary spiral had
begun. By that time, the deflationary spiral had run its course, and
reflation would have begun no matter what FDR had done.
By contrast, Bernanke has opened the liquidity floodgates in this
past year, right at the beginning of the deflationary spiral, and it's
done almost nothing to stop the deflationary spiral today. Perhaps,
if he's lucky, President Obama can find a way to take credit for
reflating the currency when its time comes, around 2012-13.
Let Bernanke try anything he wants. It will accomplish nothing.
Why is the dollar more valuable?
A lot of people have been predicting that the current crisis is going
to make the dollar become worthless. Some have predicted
hyperinflation, along the lines of Germany in the early 1920s, or
Zimbabwe today.
But there was no deflating credit bubble in either of those two
cases. The reason that the dollar is becoming more valuable is
because there's less money in the world every day, and so the dollar
is becoming scarcer. As the dollar becomes scarcer, it becomes more
valuable.
I hear politicians and financial ideologues (especially from the
so-called "Austrian school") that apply 19th century concepts to the
current situation and conclude that the dollar will become worthless.
That might be true in the absence of a deflating credit bubble, but
it is not true today.
Thus, there should be no surprise at all that the dollar continues to
strengthen sharply against almost all currencies (except the yen),
and also continues to strengthen against "safe havens" like gold.
When I make statements like this, people accuse me of being
nationalistic. That has nothing to do with it. The strengthening of
the dollar has to do with only one thing: The leaking of the credit
bubble, resulting in a deflationary spiral that strengthens the value
of the dollar.
Here's a question from the forum:
"If money is scarcer, and on the basic laws of
supply and demand why does it not lead to inflation? The less
money there is the more expensive it will become leading to
inflation."
To understand this, you have to look at the dollar from the point of
view of another currency, like the euro or yen.
If you hold euros, and you want to buy dollars, and dollars are
getting scarcer and scarcer, then by the law of supply and demand the
price of dollars in euros is going to increase, which means that
dollars become more valuable relative to the euro.
Therefore, the exchange rate (euros per dollar) will go up, meaning
that it's the euro that's inflating relative to the dollar, while the
dollar is deflating relative to the euro.
Here's another question from the forum (paraphrased):
"You describe "falling prices" [deflation], but
here in the EU the situation is different.
Namely, 6 months ago the oil prices was double what they are
today ($140 per barrel, against $70 roughly today). But, at the
gas stations this nice reduction of prices - is NOT seen. The
reduction is about 20-25% (at most!)"
The deflationary spiral is caused by the deflating of the massive
credit bubble, and that was created by securitization of various
kinds of flaky investments. Depending on how you count it, the
credit bubble created tens or hundreds of trillions of dollars, or
even $1 quadrillion.
However, all of these securitizations -- CDOs, CDSs, etc. -- all of
them were denominated in dollars. Thus, the deflationary spiral now
applies only to the dollar. As the credit bubble collapses, there
are fewer and fewer dollars in the world, and dollars become more
valuable relative to other currencies.
Thus, as expected, we've seen the dollar strengthen sharply against
other currencies (except for the yen). In the case of the euro, the
exchange rate was close to $1.60 a few months ago, and is now close to
$1.30.
So there are two different things going on. The commodities prices,
as denominated in dollars, have been falling sharply. But with other
currencies weakening against the dollar, commodities prices
denominated in those currencies have been falling far less.
So if we just take some round numbers, the fall in the price of oil
in terms of the dollar is (1 - 70/140) = 50%.
In terms of the euro, it's 1 - (70/140 * (1.60/1.30)) = 38%.
That 38% is still a fairly large fall, and so you should have seen
reductions at the gas pump, but not as great as at dollar-denominated
gas pumps.
Beyond that, most countries charge fairly hefty tax rates for gas,
you might want to check whether tax rates have changed in your
country in the last few months.
Here's another reader question:
"I have a question about this. The Bretton Woods
agreements caused all foreign central banks now hold mostly
dollars in reserve. If the dollar becomes twice as valuable, then
does that mean that the central banks can issue twice as much
foreign currency?"
The easiest way to understand it is as follows: The dollar becomes
scarcer, and therefore more valuable. So if another central bank
wants its currently to maintain parity with the dollar, it would have
to make that currency equally valuable, by withdrawing the currency,
and making it scarcer. Of course, that would be politically
impossible.
Here's another comment posted by a forum member:
From: Peter Schiff
To: j8272@aol.com
Sent: Tue, 21 Oct 2008 4:28 pm
Subject: RE: Dollar discussion
I disagree in that the dollar is intrinsically worthless and will
approximate that value based on the policies we are
perusing.
"This is a response received from Peter Schiff regarding the
dollar's eventual decline. At some point the bubble in
treasuries will pop and the rest of the world will discontinue
financing the USA debt and unfunded liabilities."
This claim makes absolutely no sense at all.
The US owes China, Japan and other countries $5 trillion.
If those countries were to take actions to destroy the value of the
dollar, then the US would owe these countries nothing, since the
debts are denominated in dollars.
China, Japan and the other countries will look for ways to bail out
the US, just as the US bailed out many other countries in the past.
They will do this not because they give a sh-t about Americans, but
because they'll see it as the only way to save their own economies.
As a final point, you have to separate the fate of the US from the
fate of the dollar. The fact that the US is in debt does not mean
that the dollar becomes worthless.
If you haven't read the fascinating story of "The bubble that broke the world," then now is a good time to do so. It's the story of
what happened in 1930 and 1931, when the world's central bankers got
together to save the world from financial collapse.
However, when you read that story, and compare to the situation
today, remember that America was a creditor nation in 1931, but a
debtor nation today. The debtor nation in 1931 was Germany, and the
creditor nation today is China. Thus, we should expect China today
to act like America in 1931, and America today to act like Germany in
1931.
Central bankers in Britain, the US and France got together with a
plan to prevent the financial collapse of Germany by injecting huge
amounts of liquidity into the European banks. It worked for a while,
but not for long.
Why is the yen strengthening?
If you look around the world at the major currencies, almost all of
them are weakening against the dollar. The major exception is the
Japanese yen, which is strengthening against almost every currency,
including the dollar. Why is that?
The answer is that the yen is still suffering from Japan's own
deflationary spiral. As I wrote recently, there was a huge stock market bubble in Japan in the
1980s, beginning around 1984. There was also a huge real estate
bubble and, at its height, the total price of all property in Tokyo
was greater than the total price of all property in the entire United
States. That's how huge the Japanese bubble was.
Japan's generational stock market panic and crash occurred in 1990s,
and the yen went into a deflationary spiral that last 16 years. In
some ways, it's still continuing. So the yen is still on a roughly
deflationary path, although at the end of that path.
And so the dollar is strong because it's at the beginning of a
deflationary spiral, and the yen is strong because it's at the end of
a deflationary spiral. This is not true of other currencies, and so
other currencies are weakening against the dollar and the yen.
The euro and the Emerging Market Bubble
The main problem with the euro currency is that it's so new.
The euro currency, which only really came into existence in 1999, has
not yet had enough time to gain stature as a full-fledged major
international currency. In fact, it's always been possible for any
individual euroland country to back out of the euro and return to its
national currency, as I described in 2004, based on a Morgan Stanley report. (Can you imagine any US
state trying to back out of the dollar currency, and print its own
money?)
There's really no central control for the euro currency. Each
country still has its own central bank and its own policy for
printing euros, and some European countries (like Switzerland and
Britain) don't even use the euro as an official currency.
The Europeans like to brag that, although they've had problems with
investments in near-worthless mortgage-backed securities, they didn't
risk nearly as much as the Americans did in the real estate bubble.
Well, it turns out that there's a completely different bubble that
they did invest in: The Emerging Market Bubble.
While America invested $5 trillion in a real estate bubble, the
Europeans invested $4.7 trillion in bonds from emerging market
countries that will never repay the loans. These emerging market
countries are in Eastern Europe, Latin America, and Asia.
Now that many of the emerging market stock markets are crashing (see
list earlier in this article), the loss in value of these investments
is creating tensions within euroland.
Austria's banks, for example, are heavily invested in Hungary,
Ukraine, and Serbia -- countries that are close enough to bankruptcy
that they're appealing for help from the IMF.
Banks in Switzerland, Sweden, Britain and Spain have invested
astronomical amounts in Latin American bonds -- bonds that have
little or no chance of repayment, as countries like Argentina and
Brazil head for a freefall.
Because different euroland countries have different exposures, and
because different euroland countries can set different banking
interest rates, the opportunity exists for these interest rate
differences to widen significantly, allowing enormous opportunity for
exploitation by hedge funds.
Hans Redeker, currency chief at BNP Paribas, says that, "The system is paralysed, and it is starting to look
like Black Wednesday in 1992. I’m afraid this is going to have a very
deflationary effect on the economy of Western Europe. It is almost
guaranteed that euroland money supply is about to implode."
What's coming next
The implosion of the euro is just one part of the massive event
that's about to occur. This is the "generational panic and crash,"
the first since 1929, and now apparently very close.
Here's how I've described it several times in the past:
"A generational crash is an elemental force of
nature, like a tsunami.
You'll have millions or even tens of millions of Boomers and
Generation-Xers in countries around the world, never having seen
anything like this before, not even believing it was possible, and
in a state of total mass panic, trying to sell all at once.
Computer systems will crash or will be clogged for hours, or
perhaps even for a day or two. People who had hoped to get out
just as the collapse is occurring will be totally screwed, and
will lose everything. Brokers and other institutions will go
bankrupt."
In the article I wrote about this
last week, I quoted Nouriel Roubini, who is expecting officials to
have to shut down markets for a week or two, and I quoted Art Cashin,
who is expecting a "dramatic climax" within the next few days.
Cashin works for UBS AG as a floor manager, one of the old-timers on
the New York Stock Exchange floor. He probably talks to hundreds of
people a day, and reaches conclusions based on those conversations.
What he's sensing is that something very big is coming. I heard him
again when he was being interviewed late Friday, and he said that he's
expecting "something major, something that will be remembered for
generations."
From the point of view of Generational Dynamics, here's what to
expect for the near future:
A massive "generational panic and crash," such as has already
been described.
A continuing fall in the stock market and other markets for
several years, probably reaching as low as Dow 1500-2000.
A deflationary spiral that will make many goods much cheaper --
since few people will be able to afford to buy them at any
price.
A substantial increase in bankruptcies, foreclosures,
homelessness and starvation around the world, including the US.
Increased restlessness among starving populations around the
world, leading to a breakdown of civil order in many places, followed
by the path to world war.
A lot of the discussion going on in Washington these days is on the
question of what new regulations to develop in order to prevent this
disaster from ever happening again.
From the point of view of generational theory, this is a joke.
Nobody today would make try to securitize debt the way it was being
done just last year, and if they tried, no one would buy the
securities. People today are far more risk-averse, just as the
survivors of the Great Depression were.
The survivors of the Great Depression passed new laws and regulations
to make sure that nothing like the 1920s bubble would ever occur
again. In fact, preventing another stock market bubble was the
primary responsibility of the SEC, but nobody even cared when they
failed to prevent the dot-com bubble.
So let them pass all the new rules and regulations they want. Those
new rules and regulations would be irrelevant now, since no one would
dare practice the same credit abuse as before. After enough time has
passed, and people have forgotten the consequences of credit abuse,
then the new rules and regulations will be repealed or ignored as
"old-fashioned old people's laws."
Stock markets in Asia and Europe are in free fall this morning,
as forced selling is causing investors to liquidate their positions to meet margin calls.
Wall Street index futures frozen at "Limit down," early Friday morning (Source: CNBC)
By 7:00 am ET, Dow Jones futures had fall 550 points, S&P futures had
fallen 60 points, and Nasdaq futures had fallen 85 points. These
falls were the maximum allowed before a "limit down" is triggered,
making it impossible to continue trading.
The "limit down" will be in effect until the markets open in New York
at 9:30 am ET.
When the markets open, it's expected that stocks will continue to
fall, driving the index values even lower. According to one pundit,
expect the market indexes to fall in the first hour, and then settle
down for the rest of the day, possibly recovering the lost amounts.
The counter argument is that these sharp falls are being caused by
forced selling, causing a vicious cycle: Forced selling pushes stock
prices lower, this causes more margin calls for investors, especially
hedge funds, and more margin calls result in more forced selling.
Other stats of note: Gold fell below $700/ounce, to new 13-month low.
The dollar continues to strengthen sharply against the euro. Crude
oil continues to crash, currently at $63 per barrel.
Policy makers may need to close markets for one or two weeks.
I've been sick for the last few days, but that's nothing compared to
how sick hedge fund investors must be feeling.
Emmanuel Roman, CEO of GLG, Europe's biggest hedge fund, can't be
feeling too well these days. Speaking at a hedge fund conference in
London on Thursday, Roman said that 25-30% of the world's 8,000 hedge funds would
disappear "in a Darwinian process." He added, "This will go down in
the history books as one of the greatest fiascos of banking in 100
years."
Speaking at the same conference, New York University Professor
Nouriel Roubini agreed, saying that, "We've reached a situation
of sheer panic. There will be massive dumping of assets'' [and]
hundreds of hedge funds are going to go bust.
Roubini added, "Systemic risk has become bigger and bigger. We're
seeing the beginning of a run on a big chunk of the hedge funds. ...
Don't be surprised if policy makers need to close down markets for a
week or two in coming days."
This scenario would be the generational panic and crash that
Generational Dynamics has been predicting for years. (See "List of major Generational Dynamics predictions" for more information about Generational Dynamics
predictions.)
As I've said many, many times, from the point of view of Generational
Dynamics, if you go back through history, there are many small or
regional recessions. But since the 1600s there have been only five
major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the
1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall
Street crash.
These are called "generational crashes" because they occur every
70-80 years, just as the generation of people who lived through the
last one have all disappeared, and the younger generations have
resumed the same dangerous credit securitization practices that led
to the previous generational crash. After each of these generational
crashes, the survivors impose new rules or laws to make sure that it
never happens again. As soon as those survivors are dead, the new
generations ignore the rules, thinking that they're just for "old
people," and a new generational crash occurs.
It's now been 79 years since the last generational panic and crash,
so we're probably overdue for the next one.
What would one of these look like today? Here's how I've described
it in the past:
"A generational crash is an elemental force of
nature, like a tsunami.
You'll have millions or even tens of millions of Boomers and
Generation-Xers in countries around the world, never having seen
anything like this before, not even believing it was possible, and
in a state of total mass panic, trying to sell all at once.
Computer systems will crash or will be clogged for hours, or
perhaps even for a day or two. People who had hoped to get out
just as the collapse is occurring will be totally screwed, and
will lose everything. Brokers and other institutions will go
bankrupt."
This sounds a lot like the kind of thing that Roubini is predicting.
A lot of investors don't realize this, but my expectation for a major
"panic event" is similar to mainstream predictions of a "capitulation
event."
Art Cashin is a very well known (and, I'm told, well beloved)
analyst, working on the floor of the stock exchange. He appears
frequently on TV, and on Thursday morning he appeared on CNBC before
the market opened.
Art Cashin is a major proponent of the "capitulation" theory, and in
this interview, he gave details about what he expects:
Art Cashin, on floor of NY Stock exchange. (Source: CNBC)
"Q: We're feeling the bottom again, Art. What's
going to happen?
Cashin: I would love for a little bit of an up move today - maybe
go up to 8750 or 8800 -- that would be a textbook Elliott Wave
move -- and then you'd get that big washout / selloff. I was
hoping for it by the end of this week, guess it's going to be
pushed into next week. A dramatic climax looks like it's very
near at hand here.
Q: Yikes! That could be scary. I guess if it was early
November, that's not much different than making a low in October,
is it Art?
Cashin: Well, in 1929, you made the low on November 4. I prefer
to keep them in October. ...
I'm looking for a climactic bottom, down from here obviously, and
that could carry through for several months [i.e., lead to a
rally for several months], and then maybe in May, we'll get to
know the full effect of the recession, and see how things look
then. ...
I don't want to scare anybody. You could get an overtrade, You
retest the original lows around 7850, you could go to 7400, you
could go to 7000, you could even overtrade that. But it will be
quick. Get your basket out, and be ready to catch the bargains
when they come your way."
As I've pointed out before, this is a major mainstream view, and to a
certain extent, it agrees with what I'm expecting (a generational
panic and crash, as described above). This is the kind of thing that
happened in 1987, and Cashin is expecting it to happen again.
When you drill down into the "capitulation" concept, you get
something that's very strange. There's a large, amorphous group of
investors who are slowly selling their stocks, bringing the market
down. At some point, this amorphous group will become completely
discouraged, they'll panic, sell off everything else, and
"capitulate." Once this amorphous group of investors have sold
everything off, then they won't push the market down any more, and
the market will go up again.
The problem is: Who are the investors in this amorphous group? All
the investors listen to these arguments on CNBC, so none of them is
going to simply give up and capitulate at any time. So who are the
pundits talking about with the capitulation message?
I'm trying to imagine what kind of person would see the market fall,
and would say, "I'm not going to take a chance on losing any more
money, so I'm going to get out of the market."
Generally speaking, the only person who might say that is someone
from the Silent generation (the generation that grew up during the
Great Depression). They were running things in 1987, and this is
exactly what happened. These Silent top-level managers simply decided
to get out of the market, all at one time, at a time when the market
was underpriced, and they ended up losing out in the rally.
But you can see where I'm going next -- the Silents are gone. I
can't imagine a Boomer or Gen-Xer saying, "I'm not going to take a
chance on losing any more money, so I'm going to get out of the
market." (The exception, of course, is Boomers and Gen-Xers who read
this web site.)
So this explains why there's a capitulation concept at all, why it
applied in 1987, and why it doesn't apply at all today.
And so, getting back to what Cashin said, he and I are expecting
roughly the same thing, a "panic event," but the differences in our
views have to do with the aftermath:
The Silent Generation led the selloff in 1987, and managed it
very carefully, based on their memories of the Great Depression, so
there really was no major emotional panic.
The Boomers and Gen-Xers today will be quite different, since
they have no previous experience. They'll experience total
panic, completely unlike the Silents in 1987.
Although a relief rally at some point is possible, the long-term
trend of the market will be to continue downward, for the next 3-4
years.
It's interesting that if you take all three people -- Nouriel
Roubini, Art Cashin, and myself -- we're all expecting some major,
cataclysmic event, but we all differ on the reasons for it, and what
will happen afterwards. And although I would be reluctant to name a
specific date for this event, it's clear that Roubini thinks it's
coming very soon, and Cashin expects it within the next week.
From the point of view of Generational Dynamics, this will be one of
the major events in history. From Tulipomania in the 1600s to the
1929 crash, there have been a series of five generational panics and
crashes that will never be forgotten. We're now very close to the
sixth one.
The country may need as much as $6 billion in foreign-currency
reserves, in order to meet scheduled repayments in dollar-denominated
bonds before February.
As recently as Thursday, the Financial Timeswas reporting that China had promised to save Pakistan from
default. The promise was expected to become a commitment during
Pakistan President Asif Ali Zardari's visit to Beijing at that time.
But when he returned Friday night, he had a promise from China to
build two nuclear power plants, but no commitment for the badly
needed aid.
Next, Zardari will have to turn to the International Monetary
Foundation (IMF) for a bailout, but this will be a bitter pill to
swallow because the IMF will impose onerous controls on spending and
governance in return for the money. These controls will be extremely
unpopular, and will be blamed on the U.S. The Taliban, which have
been conducting a series of terrorist acts throughout Pakistan, will
be emboldened to do more.
China's failing economy
It's quite possible that China is refusing to provide financial aid
to Pakistan because it cannot afford to. China's own economy may be
failing, now that the massive building bubble from
the Beijing Olympics has ended.
You never know in advance what event is going to trigger anxiety,
fear and even panic in the markets, but such an event occurred
earlier this week, when the CEO of Rio Tinto said that China's economy will "pause for
breath" in the next quarter. The remark spooked markets throughout
Asia, especially in the energy sector.
Commodity prices (Source: wsj.com)
Rio Tinto is a giant multinational firm, one of the largest mining
companies in the world. It has seen sharp declines in prices for iron
ore, aluminum and copper in recent months, throwing the company into
financial distress.
It's attributing the fall in these commodities prices to the cooling
of China's economy.
This would not be a surprise to thousands of employees of toy
factories in southeast China.
Half of China's toy makers have declared bankruptcy recently, as it
became clear that sales to the U.S. and Europe are going to be
particularly slow this year. In one of the highest-profile examples,
a toy maker that sold to US giants Mattel and Disney announced last week it had gone bust due to the global economic
crisis, leaving up to 7,000 people jobless.
Some analysts see dire warning signs in China. Independent
Shanghai-based economist Andy Xie says that a property crash is
imminent because prices are too high and developers have borrowed
heavily and built too much.
In fact, malaise is affecting the entire Chinese economy, and many
analysts believe that the trouble goes deeper than just a
post-Olympics pause.
Whether it's millions of tonnes of surplus coal stacked up in ports, or Swiss
jewellers from Shanghai experiencing total despair, the signs of
collapse are growing.
A collapse of China's economy would affect all of Asia. Vietnam,
Cambodia, Thailand and other Asian countries supply materials and
unfinished goods to the Chinese, who finish them and ship them off to
the Americans and the Europeans. The knock-on effects have extended to
South Korea, whose currency, the won, crashed earlier this week, and
has to be bailed out. So the reluctance of Americans and
Europeans to buy as many toys this year is having knock-on effects
throughout Asia.
And, of course, it means that Pakistan won't get aid from China.
From Eastern Europe to Latin America
Pakistan is not the only country seeking aid from the IMF to weather
the global credit crisis.
In Eastern Europe, Ukraine, Hungary, and Serbia are all in emergency talks with the IMF. The plunge in prices for
commodities like grain and steel, their chief exports, along with the
drying up of foreign investments, have brought these countries close
to default as well.
"This is turning serious," said Hans Redeker, currency chief at BNP
Paribas. "Countries in Eastern Europe have been living beyond means
for years and now they face a full-blown credit crunch. They are
going to have to cut back on imports and that will push the eurozone
deeper into recession. We think the next phase will be an attack on
the currency pegs in the Baltics and Bulgaria."
He points out that many other countries Argentina, Ecuador, the
Baltic States (Estonia, Latvia and Lithuania), Romania, Bulgaria, and
Turkey are all flashing warning signs that are much worse than they
were a few months ago.
"The global credit crisis is spreading to the most leveraged
economies in the world," says an East Europe bank expert. "Iceland
was the canary. It was the first to need a helping hand from the IMF,
but all countries that have had asset bubbles and rely on foreign
funding are vulnerable."
This has been caused by the high-flying, big-spending Prime Minister
Vladimir Putin, who was counting on high prices for oil exports to
fund his projects. With the price of oil now down almost 50%, the
country is in serious trouble.
Meanwhile, hedge funds around the world are collapsing, thanks to the
fall in commodities prices, stock prices, and developing nations'
currencies. This forced selling creates a vicious cycle, where
stock prices fall, leading to more margin calls, leading to more
forced selling.
According to one expert, hedge funds "are not the sole culprit" for
the selling vortex that's going on. He says mutual funds,
pension funds and sovereign wealth funds also have been pulling money
out of the market.
It's this kind of forced selling cycle that caused the crash of 1929.
Experts today are hoping that the forced selling cycle will burn
itself out, and that things will return to "normal" (whatever that
is). But after many years to create the credit bubble, worth
hundreds of trillions of dollars, it's going to be a long time and a
huge deflationary spiral before anyone can talk about "normal" again.
The questions were penetrating, but NYU economist Mark Gertler evaded
them all.
Mark Gertler, New York University professor of economics
This interview with New York University professor of economics
Mark Gertler is
significant because Gertler has worked closely with Fed chairman Ben
Bernanke for many years. Bernanke, of course, is considered the
world's leading expert on the Great Depression, so this interview
provides insight into Bernanke's theories and thinking.
It was the usual nonsense by an economist, but what was interesting
is that the interviewer, Owen Bennett-Jones, asked some very
difficult and pointed questions, much more penetrating than you ever
hear on CNBC or elsewhere in the mainstream media. The result is that
we have one more view into the shallowness of modern macroeconomics.
(The interview can be heard for a week by going here, or by clicking here.)
I'd like to quote three excerpts from the half-hour interview:
Owen Bennett-Jones: "Is this where
economics crosses with social science, and can we say that in 70,
80 years time this will happen again and people WON'T remember,
and people WILL feel overconfident, for precisely the same
reasons as they did this time. And that's part of the cycle,
actually."
This is a remarkable question in the mainstream media, for several
reasons:
It mentions the 70-80 year cycle, and raises the possibility
that Owen Bennett-Jones, the BBC interviewer, has read this web
site.
It mentions the Great Depression in comparison to today,
something that was completely forbidden in the mainstream media until
recently.
It is a far more pointed questions than you usually
hear.
Gertler's answer shows how completely oblivious he is to the question
being asked:
Mark Gertler: "Well, I guess in some sense
you have a point. What's happening now is similar to what
happened in the US for example in the late 80s, early 90s. There
was deregulation in banking, and we had instead of residential
mortgages it was commercial mortgages that got into trouble, we
had to go in and bail those out. It's just that at the time the
problem was contained in the commercial banks, which the fed
directly regulated.
This time, it's happened again, just 20 years later. The problem
is much more complex, and hopefully we'll learn from this bigger
crisis going forward to avoid the same situation. I guess it's up
to us as academics to kind of take the lead on this."
As usual, Gertler has no historical sense of what's going on.
He immediately goes back to the 1980s, as if it were relevant to what
happened in the 1930s.
Mainstream economics has a flat view of time. In their standard
models, every decade is pretty much like every other decade. 60 year
olds in one decade are the same as 60 year olds in another decade.
That these assumptions are totally absurd is completely obvious. 60
year olds in the 1980s, that is, people who lived through the Great
Depression, are going to have completely different attitudes and
behaviors towards money and spending than 60 year olds today. And
yet, as incredibly simple as this observation is, mainstream
macroeconomics is totally oblivious to it, as is Gertler, who
completely evades the question and gives a non-answer.
In the second interview excerpt, Bennett-Jones asks specifically about
the 1930s, and got an equally absurd answer:
Bennett-Jones: "How bad was the 30s,
and what actually happened? How bad did it get?"
Gertler: "Well, let me say the 30s - the behavior of the
real economy was much, much worse than it is now. There was a
recession in 1929-30, where output fell about 8-9%. The
situation completely deteriorated in 30-31. At this point, the US
central bank was frozen, it didn't respond, and the banking system
just collapsed."
The answer was so incredible, I could barely believe my ears. He
said that what happened was this: There was a recession in 1929-1930,
and the Fed didn't move fast enough to prevent bank failures in 1931.
I've heard economists say really dumb things before, and I've quoted
many of them on my web site, but this is really the limit.
To Gertler, there was no 1920s stock market and real estate bubble,
there was no 1929 crash. It was just an ordinary, run of the mill
recession that the Fed mismanaged.
When I was growing up and going to school in the 1950s, everyone
"knew" what caused the Great Depression: it was greed, it was everyone
buying on margin, and it was the bubble. Today, these economists
think that it was just a bad day at the beach. Do you see why I keep
calling these people morons?
It really is depressing and frightening that our nation's leaders and
experts know absolutely nothing about what's going on and what's
coming.
The third excerpt that I want to quote is actually a continuation of
the above. Gertler explains why everything is so much better today
than in the 1930s, and segues into Japan of the 1990s:
Gertler: "Unlike today, there was no
deposit insurance, there was no protection of financial systems,
so the banking sector collapsed, choked off the flow of funds to
many borrowers. There was a deflation of the price level, prices
fell around 10% a year. What this did was raise the real debt
burden of borrowers who were borrowing in normal terms. It made
it difficult for the borrowers who didn't rely on banks. It made
it difficult for them to get credit. so there was a total
collapse of the financial system, and at the trough, output fell
about 40%, the unemployment raised to 25%.
We are nowhere near that, and I expect us to get nowhere near
that. ...
The policy makers today have the tools and they're very attuned to
avoid what's now going to be a downturn to turn into a very
serious recession.
The fear is not the 1930s. The fear is a situation like Japan
where there'll be a prolonged period of stagnation. Japan
suffered a financial crisis that began in 1990, and led to slow
growth for nearly a decade. So what's going on now is to avoid
that situation."
Bennett-Jones: "What's the difference betweeen Japan and
America?"
Gertler: "The key difference is that the policymakers were
very, very slow to react. Essentially Japan went through a
situation where they continually bailed out financial
institutions, without forcing them to restructure."
Gertler's answer is always the same: It was just a recession, but the
central bankers didn't act fast enough to keep it from getting worse.
Nikkei 225 Index -- Tokyo Stock Exchange -- 1984-2007 and 1914-2007.
Last year I wrote an analysis of
Japan's 1990 stock market crash, and the aftermath. If you look at
the adjoining graphs, which are from that analysis, you can see why
Gertler's response is naďve.
Note that there was a huge stock market bubble in Japan in the 1980s,
beginning around 1984. There was also a huge real estate bubble and,
at its height, the total price of all property in Tokyo was greater
than the total price of all property in the entire United States.
That's how huge the Japanese bubble was.
The top graph shows the Tokyo Stock Exchange's (TSE's) most recent
stock market crash. The crash began on January 4, 1990. The Nikkei
index had been 38915, and fell to a low of 7607 on December 31, 2003.
That's an 80% fall over a 13 year period.
However, this wasn't the TSE's first major stock market crash. The
TSE's previous major stock market crash occurred in 1919, as shown by
the lower graph. Then, 65 years later, the next stock market bubble
began in 1984.
Did you get that? Wall Street: Crash in 1929, new bubble in 1995, 66
years later; Tokyo Stock Exchange: Crash in 1919, new bubble in 1984,
65 years later. Once again, you can see Generational Dynamics in
action. A new bubble occurs as soon the generation of people who
lived through the last crash are gone.
But Gertler is totally oblivious to all of this, and of course
Bernanke is as well. Mainstream economists have a switch turned off
in their brains, making it impossible to understand the most obvious
and trivial things about generational theory. To them, all
generations are identical, and they'd believe in Martians before
they'd believe anything else.
WSJ discovers deflation
Mainstream financial reporters are generally so oblivious to what's
going on in the world that they almost always act like they've never
heard of the word "deflation."
In the past few years, there's been an explosive bubble in commodity
prices, thanks to surging demand in China's bubble economy. And yet,
the CPI (consumer price index) has increased only modestly in that
period. It never occurred to them to wonder why those commodity
increases didn't send the CPI to over 10%, as happened in the 1970s.
Commodity prices (Source: wsj.com)
Now, with China's economy cooling, commodities demand on the margins
is crashing, and commodities prices are falling at the same time. And
suddenly WSJ is dicovering deflation:
"Falling prices in commodity markets have helped
ease inflation.
Fed officials generally consider price stability to be an
inflation rate between 1.5% and 2%. Their preferred measure of
core inflation, which excludes food and energy, stands above 2%
now, and is expected to remain above that mark as price increases
from earlier this year advance through the product pipeline.
The economic slowdown and declining commodity prices have eased
the nation's consumer inflation rate, which surged to 5.6% over
the summer. Annual inflation in the U.S. is likely to turn
negative for at least several months next year, on declining
energy and food prices.
With the unemployment rate rising rapidly and capital markets in
turmoil, "pretty much everything points toward deflation," said
Paul Ashworth, chief U.S. economist at Capital Economics. "The
only thing you can hope is that the prompt action of policy makers
can maybe head this off first."
The Japanese economy in the 1990s and the U.S. during the 1930s
illustrate how deflation can choke a weak economy and spiral out
of control. A sagging economy exerts downward pressure on prices
because of weak demand for labor and goods. Broad-based declines
-- particularly in a credit crisis, which can push asset prices
down sharply -- can also force down wages, preventing consumers
and, therefore, companies from paying their debts. Falling prices
also encourage businesses and consumers to save rather than spend,
because money would be worth more after prices decline. The
restrained spending, in turn, hurts the economy even more.
Federal Reserve Chairman Ben Bernanke, in a speech as a Fed
governor in 2002, said deflation in the U.S. is "highly unlikely"
but added, "I would be imprudent to rule out the possibility
altogether." The reason, he said at the time, was the Fed "has
sufficient policy instruments to ensure that any deflation that
might occur would be both mild and brief."
As usual, there's no historical sense of what's going on. They
mention the deflation of the 1930s without wondering whether the
inflation of the 1970s and the deflation of today are part of the
same cycle.
From the point of view of Generational Dynamics, these excerpts from
Mark Gertler and from the Wall Street Journal are important
because they demonstrate how oblivious mainstream economists and
reporters are to what's going on.
As I've said many times, mainstream economics did not predict and
cannot explain almost anything that's happened in the last 15 years
-- why the dot-com bubble occurred when it did and why it occurred at
all, why the credit and real estate bubbles occurred when they did,
and why they occurred at all, and how we got to where we are now.
The stupidity and idiocy of mainstream economists, financial
reporters, and Nobel prize winners is an important part of the fabric
of today's society that has led, in the past 15 years, to the
destruction of the world's financial system.
This weekend, I cleaned out most of my backlog of e-mail messages and
questions from web site readers, and most of them, along with my
responses, have been posted in the Financial Topics thread of the Generational Dynamics forum. For
those wishing further information, that thread will serve as a useful
resource.
In his dotage, he seems determined to bankrupt himself.
Warren Buffett is buying stocks again.
Market summary, 16,17-Oct-2008
The news seemed to electrify the market for a few hours on Friday.
The markets fell sharply on Friday morning, after a big advance on
Thursday, but as knowledge of Buffett's article spread, investors
poured into the market, to the point where the Dow was 400 points up.
Somewhere along the line, investors must have actually read Buffett's
article, and decided, along with me, that what he wrote was nuts.
Buffett says that those who are holding cash (or cash equivalents,
like Treasuries) are making a big mistake. His NY Times op-ed article says the following:
"Today people who hold cash equivalents feel
comfortable. They shouldn’t. They have opted for a terrible
long-term asset, one that pays virtually nothing and is certain to
depreciate in value. Indeed, the policies that government will
follow in its efforts to alleviate the current crisis will
probably prove inflationary and therefore accelerate declines in
the real value of cash accounts.
Equities will almost certainly outperform cash over the next
decade, probably by a substantial degree. Those investors who
cling now to cash are betting they can efficiently time their move
away from it later. In waiting for the comfort of good news, they
are ignoring Wayne Gretzky’s advice: “I skate to where the puck is
going to be, not to where it has been.”"
How could he possibly have reached these conclusions? He doesn't
have the vaguest idea how the stock market will perform over the next
decade.
He gives examples of previous market advances, and they are truly
bizarre. They're so absurd that I'm going to list a couple of them:
He writes: "During the Depression, the Dow hit its low, 41, on
July 8, 1932. Economic conditions, though, kept deteriorating until
Franklin D. Roosevelt took office in March 1933. By that time, the
market had already advanced 30 percent."
Do you get this? He's saying that the market advanced 30% from July
1932 to March 1933, and therefore you should buy stocks today. What
does one have to do with the other? Does he forget that it had
already fallen 90% by July 1932?
He writes: "Again, in the early 1980s, the time to buy stocks was
when inflation raged and the economy was in the tank."
Is he nuts? Sure, the market went up in the 1980s, but that was
after a 16-year bear market that began in 1966. How does he know we
aren't about to have another 16-year bear market?
"We continue to do little in equities. ...
Despite three years of falling prices, which have significantly
improved the attractiveness of common stocks, we still find very
few that even mildly interest us. That dismal fact is testimony to
the insanity of valuations reached during The Great Bubble.
Unfortunately, the hangover may prove to be proportional to the
binge.
The aversion to equities that Charlie and I exhibit today is far
from congenital. We love owning common stocks – if they can be
purchased at attractive prices. In my 61 years of investing, 50 or
so years have offered that kind of opportunity. There will be
years like that again. Unless, however, we see a very high
probability of at least 10% pre-tax returns (which translate to
6˝-7% after corporate tax), we will sit on the sidelines. With
short-term money returning less than 1% after-tax, sitting it out
is no fun. But occasionally successful investing requires
inactivity."
Now this is odd. He wrote this early in 2003, He says that
"short-term money" (i.e., cash equivalents) were paying less than 1%.
That's what he's warning people against today, but it was fine with
him in 2003.
Well then, where was the Dow in 2003? Well, the above report was
posted on the internet on March 6, 2003. On that day, the Dow was at
7674, after having fallen from a high of 11723 in 2000.
Today, the market is at 8852, having fallen from a high of 14164 a
year ago.
Furthermore, I doubt that anyone would argue with the claim that
after a series of bank failures, the economy today is much worse off
than it was in 2003.
How in the world could Buffett possibly conclude that the market is a
big buying opportunity today?
Actually, Buffett has been making a lot of bad decisions recently.
In 2006, when Buffett still seemed to have his marbles, he said:
"Speculators are like Cinderella at the ball
having a great time, but at midnight everything turns to pumpkins
and mice. As midnight approaches the party gets to be more fun,
and everyone thinks they'll get out before midnight. The problem
for Cinderella is that there are no clocks on the wall."
He changed enormously by May of this year, when he said, "The worst of the crisis in
Wall Street is over."
That was before the collapse of AIG, Lehman brothers and various
other financial institutions.
But it's much worse.
This is the person who called derivatives "financial weapons of mass
destruction." In May 2007, he said this:
"The introduction of derivatives has totally made
any regulation of margin requirements a joke. I believe we may
not know where exactly the danger begins and at what point it
becomes a super danger. We don't know when it will end precisely,
but ... at some point some very unpleasant things will happen in
markets."
And so, a lot of people (including me) were completely shocked when
he announced in May that first
quarter profits of Warren Buffett's Berkshire Hathaway fell by 64%
because of $2 billion in losses from investments in derivative
contracts -- some of the most irresponsible investments possible.
Buffett is saying and doing incredibly stupid things, and there's
little doubt in my mind that at age 78 he's really screwing things
up.
In his op-ed article on Friday, he writes:
"A simple rule dictates my buying: Be fearful when
others are greedy, and be greedy when others are fearful. And most
certainly, fear is now widespread, gripping even seasoned
investors."
Buffett violated his own rule when he got greedy while others were
also greedy, when he lost $2 billion in derivatives contracts that
later turned out to be disastrous.
Now he's telling people to get back into the stock market at a time
when doing so completely contradicts his own position in 2003.
Buffett is being neither greedy nor fearful. He's simply turned into
a whack job.
Actually, his op-ed piece provides a clue to his fantasizing. He
says that economic conditions deteriorated until President Roosevelt
took office, implying that they got better because of Roosevelt's
policies.
Then he says that the economy was in the tank in the early 1980s, when
President Reagan was in office.
Buffett is a open supporter and economic adviser of Barack Obama.
What I infer from Buffett's op-ed is that he believes that President
Obama will be a new FDR who will immediately improve the economy.
I've heard others say similar things, but this is a total fantasy.
FDR took office after 3 years of economic cratering after 1929, all of
which was blamed on Hoover. Whoever takes office in January will also
face 3-4 years of economic cratering, and is going to be presiding
over a national disaster.
This shows the danger of anyone getting too deep into the swamp of
politics. You start to believe your own lies, and assume that the
choice of President will actually make any difference to what's
coming.
In fact, shortly after Buffett made his statement that "the worst of
the crisis ... is over," a web site reader referred me to
an article that had appeared in the New York Herald
Tribune on May 1, 1930:
"WASHINGTON: Attributing the Wall Street crash of
last fall to the "inexorable consequences of the destructive
forces of booms" and paying tribute to the American people for
their "unity of action in time of national emergency," President
Hoover addressed the United States Chamber of Commerce here
tonight [May 1]. "We have been passing through one of those great
economic storms which periodically bring hardship and suffering to
our people," said Mr. Hoover. "While the stock exchange crash
occurred only six months ago, I am convinced that we have now
passed the worst, and with continued unity and effort we shall
rapidly recover."
A lot of people who compare today's events to those of the Great
Depression think that George Bush will be the discredited "Hoover"
figure today. But if Obama listens to Buffett (and even if he
doesn't), then it's Obama who will be the new "Hoover."
From the point of view of Generational Dynamics, the world is headed
for a major financial crisis and then a world war, and no power in
the world can stop it, even Warren Buffett.
Iran's President Mahmoud Ahmadinejad says "it is the end of
capitalism."
The Tehran stock market has been unaffected by the credit crisis that's affected other
stock markets around the world. This includes stock markets in
neighboring Gulf states.
But it doesn't include Iraq's stock market, which soared 40% in September, at
a time when other stock markets were crashing.
From the point of view of Generational Dynamics, the reason is
simple: Both countries are in generational Awakening eras. The
bloody, genocidal Iran/Iraq war of the 1980s, and now a full
generation has passed.
The Iran/Iraq war devastated, destroyed and flattened both countries.
When the war ended, people in both countries started rebuilding.
Now, 25 years later, both countries' industries are really humming.
Instead of living off of credit, both countries are generating goods
and services. What a radical idea!
Contrast that with the United States where, in the last ten years,
tens of millions of manufacturing jobs have fled to China, and as
many service jobs have fled to India, and the principal business of
the country has been financial transactions and figuring out more
ways to create new debt and credit.
In the 1960s and 1970s, when the United States was in a generational
Awakening era, our industries were really humming. The Great
Depression had destroyed most existing businesses, and forced the
remaining ones to completely renew themselves. By the 1960s, they
were mature enough that they were really turning out products that
everyone wanted.
Mainstream economic models completely mishandle the birth and death
of businesses. The assumption (usually unstated) is that businesses
are born and die pretty much at the same rate in every decade. But
that isn't true. Almost every business died, in one way or another,
in the 1930s, and by the 1940s, almost all businesses were new.
Those businesses grew and thrived in the 1960s and 1970s.
Today, those businesses are old and mature. The employees used to
focus on producing the best products for the customer, but today the
employees focus on doing as little work as possible while maintaining
the most pleasant lifestyle. (See "Boomers and Gen-Xers: Dumbing down IT" for how this
works in the computer industry.)
That's generally true of all the countries that fought in WW II as a
crisis war. Their industries were all destroyed, and their
businesses have gone through a similar birth and death cycle as the
United States has.
Even China, for all its vaunted industrial strength, is unraveling.
Its economy depends on manufacturing goods for sale in the US, and
now the credit crisis in the US is also a credit crisis in China.
Of course, that isn't the way officials in Iraq and Iran look at the
situation.
Taha Abdul-Salam, the head of Iraq's stock market, says, "I believe
we're still far from what's happening in the world in the financial
markets. But in the end you must know we are part of this world. I
believe somehow we will have some problems."
At least he isn't too arrogant about what's going on. But that
description doesn't apply to Iran
Iran's President Mahmoud Ahmadinejad, who is known to believe in
the Mahdaviat of Shia Islam, the
belief that the Mahdi is coming soon to save mankind.
Thus, it's not surprising that Ahmadinejad would see the financial
crisis as a divine sign that "the oppressors and the corrupt will be replaced
by the pious and believers," and that "an Islamic banking system will
help us survive the current economic crisis."
In a recent sermon at Tehran University, Ayatollah Ahmad Jannati
said, "We are happy that the U.S. economy has come across difficulty.
They are attesting unfavorable consequences of their conducts. They
are experiencing divine punishment. We are happy over that. The
unhappier they become, the happier we get, as they become happy as we
get unhappy."
We can't stop here without mentioning that while Ahmadinejad is
waiting around for the Mahdi, he has plenty of troubles of his own.
Those who remember America's Awakening era in the 1960s will recall
that it was peppered with mass riots and demonstrations, and even
violence and bombings.
Well, Ahmadinejad is beginning to have his own share of similar
activities, typical of what happens in any country's Awakening era.
Ahmadinejad has had student protests, and protests by women who wear loose headscarves.
Commentary on Wednesday has been the most negative I've ever heard,
although it's framed in terms of a "severe recession." Still, I
believe I've heard the words "1929" and "depression" more often
on Wednesday than I ever have (since I was in school in the 1950s).
Market summary, 15-Oct-2008
Wall Street indexes fell sharply at the open, and continued to
fall throughout the day. Markets in Asia and Europe also fell
sharply, and as I write this on Wednesday evening ET, Tokyo's Nikkei
index has fallen another 11% in the last two hours.
The market seems to be reacting to the drunken orgy on Monday, where
the market went up 11%, following the incredible worldwide fantasy
bailout over the weekend. Now, the market seems to have resumed its
path for the preceding three weeks, where the market fell 25%.
A major problem is that interest rates are not falling fast enough.
This was apparent yesterday from the quote from Rick Santelli that I
posted yesterday.
On Tuesday afternoon, after the Fed auction, CNBC reporter Rick
Santelli reported that interest rates causing the credit crisis were
not easing, despite Monday's fantasy bailout announcement. He made the
point that interest rates for GSE bonds (bonds offered by Freddie Mac
and Fannie Mae) continue to be much higher than interest rates for US
government Treasury bills. Here are his words:
"Some of us are disappointed in the thaw, and I'll
tell you why. If the government is basically underwriting the
GSE's, and they've ramped up all of their coverage, like FDIC,
tell me why it is that the 3 and 6 month bill for the auction
today garnered a yield of .5 and 1.10 respectively?
Yet, when Freddie went to the market with 3 and 6 month bills,
their 3 month bill was at 1.95, and their 6 month was at 2.70.
This is living proof that, for whatever reason, we're not seeing
this money that's been thrown into the banking system do exactly
what it is we want it to do. And somebody at Treasury or Fed, or
the banking regulators, have to go pound some heads, because the
T-bill rate should be coming up, and the GSE rate should be
coming down, and it's NOT HAPPENING."
On Wednesday, the credit crisis still showed little or no sign of
easing. The news services tried to put the best face on it. Here's a
a news story from Wednesday morning:
"Libor for Dollars Drops as Central Banks Offer
Unlimited Cash
By Gavin Finch and Nate Hosoda
Oct. 15 (Bloomberg) -- Dollar money-market rates fell after the
European Central Bank, Bank of England and Swiss National Bank
offered lenders unlimited U.S. currency for the first time in a
coordinated effort to unlock credit markets.
The London interbank offered rate, or Libor, that banks charge
each other for three-month dollar loans dropped for a third day,
its longest sequence of declines in seven weeks, according to the
British Bankers' Association. It slid 9 basis points to 4.55
percent today. The comparable euro rate declined to 5.18 percent.
Asian rates also decreased."
That sounds pretty good, until you read several paragraphs later:
"While the cost of three-month dollar loans has
dropped in the wake of the measures, it's still 305 basis points
more than the Fed's target rate. The difference was a record 332
basis points on Oct. 10. It was 82 basis points on Sept. 15, the
day Lehman Brothers Holdings Inc. filed for bankruptcy and 11
basis points on July 31, 2007, just before the start of the credit
squeeze."
And so, if you look at interest rate spreads in the past year (where
100 basis points equals 1%):
Date Basis points
--------------------- ------------
July 31, 2007 11
Sept 15, 2008 82
Oct 10 332
Oct 15 305
In other words, the Libor spread has fallen a tiny amount, compared
to where it was even just a month ago.
This is just one major cause of the huge pessimism among investors
that was evident on Wednesday.
This was buttressed by a slew of disastrous data: The U.S. retail
sales report revealed big September sales declines, and the U.S. Empire State
manufacturing index plunged the greatest amount in its history.
This afternoon, Ben Bernanke gave a speech, in which he attempted to defend Fed policy, adding that
the recession is going to last a long time.
The market fell sharply after that speech. Well-known financier Mort
Zuckerman commented on Bloomberg television after the speech.
Zuckerman is normally a pretty upbeat guy, but on Wednesday
afternoon, he was bitter and angry:
Mort Zuckerman (Source: Bloomberg)
"I think that the economy is not only bad now, but
it's going to get worse. The fact is the credit crunch is not
over, and it's not going to be over.
What they just did for the banks is to make sure that no major
financial institution is going to fall down a trap door and
disappear in 72 hours, but it is not going to dramatically change
the credit crunch.
And so we're in for a very, very weak period in the economy, and
who knows how far that will go? Nobody knows, because there are
unknown factors in our economy that we've never had to deal with
before, one of them being plummeting house prices, which has a
good ways to go. They're off about 20% and may go down another
15%.
And another is these toxic securities and credit default swaps,
and nobody knows how bad they're going to be."
This is a real statement of despair, but it's realistic. I've been
commenting on the issue of real estate prices and mortgage-backed
securities (CDOs) for a long time, and I've mocked and ridiculed
analysts on CNBC, in WSJ and elsewhere, who said that the real estate
crash was near the bottom, or that the mortgage-backed securities was
a small, "contained" problem.
My thoughts go back to a year ago, when pundits were
talking about a "kitchen sink" quarter. This meant that corporations would take as
many writedowns as possible in the third quarter, so that they'd be
completely rid of them.
We heard the same thing every quarter since then. Even those who
thought that the problem would go on for a while longer were
absolutely certain that it would be over by now, near the end of
2008.
But you could hear the bitterness in Zuckerman's voice when he said
that falling home prices, toxic securities, and failing credit
default swaps will go on for an indefinite time. He expressed no
hope whatsoever.
He was asked, "Ben Bernanke, who's studied the Great Depression, says
that it won't happen again. Do you agree?"
"Well, we won't have a similar kind of depression.
We won't have the Treasury and the Federal Reserve not providing
the liquidity to the financial system. We won't have a balanced
budget - we're gonna have a huge deficit. We won't have trade
dropping because of Smoot Hawley and similar things like that.
But we have different things that may be just as serious. For
example, we their $52 trillion in credit default swaps out there
-- nobody knows how good they are.
When they came [to rescue] AIG, AIG thought they needed $40
billion to get out of the hole. The government said $85 billion.
They're already up to $121 billion. So who knows how bad it would
be?"
The AIG bailout is less than a month old, and it appears to be
spiraling out of control.
However, his answer is inconsistent. He says that the Fed will
continue providing liquidity, but he's already shown that the Fed
can't possibly provide enough liquidity to matter. The new
Depression will be much worse than the last one.
"With Lehman Brothers, which was THE fundamental
mistake the Fed's made -- they now are apparently exposing the
financial world to $360 billion of losses on credit default swaps
that were guaranteeing Lehman papers.
So I don't know where this ends. Nobody knows where it
ends."
This is another fundamental mistake. He talks as if the crisis BEGAN
only five weeks ago when Lehman Brothers collapsed, and he implies that if only that one mistake
hadn't been made, then we'd all be OK today. This is wishful
thinking.
These are dark days, and they're going to get darker very soon.
Price/earnings ratio (P/E10 only) falls below average for first time
in 13 years.
As regular readers know, for the last few quarters I've been posting
the table of S&P 500 average corporate earnings estimates, based on
figures from CNBC Earnings Central supplied by Thomson Reuters. These tables
have shown sharp falls in corporate earnings estimates from week to
week. Here's table as of the end of last week:
Date 3Q Earnings growth estimate as of that date
------- -------------------------------------------
Mar 3: 25.0%
Apr 1: 17.3% Start of previous (2nd) quarter
Jul 1: 12.6% Start of quarter
Sep 5: 0.8%
Sep 12: -1.6%
Sep 19: -0.3%
Sep 26: -1.7% End of quarter
Oct 3: -4.8%
Oct 10: -7.8%
We're seeing a very familiar pattern -- the same pattern that we've
seen for the last four quarters. At the beginning, analysts expect
meteoric increases in earnings growth. The earnings estimates fall
as the quarter progresses. Once the quarter ends, and actual
earnings begin to be published, the earnings estimates plummet.
A fall in earnings estimates means an increase of price/earnings
ratios estimates.
There's a price/earnings ratio chart at the bottom of this web site's
home page, and it gets updated automatically every Friday. Here's
last Friday's version of the chart:
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 10-Oct-2008. (Source: MarketGauge ® by DataView, LLC)
As you can see, the P/E ratio index was at 18 for several years,
which is well above the historical average of 14. In fact, the index
has been above average for 13 years, since 1995, and by the Law of
Mean Reversion, this means it has to be equally below average for
roughly the next 13 years.
Starting in March, however, the P/E index is spiked upward again, to
astronomical levels in the 20s. This was when first quarter actual
earnings were coming in. But investors believed that they should be
ignored; the common wisdom was that the credit crisis would be over
by the fall (i.e., now), and that earnings would grow in the third
and fourth quarter by 25% and 50%, respectively.
Because of that widely held belief, investors pushed the P/E index up
into the 20s. It's only in the last three weeks that it came back
down to 18. This was thanks to the stock market losing 25% of its
value in the last three weeks.
However, Monday's drunken orgy, pushing the stock market up 11%, has
also pushed the P/E index up above 20 again. Those who claim to
believe that the market is going to rally this quarter, in the face
of falling corporate earnings and high P/E ratios, are going to be
disappointed.
Market Summary
Asian and European markets were sharply higher last night. Wall
Street opened sharply higher, with the Dow up 400 points at one time.
But by 11 am, the Wall Street indexes turned around, and are now flat
or negative.
Market summary, 14-Oct-2008
The pundits, who this morning were still grinning like idiots, as if
they'd just gotten laid, were talking about how and why everyone
should get back into the market. By the end of the day, the pundits
were far more serious, as the Dow fell to a 300 point loss, before
partially recovering.
At the very least, what this means is that the panic buying spree
that followed the latest worldwide insanity bailout is over, and
stoned, drunken investors are beginning to sober up and look at the
reality.
One sobering reality is that P/E indexes are still astronomically
high, and computer software is telling investors to "Sell! Sell!
Sell!"
Another sobering reality is that the market is still 35% down from
its high, and there is still a lot of deleveraging and forced selling
going on. In fact, investors are withdrawing money from money market funds at record levels,
causing a potential chain reaction.
(Correction: A web site reader has pointed out the phrase "money
market funds" is incorrect in the above paragraph. The record
withdrawals are from stock and bond mutual funds, and those are not
money market funds.)
Nouriel Roubini provided another sobering reality. In a Bloomberg interview, he said that the US would have the worst
recession in 40 years. "There are significant downside risks still
to the market and the economy," he said. "We're going to be surprised
by the severity of the recession and the severity of the financial
losses."
Nobel prize winning economist Paul Krugman spent the day texting Matt Damon. He did have a hard-hitting statement
in his blog, however, saying that, "The policy outlook has
improved a lot.... But it’s way too soon to start counting chickens."
P/E10 drops below average for the first time since 1995
According to Robert Shiller, in a WSJ interview, the price/earnings index (P/E10) has fallen below
average for the first time since 1995.
Robert Shiller, whose 1999 book "Irrational Exuberance" predicted the
Nasdaq crash, and whose 2005 second edition predicted the real estate
bubble crash, has a web site that provides the historical data that I and other
researchers use.
When I write about the "price/earnings ratio" or P/E ratio, I'm
usually referring to P/E1 -- the current price of a share of stock,
divided by the company's earnings per share for the previous year.
This is the version that's used in the chart that appears on the
bottom of this web site's home page.
Robert Shiller prefers to use the measure P/E10 -- the current price
of a share of stock, divided by the average of the company's earnings
for the previous 10 years.
I believe that P/E10 is a more meaningful measure, but I write about
P/E1 because it's easier for people to understand, and it makes the
same point: That P/E ratios have been way above average since 1995,
and by the Law of Mean Reversion, will have to fall to values way
below average for roughly the next 13 years. Either P/E1 or P/E10
can be used, as long as it's used consistently. The historical
average for P/E1 is about 14.1, and the historical average for P/E10
is about 16.3.
According to Robert Shiller, last week's bloodbath brought P/E10 down
to 15, which is below the historic average of 16.3.
In the Wall Street Journal interview with Shiller, he says he
"doesn't make predictions" and he's afraid that "it might go down a
lot more." He's being very diplomatic with the Journal, by not quoting
the Law of Mean Reversion, which says that it will certainly go down a
lot farther, and stay down for a long time.
So add P/E10 to the list of things that have been crashing in the
last weeks -- commodities, emerging market currencies, worldwide
stock prices, the Baltic Dry Index, various major financial
institutions -- and now add one more, P/E10.
This is a huge downward trend with a great deal of momentum. It's
like a ten thousand-pound boulder is rolling downhill, and you'd like
to stop the boulder, and start pushing it up the hill again. It
can't be done.
The world is a much more dangerous place today than yesterday.
Unfortunately I used up the phrase "Bailout of the World" to describe
the last major bailout announcement -- the one that preceded last
week's bloodbath. So what should I call this one? Bailout of the
Universe?
Countries around the world have been moving to guarantee all bank
deposits of whatever size. What's new this time is that countries
around the world are moving to guarantee all bank obligations.
So now every investment by every bank is backed by some country's
taxpayers. Essentially, the concepts of "bank" and "country" and
"hedge fund" have merged. Last week it was just Iceland. But now,
every country is also a bank and a hedge fund. In fact, the world
(or at least most Western countries) are one large investment bank /
hedge fund. So let's call this bailout plan the World Hedge Fund
bailout.
We don't have enough money to bail out all the foreclosed real
estate, but somehow we do have enough money to bail out all the
securities backed by foreclosed real estate. And any bank failure
immediately becomes a country failure.
These CDOs and CDSs that I've been writing about for years are much
huger than a government can handle. The US government perhaps has
one or two trillion dollars of resources, but the CDOs and CDSs are
exposures of tens or perhaps hundreds of trillions of dollars.
It was one thing when those obligations were on the books of banks
and other financial institutions, as well as investors. But now, all
those obligations are on the books of the US and other nations.
This has got to be the stupidest, most disastrous move in the history
of mankind.
You know, Dear Reader, I've been saying for years how astounded and
amazed I am at what's going on in the world, and what people are
doing, out of sheer stupidity.
But I've completely run out of superlatives. This can't possibly be
happening. Surely I'm dreaming this, or perhaps fallen asleep in a
very bad movie. This is a fucking disaster.
Market summary, 13-Oct-2008
And just to show what a disaster it is, the European and New York
markets surged over 10% today on panic buying. As I'm writing this,
on Monday evening, the Nikkei is up 12.5%. I just saw some giddy
idiot on CNN, grinning from ear to ear, saying that the worst was
over, and people should start buying stocks now.
I actually heard someone describe this as "they've finally managed to
restore investor confidence." This emotional outburst of panic buying
is supposed to represent "investor confidence"? What superlative can
I use to respond to that?
Sure, go ahead folks. It's time to buy. Raid your kids' piggy banks
and your parents' retirement funds and get into the market. That's
what the "smart money" is doing. Why shouldn't you?
"Headline: Nobel prize committee disses John
Xenakis on economic prize.
In a surprise announcement the Nobel committee decided NOT to
give John Xenakis the Nobel prize for economics. “While we do
believe his work has merit, it is far too simplistic and easily
understood by 90% of the world population. We prefer intricate and
complex analysis using arcane and irrelevant factoids that are
overblown and dissected ad nauseum, the covert purpose of which is
to seduce 17 year olds to mortgage their future to overpriced
universities with the hope that they too can achieve academic
stardom."(600,000 to one chance).
We have awarded the prize to Paul Krugman who retread a 19th
century principle, which is not the reason he got the prize. The
real reason is he hates George Bush and so do we. (ha ha)"
I got a big chuckle out of this. Thank you, Mary.
As I wrote last week, at least
Nouriel Roubini has done some brilliant work, and has at least
foreseen some of the current crisis before it happened. But Krugman
has done nothing. The guy's a macroeconomics idiot.
Ironically, the Nobel committee was too clever by half. They wanted
to stick it to President Bush, so they gave the prize to Krugman,
saying it was for some obscure work he did years ago. The result is
that they've damaged their own credibility, as well as Krugman's (both
of which were already pretty low anyway). All of the accounts of the
award mention Krugman's war against the Bush administration, and that
he's a Barack Obama supporter and adviser, and one article accuses Krugman of having "pandered" to politics in his
economics. So even in the remote possibility that the Nobel
committee thought they were being politically neutral, nobody
believes it.
However, there's a very interesting by-product of the Krugman
selection: Krugman fully endorses the World Hedge Fund bailout plan.
Here's what he wrote on his blog last night, before learning of his award:
"Worthwhile British initiative
Ask, and you shall receive. I asked plaintively for policy makers,
at least once, to exceed expectations in this crisis instead of
falling short — and it seems that the eurozone governments have
delivered, more or less adopting the British plan.
And I should have given props to the British government, which
vastly exceeded expectations last week — and has effectively shown
the world the way forward."
What he means to imply by this is the following: Led by the UK, the
Europeans have taken steps that "exceed expectations," steps that the
US didn't take. On a BBC interview today, he indicated that the
reason that the US didn't take these steps earlier is because of
"ideology." He loves the fact that these governments are all going to
become banks (and hedge funds), and thinks that will save the world.
On the BBC interview, he compared today to 1931, saying that things
could easily slide into another Great Depression if the markets were
left to themselves, but now the governments have done exactly what
they need to do to prevent that.
He apparently doesn't have any idea that today is more comparable to
the time just before the 1929 crash.
Actually, Dear Reader, I suppose we have a little contest here.
Krugman and other economists think that this new plan will save the
world from the worst, leading to at most a recession.
I say that World Hedge Fund plan is a total, utter, fucking disaster,
and will make things much worse than they would have been otherwise.
I guess we'll have to see who's right. Actually, I'd be only too
happy if Krugman were right. But Generational Dynamics and
generational theory haven't been wrong yet, and I don't expect them to
be wrong this time.
And I haven't said this recently, but receiving Mary's message,
quoted earlier, has reminded me.
I don't get paid to write for this web site. I do it because (*)
it's an obsession; (*) I want to prove that Generational Dynamics is
a viable scholarly subject; (*) I'm saving people's lives.
When people write to me and I respond, or when I post something in
the new Generational Dynamics forum, which I usually do several times
a day, I never forget the fact that I have an enormous obligation to
my readers. Something that I write could literally mean life or
death in some cases. People who have been long-time web site readers
have prepared themselves for what's coming, and many of them will
survive because of me. I never forget this obligation for a second.
As usual, you can write to me using the "Comment" link at the top of
every page. Or you can write to me by using the "Forum" link at the
top of every page, and taking part in the forum discussion. I can't
always respond quickly, but I have still been keeping up with the
e-mail messages, and usually get back within a couple of weeks.
(14-Oct-2008)Permanent Link
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Once again, officials are attempting to take action before Asian
markets open
on Monday morning (Sunday evening ET). This follows a familiar
pattern that's been going on for several weeks now, even though these
weekend meetings never seem to prevent the markets from getting
worse.
On Friday and Saturday, we had meetings of leaders of the G7 nations,
"united in their resolve to avert a global financial meltdown." They
didn't come up with any solutions, but they did issue statements
designed to project the image that they were accomplishing something.
(The Group of Seven (G7) includes the United
States, Japan, Germany, France, Italy, the United Kingdom and Canada.
The European Union is also a participant. The G20 includes those eight
and adds China, Brazil, Russia, India, Mexico, South Korea, Saudi
Arabia, Argentina, Australia, Indonesia, South Africa and Turkey.
Together, the G20 account for about 90% of global gross domestic
product.)
"[O]ur government will continue using all the
tools at our disposal to resolve this crisis. At our meeting,
Secretary Paulson and I described the bold actions the United
States has taken over the past few weeks. ...
I'm pleased that other G7 countries are making strong -- are
taking strong measures. Finance ministers and central bankers have
acted to provide new liquidity to markets, strengthen financial
institutions, protect citizens' savings, and ensure fairness and
integrity in the financial markets. ...
As our nations carry out this plan, we must ensure the actions of
one country do not contradict or undermine the actions of another.
In our interconnected world, no nation will gain by driving down
the fortunes of another. We're in this together. We will come
through it together."
I think it's really interesting that the emphasis is not on finding a
solution (there is none, anyway), but on avoiding the "every country
for itself" trend that has been increasing, especially in Europe.
Exactly the same sentiments were expressed at a Sunday meeting in Paris of leaders
of 15 euroland countries. French President Nicolas Sarkozy said, "I
expect Europe to speak with a single voice."
And German Chancellor Angela Merkel said:
"The goal is to define a coordinated common
procedure for the euro zone that enables us in the next few days
to take national steps to stabilize the financial market, but
measures that do not discriminate against individual member
states. ...
I think that the meeting today will send a very important signal
to the markets."
The Paris meeting of euroland countries did tentatively agree to guarantee interbank loans, in order to end the
worldwide credit freeze caused by banks' fear of loaning money to one
another.
However, the agreement is not certain, and is likely to falter on
parochial grounds; for example, will an eastern European country be
required to help bail out a German or French bank? The question will
be decided at another meeting, scheduled for Wednesday.
The meetings of G-7 leaders and European leaders, in the end, didn't
accomplish anything except provide an opportunity for photo ops and
self-serving statements, just as is happening in the US political
campaign.
Listening to the Sunday morning news shows today gave me a headache.
I don't believe I heard anyone make any sense whatsoever. Pretty
much everyone took an ideological position, with the Republicans on
the defensive. Several people blamed Ronald Reagan and George Bush
for the current situation, but no one blamed Bill Clinton for the
dot-com bubble.
Of those who said things that weren't purely ideological,
they all followed the Nouriel Roubini formula: "Do exactly what I
tell you to do, or we'll have a major worldwide crisis." That way,
even though they have absolutely no idea what's going on, they've
covered their asses no matter what happens, and if there's a crisis,
they can blame it on the fact that no one listened to them.
What's really sickening is that no one gives a f--k what happens to
anyone else, as long as they're protected. "It's everyone's fault
but mine."
As always, there were the usual soothing words that people were
saying in 1929: "The fundamentals are sound." "This will pass soon."
"We've had recessions before."
The most amazing time in my life, and also the most sickening.
Possible exception: One of the days just before or after the 1929
crash.
Market summary, 10-Oct-2008
The Dow index fell 621 points within moments after the market opened
on Friday. In the next few minutes, it rallied by 688 points.
Several times, the Dow went up or down over 100 points within a few
minutes. In the last hour of trading alone, the Dow changed
direction 16 times. During just one commercial break on CNBC around
3:45 pm, the Dow went from +300 to -100. Never before in history has
the intraday high been more than 1000 points above the intraday low.
The Dow ended down 128 points.
The Dow has fallen 25% in the last three weeks alone. This would
cause huge amounts of forced selling anyway, even if we didn't know
that many hedge funds are liquidating.
And yet, I was shocked that one person after another called this good
news. CNN's Ali Velshi said that it meant that the market would
start going up again.
In the Financial Topics thread of the Generational Dynamics forum, one
person wrote, "today was the most bullish day we've had so far during
the decline." Another wrote, "My best guess is that ... stocks will
rally for a few days, or maybe even a few weeks or months. " My best
guess is that you are correct this time and stocks will rally for a
few days, or maybe even a few weeks or months."
At a time when P/E ratios are at astronomical highs, and corporate
earnings keep falling, it's really hard for me to understand how
anyone could hold that belief.
And yet, analysts and pundits seem to have no idea what's going on.
International superstar Professor Nouriel Roubini says that Dow 7,000
is likely "sometime next year," though apparently not before then.
Actually, he said that on Tuesday, when the Dow was just beginning to fall
through 10,000. I wonder what he thinks on Friday, with the Dow near
8,000?
I'm getting increasingly bemused by Roubini. He's become the the
Paris Hilton of economics: He always knows exactly how much leg to
show in order to keep himself in the headlines.
His 12 steps to financial disaster was actually quite brilliant, but when it comes to saying
what's going to happen, he seems to change his mind every day. Will
there be a recession, or not? Will it be V shaped or U shaped or L
shaped? If you don't like his answer, then wait a minute.
However, whatever Roubini says on any particular day, the formula is
always the same: "Unless the Administration does exactly what I say,
then the world is going to suffer systemic financial crisis." He's
got it both ways. If there's no crisis, then he can slide by; if
there is a crisis, he can claim that he predicted it, because they
didn't listen to him.
Paul Krugman is another Paris Hilton-like figure. In his latest column, entitled "The Moment of Truth," he says the
following:
"They’d better do something soon — in fact,
they’d better announce a coordinated rescue plan this weekend — or
the world economy may well experience its worst slump since the
Great Depression."
Whew! I'm shaking from what a hard-hitting statement this is.
They'd better DO something or something MAY happen. Wow, you can
take that to the bank.
Actually, I heard Krugman being interviewed on Bloomberg tv on
Friday, and I really had to laugh when he was asked what's different
today from 1929? Here's what he said:
"Two things are different. We know the Great
Depression happened, and this actually gives us some urgency in
policy. And I think we do understand economics better than we did
75 years ago. I think we know something about what needs to be
done."
Boy, you could fool me. These economists have no idea why the
dot-com bubble occurred, why the real estate bubble occurred, why the
credit bubble occurred, why they all occurred at the time they did,
and how we got to where we are today. They have no idea whatsoever.
Mainstream economists know little more than they did in 1929.
I have to mention the latest column by Michael "Mish" Shedlock. He applies Elliott
Wave analysis to the current situation, and evidently fails to find
any pattern that predicts what's going to happen.
Things like K-cycles and Elliott Wave analysis actually are valid,
but researchers always make the same mistake: they try to use them to
analyze generational crashes, and they're not valid for that purpose.
Generational cycles are completely independent of K-cycles and
Elliott wave cycles, and the fact that researchers don't take that
into account is why these tools never seem to work.
I mention this today because I want to make this point: That tools and
policies that work fine in "ordinary" times do not work at times of
generational crisis. In a generational Crisis era, the financial
crisis or war crisis is caused by massive generational behaviorial
changes that can't be stopped by any policy that would have worked
fine just a few years earlier.
This is something that the survivors of the Great Depression and
World War II understood, because they learned that lesson in the
1930s. But those people are all gone now, and today's Boomers and
Gen-Xers, including people like Roubini, Krugman, and Shedlock, have
to learn all over again.
I had to chuckle when I was listening to a radio talk show on Friday
with Krugman as a guest. A lady called into the show and asked, "Why
do you give all the air time to people who have been wrong over and
over again in the past few years? Why don't you find someone whose
predictions have been correct?"
Being right or wrong is completely irrelevant in today's society. If
people like Roubini, Krugman and Shedlock are wrong time after time,
they're still listened to because they're skillful at saying what
people want to hear, rather than what's true.
That's certainly not my skill, as I get shunned by the media, even
though every major Generational Dynamics prediction has been correct for the past six years.
The media are interested only in supporting their own political
biases; they're not interested in the truth.
So I will now once again state the truth, as I have so many times
before, about what's coming.
The Wall Street stock markets are now down 60% from their peak a year
ago. We're following the same cascading pattern as happened in the
1929 crash. But does that mean that the market is going to keep
falling, as it did in the 1930s, and reach below Dow 3000? Or will it
bottom out where it is now, around Dow 8000?
Certainly the "experts" don't expect it to go much lower, and neither
do the pundits that I hear on tv and read in the papers.
As I'm writing this, I just received an e-mail message informing me
that John Mauldin's new column is now available. I've criticized
Mauldin for being "muddled" in the past, and this column is no
exception. Here's what he says:
"This is not the end of the world. There are a
lot of very positive things happening in the US and the world.
Companies are creating new inventions. Much of the economy,
including health care, is moving along fine. I have lived through
two serious recessions (1973-74 and 1980-82), and the point is
that a free-market economy will find a way to eventually get back
to solid growth. Recessions are simply part of the business
cycle. Congress cannot repeal the business cycle. This will not be
the last recession of my life. I hope to live long enough to go
through 4 or 5 more.
Depressions are caused by governments making major policy
mistakes. And we have made some in the areas of not regulating
mortgage lending, allowing the five large investment banks to
increase their leverage to 30 or 40 to one in 2004 (what was the
SEC thinking?), and failing to oversee the rating agencies. That
is behind us. It will make a normal recession deeper and the
recovery longer, as I have been forecasting for some time.
But as I argue below, immediate actions must be taken by the
government to avoid a much deeper problem. To not take actions to
stem the credit crisis would be that major policy mistake which
would compound all the other mistakes. I think everyone knows the
seriousness of the problem and will act. Let's pray they
do."
I have nothing against John Mauldin, and I wouldn't be picking on him
if I hadn't just received this e-mail message. But this is typical
of the nonsense that all the pundits and analysts are using. He's
lived through the 1973-74 and 1980-82 recessions? That's nice, but
what could that possibly have to do with the deflationary spiral
that's going on today?
He criticizes government "policy mistakes," allowing investment banks
to increase their leverage. Well, did he say anything about that
when it was happening? Mauldin is an investment expert who boasts
that his clients all have at least $2 million in assets. He claims
to be able to be giving these people expert advice on where to
invest. Well, did he ever give these people expert advice about
avoiding investing in financial firms that have been over-leveraged?
I doubt it very much. He had no idea what was coming, just as he has
no idea today what's coming. (As I said, I have nothing against
Mauldin in particular; he's just like all the others.)
Of all of these experts I've quoted today, only Roubini has at least
foreseen some things before they happened, although he was late to the
game, and he's still playing his Paris Hilton act.
But in general, these experts and pundits and politicians and
journalists and analysts and college professors have no idea what's
going on, and when their so-called "predictions" are wrong, as they
are time after time after time, they simply blame someone else. "The
regulators should have stopped this." "The Administration should
have stopped it." "Congress should have stopped it." Pick your
favorite target. If you're an "expert" or even worse, a politician,
who's been wrong time after time after time, it's never the fault of
your own stupidity and short-sightedness. It's the fault of everyone
BUT yourself.
I listened to Fox News Channel's Bill O'Reilly on Friday night. Just
three days ago, I heard him advise everyone to take a deep breath and not panic, essentially advising
his millions of viewers not to sell, because "The bottom will soon be
reached." Now he's claiming that he doesn't give investment advice,
and that everyone is at fault but him for not seeing this. Well, why
didn't he see it? He's always running various exposés of all kinds
of political and financial scams. Why didn't he ever run an exposé
of this one? Like all the other "experts," he never blames his own
stupidity and short-sightedness. It's the fault of everyone BUT
himself.
So let's get back to the truth that none of these "experts" ever
talks about:
The S&P 500 price/earnings ratio index is in the 20s, and corporate
earnings continue to fall, so the market is nowhere near a bottom.
Furthermore, the P/E ratio has been at historically high levels for
13 years -- since 1995 -- and so by the Law of Mean Reversion, the
P/E ratio will be at historically low levels for roughly the next 13
years.
That's what I've been saying for six years, and I've been right every
time, and it's really all the proof you need.
Now, I don't expect someone like Bill O'Reilly or CNBC anchor Maria
Bartiromo to understand something as mathematically deep,
sophisticated and complex as the computations for the price/earnings
ratio (i.e., you divide the price per share by the earnings per
share), since these people would have trouble figuring out how to add
two numbers together.
But Nouriel Roubini is a Professor of Economics at New York
University. Paul Krugman was a Professor of Economics at Princeton
University, the same place where Fed Chairman Ben Bernanke was head of
the Economics Department.
Now, do they even teach calculus in the economics departments of
these schools? Judging from what I hear from these "experts," I
wonder if you have to know any math at all to be a Professor of
Economics at Princeton University or New York University. It seems
that all you have to really study is sociology, because these
"experts" never seem to say much beyond sociological statements.
I've been analyzing this situation since 2002, which is when I first
noticed that we had to be headed for a new 1930s style Great
Depression. I've been posting all of these analyses on this web site
over the years, and I summarized them last year in the article,
"How to compute the 'real value' of the stock market."
As I've noted before, the timeline for the past year has been
different from 1929, as you can see from my Dow Jones historical page. The timeline in 1929 was as follows:
3-Sep-1929: Market peaks
3-Sep to 23-Oct: Market falls 20% in six weeks.
24-Oct to 6-Nov: Generational crash - market falls 25% in 10
days.
6-Nov-1929 to 9-Sep-1930: Market is flat over the period of one
year.
9-Sep-1930 to 8-Jul-1932: Market keeps falling, to 10% of its
peak value.
The timeline so far today is as follows:
17-Aug-2007: Credit crisis begins, causing Fed to make
extraordinary interest rate reduction.
17-Aug to 9-Oct: Market rises, reaching peak of 14164.
10-Oct-2007 to 12-Sep-2008: Market falls 20% from its peak in 11
months, in a period of collapses of many financial institutions.
15-Sep to 10-Oct: Market falls 25% in three weeks, amid multiple
market crashes around the world, and significant worsening of the
credit crisis.
Now, first off, it's incredible and baffling to me that any experts
could now predict that the trend described in the above list could
suddenly be reversed, and the market will start going up. Obviously
this is trending toward an accelerating crash, and only an idiot
(which apparently includes most "experts") can miss it.
But the question I want to address is this: Have we somehow managed
to avoid the generational panic and crash that I keep talking about?
I've described many times what I expect to see happen; here's a
summary: An elemental force of nature, where millions or even tens of
millions of Boomers and Generation-Xers in countries around the world,
never having seen anything like this before, and not having believed
it was even possible, suddenly try to sell everything in a mass panic.
This will bring down computer systems for hours, perhaps even for a
day or two, as people watch tv in glazed horror as their life savings
disappear.
That's the kind of generational panic that occurred in 1929, and is
remembered as "the crash of 1929," and it was a year after the
generational panic that the market was 40% below its peak. But that
hasn't happened this time, even though the market has already fallen
40% from its peak value in the last year. So have we managed to
avoid it?
Generational theory says "absolutely not." This generational panic
MUST occur, if only to teach a lesson to the generations of "experts"
who keep saying stupid things. Generational panics are nature's way
of educating "experts" to what is really going on.
However, remarkably enough, this is actually a point of commonality
between me and mainstream pundits. Most of them are expecting some
sort of "panic event," like the panic of 1987, that will cause a
"capitulation," and the market will bottom out and start going up
again.
So in fact, most pundits and I are in agreement that some kind of
major panic is going to be occurring shortly. The pundits that I
hear are expecting it very soon, perhaps as early as next week.
However, this is in the "be careful what you wish for" category,
because my expectation is that it will proceed far differently than
the mainstream "experts" expect. Actually, this shouldn't surprise
anyone, since what happened on Friday didn't happen in 1987, and
hasn't happened at any time since 1929. My expectation is that the
market will continue its downward path, just as happened in
1930-1932.
There's no way to predict with certainty what's going to happen next
week, but I feel pretty safe making the following prediction: One way
or another, next week is going to be very rocky.
The last hour of trading on Wall Street on Thursday was close to a
full scale panic.
Market summary, 9-Oct-2008
At 3 pm, the Dow index was down 200 points.
At 3:30 pm, it was down 400 points.
At 4 pm, it was down 579 points.
At 4:07 pm, it was down 679 points.
Note that the market closed at 4 pm, but the post-closing final
settlements brought the Dow down another hundred points in 7 just
minutes on huge volume.
According to CNBC, the final rush was caused by forced selling by
hedge funds and money market funds, because people are pulling their
money out of these funds, and also forced selling by people required
to meet margin calls (when they had acquired their stocks on credit).
At this writing, on Thursday evening ET, the Asian markets are
falling sharply, as much as 5-12%.
Believe it or not, I still heard analysts today say that this is a
GOOD thing. "The stock market is oversold by ABSOLUTELY HISTORIC
proportions," said one. "You could see a thousand point pop any day
now!" Another said, "This must finally be capitulation, and the
market has reached a bottom."
These people use the word "confidence" at least once every ten
seconds. "The bailout hasn't restored confidence. We have to
restore confidence. What can the Fed do next to restore confidence?"
This market crash has never been about confidence. Corporate
earnings have been in a bubble for years, and now corporate earnings
have been falling, as I've been demonstrating for the last four
quarters. This has forced price/earnings ratios (also called
"valuations") up to astronomical levels, so that investors' computer
models began to say "Sell!" We'll get another earnings report on
Friday, so we'll see what comes next.
October 9, 2007, exactly one year ago, was the day on which the Dow
index reached its peak. Since then, the market has been falling
because of falling corporate earnings.
But now, especially in the last few days, something else is
happening.
Stock and bond mutual funds experienced the the greatest level of withdrawals in history in September, and
the withdrawals are trending even higher in October. (Paragraph corrected - 15-Oct)
"The U.S. commercial paper market shrank by $56.4
billion in the week ended Wednesday, the fourth consecutive week
of declines, according to data released by the Federal Reserve
Thursday. ...
In the past few weeks, the decline has been driven by money
market funds, which have been worried that the crisis among
financial institutions could result in significant losses in their
holdings. They have been hoarding their cash for fear of
redemptions. Money market funds are the largest buyers of
commercial paper, purchasing about a third of outstanding paper.
Retirement and pension funds, corporate treasuries and life
insurance companies are other buyers.
Investors have been reluctant to buy paper that matures past one
day and rates have been elevated. On Thursday, rates on
asset-backed commercial paper are quoted lower by about 100 basis
points, according to one trader at a primary dealer."
It's this freezing up of the commercial paper market that's caused
the greatest pain in the credit crunch. If an organization can't
borrow money by issuing commercial paper, then business around the
world freezes up, and that's what's happening.
"Investors can't redeem their money from hedge
funds at will; often they have quarterly windows when they can do
so. Many investors had until Sept. 30 to tell hedge funds they
wanted out. While the funds are typically not required to redeem
the money until the end of the year, the redemptions were greater
than some funds expected. That caused a scramble to raise cash to
pay the investors back. And one quick way to raise cash is often
to sell holdings of stock.
For larger investors like pension funds, their own money-raising
issues have forced more selling than they would have wanted.
"Pension funds are reducing stakes because they relied on
commercial paper for financing and that is frozen," said a person
familiar with several hedge funds that have had that
problem."
This is causing other knock-on effects.
The country of Iceland, which has been acting like a hedge fund for several years, is approaching
closer and closer to full scale bankruptcy, and the currency is
crashing.
As hedge funds unwind, they're forced to sell stocks and
liquidate other holdings, including metals and other commodities.
Copper, aluminum and nickel prices have fallen to three year lows,
and oil has fallen sharply as well. The only metal that's gained is
gold, which rose to $907 per ounce, but that's still well below its
high last year.
It's increasingly clear that a lot of forced selling has been going
on since the beginning of the credit crunch a year ago. A year ago,
the forced selling was just a trickle. Since then it's accelerated,
and today it appears to be an avalanche. At some point, and it can't
be too much longer now, the avalanche will accelerate further into a
full scale "panic event" that will be remembered for decades.
It's important to understand this, because the 1929 crash was not
caused by "loss of confidence," even though Fed Chairman Ben Bernanke
has spent his entire career believing that. It was caused by exactly
this kind of forced selling. It was a lot simpler then. Individual
investors buying stocks on margin were forced to sell to meet margin
calls. Forced selling lowers stock prices, which causes more margin
calls which causes more forced selling.
But this time, it's not just individual investors meeting margin
calls. You've got $60 trillion of interlocked credit default swaps
that will have to unwind, and there are other credit derivatives
totalling $1 quadrillion.
Thus, the generational panic and crash, when it comes, will be far
larger than anything that happened in 1929.
The puzzle, as I've mentioned before, is that the timeline is a
little different than it was in 1929. In 1929, there was a huge
panic that dropped the market 40%, and after that it kept falling to
10% of its peak value.
Today, a year after the credit crunch began, the market has already
fallen 40%, so a generational panic and crash might push the market
down another 10-20% pretty quickly. Despite the differing timelines,
in the end, though, it's reasonable to expect that the market will do
as it did in 1929, ending up at 10% of its peak value, or around Dow
1400, sometime around 2012.
As I'm writing this late Thursday evening ET, Asian markets are still
falling sharply, and Wall Street market futures for Friday morning
are indicating a sharp fall at the open. That doesn't mean that the
market will fall on Friday -- we could certainly have a big one-day
rally, as happened more than once after the crash of 1929.
But the most important news is the increase in forced selling. It's
creating a vicious cycle (forced selling depresses stock prices,
causing more margin calls, causing more forced selling) that has to
lead to full scale panic at some point, and that point can't be very
far off now.
The remaining hope: The news is so bad that it must be over.
Interest rate changes, Oct 8, 2008 (Source: AFP)
Six central banks launched a coordinated effort to provide a psychological boost to
investors by lowering short-term rates by a half-percentage point in
unison.
A year ago this would have been a historic effort, but now it's just
another day, and investors weren't particularly impressed.
Market summary, 8-Oct-2008
I had actually expected the markets to rally upward today, just based
on the wild oscillations that occurred in 1929. Panic buying is not
much different than panic selling.
However, the coordinated announcement must have seemed like such an
act of desperation, that an early rally didn't last long.
After another rocky day, major indexes fell 1-2%, with the Dow index
now at 65% of its peak value, exactly one year ago on October 9,
2007.
Around the world, things were bad. The Nikkei fell 9%, the greatest
plunge since 1987. In India, stocks fell sharply, below the key
11000 level. Iceland's currency continues to crash. Stocks fell
sharply in Brazil. And worldwide interbank lending rates continue at
historic highs.
If we count the "crash" as starting in August, 2007, which is when
the credit crunch started, then we're actually following the 1929
crash pretty closely.
With one big exception.
We haven't seen a major generational panic yet, where millions of
Boomers and Gen-Xers panic and try to sell everything.
Must such a panic occur? I believe it must. Generational theory
says so.
But this time it won't be just a stock market panic. It will stretch
much farther, into hedge funds, credit default swaps ($60 trillion)
and other credit derivatives ($1 quadrillion).
All the Fed interventions of the last years -- the TAFs and TARPs and
other stuff -- have been very successful it targeting specific points
of weakness.
If you imagine the global economy as a huge ballooon, then the Fed
interventions have targeted specific large holes in the balloon.
But there are thousands, perhaps millions, of tiny pinholes in the
balloon that have escaped the Fed's interventions, and so the balloon
as a whole has still be deflating. Even worse, as the balloon
contracts, the pinholes actually get larger -- the physical analogy
breaks down here, but the hedge funds that represent the pinholes
become more and more exposed as the market falls.
Pundits that I heard on Wednesday seemed to me to be
stunned, stupefied and exhausted. They've been parroting the same
super-optimistic words for over a year now, and those words have
proven wrong every time.
"When I started this blog (Jan 2005), I was
concerned about excessive speculation in housing and extremely
loose lending practices. It appeared that housing starts and new
home sales would fall significantly. I forecast record
foreclosures and significant declines in home prices. Many of us
wondered who the eventual bagholders would be for all the bad
loans. I was also concerned about the extent of equity extraction
from homes (the home ATM), and I believed that the coming housing
bust would lead the economy into a recession.
This blog was a daily dose of doom and gloom! ...
I'm frequently asked if I'm more concerned today than I was in
2005. There are reasons for concern: the credit markets have
seized up, many financial institutions are insolvent, consumer
spending and investment in commercial real estate is starting to
decline, export growth appears to be slowing, the unemployment
rate is rising ... and the economy is clearly in a recession.
There are huge and scary downside risks today, but I'm actually
more sanguine now than I was in 2005. ...
It's easy to get caught up in the day to day financial crisis and
recession news - and this blog will continue to bring you the doom
and gloom of the worsening recession. But it's important to
remember that even though the adjustment process is painful,
progress is being made. ...
The financial crisis is worse today than in 1990, and there are
many problems ahead (like less consumer spending and business
investment), but I believe progress is being made."
With the news worse than ever, Calculated Risk apparently believes
that the worst is over.
Analyst Kevin Depew, quoted by blogger Michael "Mish" Shedlock,
was equally mushy:
"Here is where we stand with the point and figure
bullish percent indicators for equities, based on Investors
Intelligence data.
NYSE Bullish Percent: Os (Negative) 9% - lowest since
1987
S&P 500 Bullish Percent: Os (Negative) 7.9% - exceeds 2002
and 1998 lows
Nasdaq Composite Bullish Percent: Os (Negative) 13.4% -
lowest since 1987
Nasdaq-100 Bullish Percent: Os (Negative) 4% - in 2001, this
indicator actually reached 0
Russell 2000 Bullish Percent: Os (Negative) 14.1% - equals
January low
NYSE High-Low Index: Os (Negative) 2.5%
Nasdaq High-Low: Os (Negative) 2.8%
It is easy to be bearish given the circumstances, but the fact of
the matter is these indicators are so washed out and so low that
the probabilities increasingly favor a sustainable rally. Given
the macro headwinds combined with approaching earnings season, it
is doubtful this is THE bottom, but we are nearing, or at, a low.
Keep in mind, these are probabilities. The market may simply
continue lower. Yesterday's action was not capitulation in the
traditional sense."
The message is the same: The news is sooooooooooo bad, that there's
nowhere to go but up.
This is the kind of nonsense I've been complaining about for years.
When the bubble was growing, good data meant that the stock market
was going up, while bad data meant that the Fed would lower interest
rates, so the stock market would go up.
Now Depew can't identify even one tiny piece of good news, and yet he
still concludes that the stock market is going up.
What's interesting is that data is irrelevant to these people. If
the data is bad then the stock market is going up, and if the data is
good then the stock market is going up. Therefore, data is
irrelevant.
These people are stunned, stupefied and exhausted, and have no idea
what's going on. And they seem incapable of learning. They've been
wrong almost every day for a year, and yet they continue to make the
same stupid mistake every day.
So, if I can summarize the things I've written about the last few
days, it's that investors and pundits are waiting for something to
happen. Some of them believe that the downward drift of the stock
market will just end, and the market will go up again. Others
believe that there's going to be a "crash event," and the market will
go up again. Either way, it'll be "capitulation," and the market
will go up again.
Generational Dynamics predicts something a little different: Yes,
there'll be a "crash event," but it will stun the world, just like
the one in 1929 did, and will be remembered throughout future
history. The only thing we can't predict is the date, but it can't
be too far off now.
With the króna ("krona" or "crown") currency crashing, Iceland
apparently went begging from country to country for a bailout, and
Russia is looking favorably on a €4 billion loan to Iceland.
According to an Iceland official, "We have been calling for aid from
neighboring countries and have been turned down. This is looking like
the beginning of relations between Russia and Iceland."
There's an irony to that because Russia itself is in a downward
spiral.
"Russia and Brazil crumble as commodity prices
crash
The entire complex of commodities and emerging market stocks,
bonds, and currencies is now in free-fall as the economic crisis
spreads like brushfire, threatening to draw every corner of the
globe into the vortex of recession. ...
The euro’s dramatic slide over the past two weeks has for the
first time exposed the instability of the twin-pillar system
holding up global finance. ...
There are fears that Russia could slip into a downward spiral if
oil drops to $50 a barrel, which is now the lower end of Merrill
Lynch’s forecast.
Moscow has become addicted to the oil bonanza, ratcheting up
spending so quickly that it may now need prices to stay above $90
to fund spending plans. Veteran analysts say they have seen this
movie before."
Evans-Pritchard appears to be the only mainstream journalist in the
world who appears to have any idea what's going on.
Market summary, 7-Oct-2008
Wall Street was convulsed on Tuesday, as the market
However, you'd barely even know there's a problem if you listen to
the pundits on tv.
As I'm typing this on Tuesday evening, I'm listening to two clowns on
tv listening to questions and delivering carefully scripted responses
that say less than nothing. Both of these guys are totally oblivious
to what's going on.
But that's nothing compared to what I heard this afternoon.
Keep in mind that nobody has any idea what's going on. They either
can't or won't face the fact that the market has been in a bubble for
many years, and is now going to plummet for many years, by the Law of
Mean Reversion. You'd think that Ben Bernanke, at least, would
understand that, but I don't get the impression he has any idea
what's going on.
So here's what I heard on Bloomberg TV on Tuesday afternoon:
Top: Scott Minerd of Guggenheim Partners. Bottom: John O'Donoghue, Cowen and Company, LLC (Source: Bloomberg)
Scott Minerd of Guggenheim Partners: On a
tactical basis, I think the market's getting close to a bottom.
Now it may be 800 on the S&P in the next week or two, but tehre's
a lot of seasonal pressure here. We're getting deeply oversold,
so I would look to put some money to work in equities. I might
not dive into financials aggressively, but I would certainly
dabble in financials.
And I think that in the longer term, maybe we get a rally off of
the bottom here in the order of 25% or so, and then we rethink
what the long term looks like.
I would like to see the market have a wholesale panic in the next
week or so. We keep having these days when we go down, then we
trade up, then we go down, then we trade up. I'd like to see us
close down 1000 Dow points, and then set a bottom.
Q: Man, I would not like to see that. John do you want to
see a wholesale panic?
John O'Donoghue, Cowen and Company, LLC: No, I've through
a lot of these and I don't like those too much. It's worse than
going to the dentist. But I will tell you this: The amount of
money that has been taken out of this marketplace prior to the
third quarter -- now here we are into the second full week of the
third quarter -- as opposed to the 25% drop that we had in 1987
-- this is more like Chinese water torture.
I think you'll probably come to the end of this probably in the
next week or so. It's just a matter of the selling becoming
exhausted, as opposed to - you're going to see this one big
swoop-down day. It's becoming quite disconcerting with the false
positives that you're seeing.
Q: There's so much cash on the sidelines.
Minerd: And that's why I think you'll get a pretty good
lift here - 20-25%. If you're a trader, and even a long-term
investor, you've got to start to consider putting your money to
work.
There's a really interesting bit of research done -- there's an
old saying, "Sell in May, go away, come again on Arbor Day."
Well, statistically, it's actually sell on Memorial Day, and buy
at the first game of the World Series. So I'm waiting for the
World Series.
There's been a lot of bottom-fishing, and I think we've got to
get those people discouraged.
Q: If you see us drop to 800 on the S&P in the next couple
of weeks, where to you see us at the end of the year?
Minerd: I think maybe at the end of the year we're up to
1000, maybe 1100."
You know, Dear Reader, there are many times when I've expressed
astonishment at what was going on. This was true throughout the
growth of the bubble, when I always expressed amazement that the
investors could possibly be making an enormous bubble even larger.
But I don't know how to express in words what I'm seeing and hearing
now. The conversation I quoted above is almost beyond belief in any
way possible.
What could these guys possibly be thinking? There is no possible way
that they could have the vaguest idea what they're talking about.
One is calling for a 1000 point fall in the Dow, after which (he
claims) the market will spring back with a 25% rally. The other one
says almost the same thing, but with a slower selloff in the next two
weeks.
They're just making this stuff up. It's pure fabrication. They have
absolutely no idea what's going to happen, so they pass themselves
off as experts and say stuff like that. Didn't it even occur to them
that on a day when a country like Iceland goes bankrupt, it might
mean something on Wall Street?
"Insanity in individuals is something rare - but
in groups, parties, nations and epochs, it is the rule." --
Friedrich Nietzsche
When I started talking about the Principle of Maximum Ruin several
years ago, I knew it was coming by analysis of previous generational
crashes, but I didn't know the exact mechanism.
Now that I see it happening, it's more like a cartoon than anything
else. These guys literally have no idea what they're talking about,
and they're making stuff up.
How can this be? How could we have come to this.
It's one thing for analysts to make these things up and talk about
them on a financial channel like Bloomberg TV.
It's another thing for a mainstream commentator to do the same thing:
Bill O'Reilly (Source: Fox News Channel)
"More bad news today - Dow down more than 500
points. Just hang in there. Work hard, tough it out, don't
panic. The bottom will soon be reached."
There's a HUGE irony here. Last week, O'Reilly got into a huge
shouting match with Massachusetts congressman Barney Frank. The
tongue-lashing that Frank got was well-deserved, as he's one of the
worst hypocrites around. O'Reilly criticized Frank for saying
everything was OK, and allowing ordinary homeowners to be hurt.
But now look at what O'Reilly is doing. He's giving investment
advice to millions of viewers. He's telling them not to sell, and
he's telling them the market will reach bottom soon.
How could he possibly know that? Does he have a crystal ball?
Perhaps he prayed to God, and God gave him the information. (Though
I have to wonder if even God can predict chaotic events.)
Or, O'Reilly made it up. Having no idea what's going to happen, he
simply made up what he wants to happen.
So now when millions of people listen to him and take his advice,
they're going to lose their money. And O'Reilly will be to blame.
O'Reilly keeps saying how furious he is about what's going on. That
fury will now be directed at him. I hope he has his bunker picked
out.
These are truly incredible days, certainly the most incredible days
of my life. It's almost too much to believe what's going on.
Last March, I wrote that the country of Iceland was close to financial default, because for several
years, Iceland has been acting like a hedge fund, instead of a
country, and the króna ("krona" or "crown") currency was crashing.
The problems in Iceland set the stage for the day.
Overnight inter bank lending rates rose sharply, demonstrating that the
$700 billion bailout bill, which
just became law, is not having the desired effect of motivating banks
to trust one another and lend money to one another.
Tokyo had already suffered its worst day in years. Russia shut down its stock markets 3 times, and finally ended 20% down,
its worst day in history. Throughout Latin America, stock markets had
big losses of as much as 17%.
World stock market indexes, Sept 1 to Oct 6, 2008 (Source: AP/cleveland.com)
In European markets, there was a stampede to sell. Britain's FTSE lost 7%, the worst since the
Panic of 1987. Markets in Germany, Italy, France and Spain were down
4-5%.
Appearing on the NBC Today show on Monday morning, CNBC's Jim Cramer said he expected as much as a 20% further decline in the
stock market and, "Whatever money you need for the next 5 years, take
it out of the stock market."
With regard to corporate earnings, he said, "The previous quarter,
the second quarter, was a bad quarter, but it will look good compared
to the coming quarter."
Market summary, 6-Oct-2008
So on Wall Street, there was a lot of anxiety, but there was also a
fair amount of glee, because pundits and investors felt that their
fantasy "capitulation event" might finally be occurring, meaning (in this fantasy)
that the market would now start going up again, and the bubble would
grow again.
The Dow Industrials index fell 800 points in the morning, to well
below 10,000 for the first time in years.
In the afternoon, the market regained about 400 points, leaving a lot
of people scratching their heads, since there was no special news in
the afternoon.
There was a lively discussion on Monday in the Financial Topics thread of the Generational Dynamics forum. One
person wrote,
"I could not be more pleased with what I saw today
from a traders perspective. We got a beautiful key reversal on
massive volume."
Another wrote:
"I had lunch with my co-workers today. Some of
them said waiting for some points to jump in the market and pick
up some bargains. I think some of these guys may regret not jump
into the market this afternoon by seeing the come back."
After the market closed, an analyst on the BBC was asked why the
market came back after such a disastrous fall. He said,
"That's a terrific question - we're trying to
figure that out ourselves. The pundits are saying that someone
with deep pockets came in and started buying, but we don't know
who. The stocks that are considered recession-proof -- McDonald's,
Pepsi, Coca-Cola -- led the comeback."
What's clear is that the Principle of Maximum Ruin is alive and well.
These people are going to lose a lot more money.
The Fed has expanded its liquidity program this morning. European
central banks are doing the same. They've already done so much, I
didn't think that was possible. But it's not helping. Investors have
finally caught on to the fact that the psychological boost of a
liquidity injection doesn't last more than a day or two.
It's been amazing to watch this, since I set up the Generational
Dynamics web site in 2002. I couldn't foresee the details of what
was going to happen, but I applied generational theory to the
situation, as well as well-established laws:
The Law of Exponential Growth
The Law of Mean Reversion
The Law of Diminishing Returns
I didn't make up these laws, but I've been applying them ruthlessly
for years, to predict what's happening now. And, not surprisingly,
the predictions derived from these laws have all turned out to be
brutally true.
And the fall has much farther to go. Here's Friday's version of the
graphic that appears on the bottom of the home page of this web site:
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 3-Oct-2008. (Source: MarketGauge ® by DataView, LLC)
As you can see, P/E ratios (also called "valuations") are still at
really astronomical heights.
Incredibly, the P/E index hasn't even gotten as low as it was back
prior to March. It's been at astronomical levels since 1995, and now
appears to be the time when the Law of Mean Reversion is applying
itself. That means that it's going to be falling well below 10.
All this is lost on the pundits, however. Many of them see this
selloff as good news, because it's a "capitulation" event that will
cause the market to "snap back" quickly. There's just no limit to
the stupidity of these people.
One snap back that we are seeing is the snap back of the dollar,
especially against the euro. Those of you who have told me that the
dollar would become worthless can now begin to see why you were wrong.
The dollar is in a deflationary spiral, which makes it increasingly
valuable, while other currencies, including the euro, are collapsing.
I've received a lot of questions about this issue. It's true that
America is deeply in debt, inasmuch as we owe China, Japan and other
foreign countries far more money than we can ever pay back.
But that's not the issue. The dollar has been the reserve currency
since at least the 1930s, and there are huge amounts of dollars in
countries around the world.
In the case of Germany's Weimar Republic, which suffered hyper-inflation in the 1920s, few people
outside of Germany owned marks. In the case of Zimbabwe today, no one
outside of Zimbabwe owns Zimbabwe dollars.
But there are huge amounts of dollars outside of America -- Europe,
China, the Mideast -- and all of those holders are as committed to
the value and integrity of the dollar as America is.
Forget about the dollar as an American currency. Think of the dollar
as a world currency. Even if America no longer had any dollars
whatsoever, the dollar would still be valuable on international
markets as a world currency.
People have accused me of being "nationalistic" when I write this
about the dollar, but that has absolutely nothing to do with it.
It's not nationalistic to say that the dollar has become an
international world currency, whose value no longer even depends on
how many dollars America has. America is just one holder of dollars,
among hundreds of other countries, and the value of the dollar is
determined by the collective value assigned to it by all those
hundreds of countries.
For that reason, the dollar will continue to strengthen against other
currencies, as the deflationary spiral continues.
The only other currency I'd be willing to bet on is the yen. Why?
Because Japan has already gone through a generational crash in 1990,
and they're a nation of survivors of that crash. I'd bet that if
there were a way to take a survey of Japanese mattresses, a lot of
them would be found to be stuffed with cash.
That means that cash is king. And you should take Jim Cramer's
advice: If you're going to need any money in the next five years,
then take it out of the stock market, and keep it in cash.
According to my Dow Jones historical page, the Dow Industrials index is now at 70% of its high on
October 9 of last year. That's putting an enormous strain on money
market funds, hedge funds, endowments, and everything else, and
because of high leveraging in the past, it may take just a few more
straws to break the camel's back.
In the so-called "European Union," it's every country for
itself now.
The good news is that if you're rich, you can now shift your money
into a European bank, and be fully insured -- even for deposits in
the millions of euros.
The bad news is that Europe is in the midst of a rapidly spreading
bank crisis, and you can't be sure that the bank where you deposit
your money will be around much longer.
The crisis was heightened on Sunday when a bailout plan for Germany's Hypo Real Estate collapsed.
Ireland was heavily criticized earlier this week when its Parliament
voted to provide a $600 billion guarantee to all deposits, of whatever
size, in all Irish banks. The reason given was that the Irish feared
a run on Irish banks by panicky depositors afraid of losing their
money.
European leaders, led by German Chancellor Angela Merkel, accused
Ireland of a "going it alone" approach that ignored the needs of the
entire European Union. Some leaders accused Ireland of trying to
seduce depositors in other countries to move their funds to Irish
banks, risking a run on OTHER European banks. But by Thursday,
Greece had joined Ireland, by guaranteeing all bank deposits in
Greek banks.
At a meeting of European leaders in Paris on Saturday to deal with
the banking crisis, many leaders wanted to take a hard-line position
that the banks must deal with their own problems. Hypo bank, in
particular, already had a rescue plan in place, with $50 billion to be provided by
other banks.
The European leaders particularly rejected a US-like bank bailout,
mostly because it would be almost impossible to achieve. All
American banks are regulated in the same way, but euroland banks in
different countries operate under wildly different sets of
regulations. So any attempt at a uniform European response to the
banking crisis would immediately get bogged down in different details
in every different country.
So the European leaders on Saturday agreed that they didn't know what
they would do, but that they would do it together, en
famille.
But it took only one day for the entire non-agreement to collapse
completely. The other banks backed out of the rescue plan for Hypo
bank, and on Sunday a panicked German government, still led by the
same Angela Merkel, has guaranteed the savings in all German banks,
As of Sunday evening, officials in Berlin are having frantic meetings
to rescue Hypo Bank before the European markets open, around 3 am ET.
However, the bigger picture is the weakness and continuing
disintegration of the European Union.
It seems like years ago, but actually it was only four months ago, in
June, when Europe was in chaos because Ireland rejected the Lisbon treaty, which had been meant
to centralize the EU government. The Europeans would be nostalgic for
that kind of chaos right now.
The euro currency, which only really came into existence in 1999, has
never been considered entirely trustworthy. In fact, it's always
been possible for any individual euroland country to back out of the
euro and return to its national currency, as I described in 2004, based on a Morgan Stanley report.
Ireland rejected the Lisbon Treaty, putting Europe into a state of
chaos as its hopes for a centralized government were dashed. And
now, Ireland has led the way to destroy any common European strategy
to deal with the world financial crisis.
Basically, the European Union exists only when everything is going
OK; the European Union starts to disintegrate whenever there are any
problems.
The events of the last week mean two things, both of which are
extremely bad news:
The parade of bank failures is going to continue, and
probably accelerate.
The countries of Europe will compete with one another, rather
than cooperate with one another. It's every country for itself,
now.
The deflationary spiral continues and accelerates.
It's based on a complete misreading of what happened in 1987.
As I described a few days ago,
pundits, analysts and investors are actually all smiles these days
because they like what's happening on Wall Street.
They're hoping for "capitulation," where the markets sell off wildly,
and then the market starts going up again. This is exactly the mistake
that investors made in 1929, and it leads to what I've been calling
the "Principle of Maximum Ruin," where everyone gets back into the
market, only to lose money again -- the maximum number of people are
ruined to the maximum extent possible. In 1929, the markets fell for
four years - to 10% of their peak value, by 1933.
In this article, we're going to explain why investors have the
fantasy that a "capitulation event" will cause the market to rise
again.
The "capitulation" concept is a complete misreading of what happened
in 1987, in what I call the "False Panic of 1987."
To understand it, begin by looking closely at the following table,
with data from my Dow Jones historical page, which shows the lead-in to the Panic of 1987:
Date DJIA (Change) (% of 1987 high)
----------------- -------------- ----------------
Tue 1987-08-25 2722.42( +0.94%) (100% of 87-08-25)
Wed 1987-08-26 2701.85( -0.76%) ( 99% of 87-08-25)
Thu 1987-08-27 2675.06( -0.99%) ( 98% of 87-08-25)
Fri 1987-08-28 2639.35( -1.33%) ( 96% of 87-08-25)
----------------------------------------------------
Mon 1987-08-31 2662.95( +0.89%) ( 97% of 87-08-25)
Tue 1987-09-01 2610.97( -1.95%) ( 95% of 87-08-25)
Wed 1987-09-02 2602.04( -0.34%) ( 95% of 87-08-25)
Thu 1987-09-03 2599.49( -0.10%) ( 95% of 87-08-25)
Fri 1987-09-04 2561.38( -1.47%) ( 94% of 87-08-25)
----------------------------------------------------
Tue 1987-09-08 2545.12( -0.63%) ( 93% of 87-08-25)
Wed 1987-09-09 2549.27( +0.16%) ( 93% of 87-08-25)
Thu 1987-09-10 2576.05( +1.05%) ( 94% of 87-08-25)
Fri 1987-09-11 2608.74( +1.27%) ( 95% of 87-08-25)
----------------------------------------------------
Mon 1987-09-14 2613.04( +0.16%) ( 95% of 87-08-25)
Tue 1987-09-15 2566.58( -1.78%) ( 94% of 87-08-25)
Wed 1987-09-16 2530.19( -1.42%) ( 92% of 87-08-25)
Thu 1987-09-17 2527.90( -0.09%) ( 92% of 87-08-25)
Fri 1987-09-18 2524.64( -0.13%) ( 92% of 87-08-25)
----------------------------------------------------
Mon 1987-09-21 2492.82( -1.26%) ( 91% of 87-08-25)
Tue 1987-09-22 2568.05( +3.02%) ( 94% of 87-08-25)
Wed 1987-09-23 2585.67( +0.69%) ( 94% of 87-08-25)
Thu 1987-09-24 2566.42( -0.74%) ( 94% of 87-08-25)
Fri 1987-09-25 2570.17( +0.15%) ( 94% of 87-08-25)
----------------------------------------------------
Mon 1987-09-28 2601.50( +1.22%) ( 95% of 87-08-25)
Tue 1987-09-29 2590.57( -0.42%) ( 95% of 87-08-25)
Wed 1987-09-30 2596.28( +0.22%) ( 95% of 87-08-25)
Thu 1987-10-01 2639.20( +1.65%) ( 96% of 87-08-25)
Fri 1987-10-02 2640.99( +0.07%) ( 97% of 87-08-25)
----------------------------------------------------
Mon 1987-10-05 2640.18( -0.03%) ( 96% of 87-08-25)
Tue 1987-10-06 2548.63( -3.47%) ( 93% of 87-08-25)
Wed 1987-10-07 2551.08( +0.10%) ( 93% of 87-08-25)
Thu 1987-10-08 2516.64( -1.35%) ( 92% of 87-08-25)
Fri 1987-10-09 2482.21( -1.37%) ( 91% of 87-08-25)
----------------------------------------------------
Mon 1987-10-12 2471.44( -0.43%) ( 90% of 87-08-25)
Tue 1987-10-13 2508.16( +1.49%) ( 92% of 87-08-25)
Wed 1987-10-14 2412.70( -3.81%) ( 88% of 87-08-25)
Thu 1987-10-15 2355.09( -2.39%) ( 86% of 87-08-25)
Fri 1987-10-16 2246.73( -4.60%) ( 82% of 87-08-25)
----------------------------------------------------
As you can see, on August 25, 1987, the Dow was at 2722, the high for
the year. At that point it started falling at the rate of a point or
two every day, and then on Friday, Oct 16, it fell 4.6%.
I actually have a personal memory of that weekend. The market had
fallen roughly from 2500 on Tuesday to 2200 on Friday, and it was
being discussed on television. My memory is of an old guy (who I now
realize must have been around 5-10 years old in 1929) saying the
following: "The market may fall a little more, but the next 300 point
move will be in an upward direction."
Then on Monday, October 19, the market fell 500 points, or 22.6%, all
in one day, to around 1700.
Now you can imagine the psychology at the time. The people in charge
were survivors of the 1929 crash. As I've described in conjunction
with the "58-year hypothesis," these are people 63+ years old who
realize that (1) the pattern from 25-Aug to to 19-Oct-1987 was almost
identical to the pattern 3-Sept to 28-Oct-1929. These people would
recognize the similarity, but younger people would be almost entirely
oblivious to it.
The 1987 panic must have been pretty humiliating for the Silent
Generation senior managers who had led the panic. They had told the
younger people -- the Boomers and Generation-Xers -- that a crash was
coming, and no crash came.
Today, the Silent Generation is gone, and the Boomers and
Generation-Xers are running things. They learned completely different
lessons from what happened in 1987:
They learned there was no longer any danger of a stock market
crash, because the Fed could stop any crash at any time by injecting
liquidity into the banking system. (This worked fine in 1987, but
the same strategy has failed miserably under Ben Bernanke's Fed since
the credit crunch began in 2007.)
They learned that when everyone "capitulates," as they did on
October 28, 1987, then the market has reached a bottom, and starts
going up again.
The "capitulation" theory comes entirely from that event, and a
couple of similar but much smaller "capitulations" that have occurred
since then. In other words, the pundits and investors believe that
when we have another day like October 28, 1987, a "capitulation," then
the market will have truly reached bottom, and will start going up
again.
Those who believe in capitulation are missing some very big points:
The cautious, risk-averse Silents were running things in 1987. In
particular, having lived through 1929, they could tell in their gut
that the 1987 panic was very different from the 1929 crash. Today,
the stupid Boomers and the nihilistic Gen-Xers are running things.
They have absolutely no idea what's going on, they believe the
stupidest things about the markets, and they're quickly entering a
state of sheer, utter panic. (See: "System Dynamics and the Failure of Macroeconomics Theory")
So it's good to understand that even people who disagree with me
about a coming stock market crash still agree that "something" is
going to happen -- something like the 22% plunge that happened on
28-Oct-1987. And this is important -- mainstream analysts agree with
me that this is what's going to happen.
So mainstream investors agree with me that some kind of panic event
is going to occur. Where we differ is what happens afterwards:
Mainstream investors believe that the market will bottom out
at that point, just as happened in 1987. To see that this belief is
silly, just understand that they believe that the stupid Boomers and
nihilistic Gen-Xers will act today just like the sensible Silents did
in 1987. That assumption is ridiculous on its face.
Generational Dynamics predicts that the market will continue to
fall for several years, as happened in 1929.
I realize that I just quoted the following a few days ago, but you
can't possibly read it too many times. It's from John Kenneth
Galbraith's 1954 book The Great Crash - 1929. It describes how
the "Principle of Maximum Ruin" played out in 1929:
"A common feature of all these earlier troubles
[previous panics] 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.
The fortunate speculator who had funds to answer the first margin
call presently got another and equally urgent one, and if he met
that there would still be another. In the end all the money he
had was extracted from him and lost. The man with the smart
money, who was safely out of the market when the first crash
came, naturally went back in to pick up bargains. ... The
bargains then suffered a ruinous fall. Even the man who waited out
all of October and all of November, who saw the volume of trading
return to normal and saw Wall Street become as placid as a
produce market, and who then bought common stocks would see their
value drop to a third or fourth of the purchase price in the next
twenty-four months. ... The ruthlessness of [the stock market
was] remarkable." (p. 108)
This is what's about to happen again.
In fact, anyone with any sense at all can see that the market can't
start going up again, since corporate earnings are still falling.
As regular readers know, for the last few quarters I've been posting
the table of S&P 500 average corporate earnings estimates, based on
figures from CNBC Earnings Central supplied by Thomson Reuters. These tables
have shown sharp falls in corporate earnings estimates from week to
week.
I haven't posted such a table for a while, because there's been so
much going on with the various bailouts. However, the third quarter
ended last week, so this is a good time to catch up:
Date 3Q Earnings growth estimate as of that date
------- -------------------------------------------
Mar 3: 25.0%
Apr 1: 17.3% Start of previous (2nd) quarter
Jul 1: 12.6% Start of quarter
Sep 5: 0.8%
Sep 12: -1.6%
Sep 19: -0.3%
Sep 26: -1.7% End of quarter
Oct 3: -4.8%
As you can see, the third quarter is proceeding just like the last
few quarters -- high hopes and high estimates of rising corporate
earnings are dashed as actual earnings come out.
The significance of this to the current article is that with the fall
of earnings, price/earnings ratios (valuations) are rising. They've
been at very high levels since March, and they continue to be at the
astronomic levels of 24-25.
What this means is that the market can't possibly start going up
again. The computerized trading programs target a valuation level of
around 18 (as I've explained many times, and even that level is way above the historical average.
The P/E ratios have nowhere to go now but down, so the hare-brained
"capitulation" fantasy can not and will not have anything like the
effect that people are dreaming of.
The political pressure to pass the Emergency Economic Stabilization
Act, which I call the Bailout of the World (BOTW), was enormous, even
though nobody could clearly state what the BOTW would do.
However, the tone of the statements from pundits and politicians has
changed a bit since a week ago. A week ago, they were always saying
something like, "The bailout will prevent the entire financial system
from melting down."
Now what they're saying is, "The bailout will make the recession less
bad."
We have some good indicators of how much the world economy is slowing
down.
Baltic Dry Index and price of oil for 2004 to 3-Oct-2008 (Source: InvestmentTools.com)
We hear talk about the real estate bubble and the credit bubble
collapsing, but this graph shows that lots of other bubbles are
collapsing as well.
Collapse of Chinese economy bubble
What it probably shows most clearly is that the Chinese economic
bubble is collapsing.
China's economy has been growing at over 10% a year since the early
1980s, and by the 2000s decade it's been clear that China's entire
economy was in a bubble. As I began discussing in 2004
( here, and in
"China approaches Civil War"), China itself agreed that the economy was overheating
and had to be slowed down.
Starting in 2003, the Chinese tried to slow their economy down from
10% growth to 7% growth. They failed to do so in 2003, 2004, 2005,
2006 or 2007. I and a lot of other people speculated that the
continuing bubble was being caused by the frenzy leading up to the
Beijing Olympics, and that the Chinese economy would finally begin to
slow down once the Olympics games ended.
I've frequently stated my belief that a major cause of the huge spike
in commodities prices in the last four years -- wheat, iron ore, oil,
and many others -- was caused by the accelerating bubble in the
Chinese economy. The prices of many of these "dry" goods is
reflected by the Baltic Dry Index.
Now the commodities bubble is leaking rapidly, and the graph above
shows that the BDI and the price of oil have fallen sharply, and in
unison. What I actually believe is that, with the excitement of the
Olympics over, the entire Chinese economy is in free fall. We'll see
in the next few weeks whether this last turns out to be true.
But now let's get back to the Bailout of the World plan.
The point I want to make is that the Chinese have totally failed,
over a period of many years, to slow down their overheated economy.
The Chinese Communist Party (CCP) had the power to do anything they
wanted. They could manipulate any macroeconomy variable they wanted.
They could manipulate interest rates, manipulate regulations,
manipulate import or export controls, manipulate business laws,
manipulate many import and export prices, and so forth. The CCP has
all the powers that the American government has, and many more. And
they don't have to go through Congress to get something changed; they
just do it.
And yet, they've totally lost control of their economy. They
couldn't slow it down when it was overheated, and now they can't
prevent it from slowing down much faster than they want.
So here's the question I want to ask:
If the CCP, with all the power that it has to regulate and
control the macroeconomics of the Chinese economy, could not control
the Chinese economy,
then how could anyone CONCEIVABLY think that the Bailout of the
World plan is going to do anything to control the American
economy?
The answer is that, as usual, the people in Washington are dreaming.
The BOTW plan will not have the desired consequences. In fact, the
American and Chinese economies are closely interlocked, and I believe
that both are plummeting quickly now.
Incidentally, a lot of people are making a mistake when they say,
"China is going to do well, because the Chinese people are savers,
while Americans are borrowers, and are deeply in debt."
Actually, the collapse of the Chinese economy's bubble is just as
disastrous as the collapse of America's real estate and credit
bubbles. The easiest way to see that is that the 1930s Great
Depression was disastrous to Americans, even though Americans had been
savers in the 1920s. Read "The bubble that broke the world" to understand how that happened.
The world waits
The bailout bill vote in the House of Representatives has been
worldwide news. People around the world have been following the vote
with rapt attention, as their economies run down. The concept is:
"The Americans did this to us with their worthless mortgage-based
securities, so now we expect American money to help us out."
That's going to be a good trick. The Fed and other central banks
have already injected a trillion dollars of liquidity, and things
have continually gotten worse, so it's hard to see how a few hundred
billion more is going to turn things around.
I hear comments from pundits and politicians like, "I feel people have
a positive view of the future," and "The economy is biased toward
growth." That's sort of true, but when they give examples, the
examples are always from the 1990s (the dot-com bubble) or 2003 (the
credit and real estate bubbles).
What they refuse to understand is how drastically people have
changed. The massive fraud and deception that was commonplace up
till the beginning of 2007 -- thanks to the lethal combination of the
stupidity of the Boomers and nihilism of the Generation-Xers -- has
now been reversed. Mutual trust has been replaced by mutual
suspicion. Mutual tolerance has been replaced by mutual
condemnation.
These are massive attitude and behavioral changes of generational
behavior. Everyone seems to expect that the Bailout of the World
bill will cause these massive attitude and behavioral changes to
reverse. Why would they believe that? Because they're thinking of
the Unraveling era, the 1990s, when the motto still was, "Whatever
feels good, do it."
Buy on the rumor, sell on the news
Market summary, 3-Oct-2008
I've heard this phrase, "Buy on the rumor, sell on the news," but
I've never been entirely sure what it means. It's something like
this: If there's a big event coming, then everyone buys. Then, when
the event actually occurs, the day traders sell, taking a profit,
leaving behind the poor schmucks who thought that buying was actually
a good idea.
Anyway, that's what happened on Friday.
The Dow went up 300 points as the House of Representatives vote
approached. Once the vote was completed, around 1:30 pm, the Dow fell
300 points quickly, and continued to fall.
Friday's stock market fall was a disaster all by itself. The Dow
index is now 28% below its peak last year in October, and is at the
lowest point since October, 2005.
Pundits and analysts had very long faces on Friday afternoon. I heard
words like "disappointing" and "disconcerting." The given causes
included Friday's disastrous employment report, and other poor
economic indicators.
The pundits have a new hope: A Fed interest rate cut on Monday or
Tuesday.
It seems that the only thing preventing a big plunge is for the Fed
to keep throwing things at the market. If $700 billion doesn't do
the trick, then it's hard for me, at least, to see how an interest
rate reduction is going to help much.
The deflationary spiral continues to accelerate. The amount of money
in the world is decreasing rapidly, fast enough so that the $700
billion can't keep up with it. Credit is becoming tighter, and
commercial interest rates continue to be at historically high
levels. It'll be interesting to see whether the $700 billion has
even a TEMPORARY effect.
The next that the pundits will be watching for is the reaction of the
Asian markets, as they open at around around 7 pm ET on Sunday
evening.
Comments from web site readers
I strongly urge everyone who wants more frequent commentary and
discussion to visit the new Generational Dynamics forum, especially
the Financial Topics thread. I've been posting frequent commentary
in that thread, and others have been posting their own comments.
In fact, if you're wondering what to do with your money, I recommend
reading the entire thread, for lots of good ideas.
Here are some recent comments from visitors to the forum:
"I read your blog about the reader who can only
choose 1 money market for his 401K. [See: "Are your 401K funds safe?"]
First of all, he has been informed of what is in it. These
companies are required to send a prospectus periodically stating
what is in each money market fund and they do. If he threw it
away, that is his problem. I read mine and pulled my money out of
the fund in 2005 when there was still plenty of time to do it.
Ignorance is no excuse. If someone is too stupid to understand
the prospectus or too lazy to read it, then that person deserves
to lose their money, and frankly, I don't feel sorry for any of
these people."
This is a very hard opinion, but it's typical of how the attitudes of
the great mass of Americans are changing. As we've said, mutual trust
has been replaced by mutual suspicion, and mutual tolerance has been
replaced by mutual condemnation. This change will accelerate.
Another person had an idea for the person who can't get money out of
his 401K:
"There is one way out of the 401K debacle if you
think you are about to get screwed. 401Ks typically have a loan
option. You can take out perhaps up to 50% (the amount equal to
the IRS penalty) and hide that somewhere else. Of course you will
have to repay that loan... I wonder what the IRS will do if
people all of a sudden lost their entire 401K yet still had a loan
out (and then lost their job, too). Gives me a headache... Oh
well, if the crash happens I will find out. I took out a loan to
provide a downpayment on a house (saved me from mortgage
insurance, heh heh).
Actually, when I tried to find out about my money market fund it
was over a year ago, before all of this stuff started headlining
the news. They had no answers then and I'm sure if anything is
wrong they will certainly stonewall me now."
I honestly don't know if this idea will work for most people. If you
borrow money against your 401K, and then your 401K loses value, then
you still have to repay the loan, and your 401K has still lost its
value. But the situation may be different for each individual, so
check with your lawyer or financial adviser.
I've frequently mentioned the Principle of Maximum Ruin -- the
principle that, as in 1929, the coming crash will ruin the maximum
number of people to the maximum extent possible. Here's one person's
posting on this subject:
"I have to laugh when I think about recent
developments. The Principle of Maximum Ruin has to happen because
people will believe what they want to... because they have to
believe in it. They are so invested (emotionally and financially)
in their Pollyannaish outlook that they can't admit that a freight
train is about to hit them. I never thought in my wildest dreams
that I would witness such collective insanity. It's REALLY
mind-boggling."
The "panic crash" or "capitulation event" that we're headed for will only accelerate the Principle of
Maximum Ruin. Don't expect the pundits, politicians, analysts and
bloggers to start saying, "Ohmigod! I've been wrong all these years,
and I now realize that we're the in the midst of a big crash."
Instead they'll say, "It's everybody's fault but mine, because the
Congress and Administration didn't take my advice. But now the worst
is over, and the market will go up again, especially if they take my
advice now."
So ordinary people will listen to this crap, will invest further in
the market, and will get further screwed, since the market is going
to continue to fall for several years. As the months go by, the
maximum number of people will be ruined to the maximum extent
possible -- the Principle of Maximum Ruin.
Incidentally, if you'd like to post something on the Generational
Dynamics forum, but you don't want to do it yourself, then send it to
me as a comment, and I'll post it for you.
I received the following question from a web site reader.
I've carefully edited the text to hide identities, and protect the
guilty:
"Not trying to create a panic, but just don't like
being held hostage by dumb rules that could effect your nest egg.
If you are in the [company 401K plan], you can not remain an
employee and move your account balance to a roll-over IRA plan
outside the [company-sponsored plan]. If you currently believe
your retirement funds should now be protected in a money market
fund and not in a stock or bond fund during these times of
financial market stress, you have only one choice under the
company plan, one specific money market fund.
The problem here is the fund's makeup is only 12% of Government
backed treasuries. The other 88% of the holdings are potentially
high risk instruments if the financial market turns ugly. They
have a security blanket to back up the fund but it is not backed
up by the US Government. I spoke to a rep at [the investment
firm managing the fund] and he confirmed the fund holds NO
guarantee that your money will be safe from loss and could face a
situation where it can not maintain the $1.00 par value. The
only way an employee can roll their nest egg out to a safer plan
is to leave the company by separation (voluntarily or
involuntarily) or retirement."
I wrote back to him: You're going to be screwed. I strongly urge you
to find a loophole. Perhaps claim a medical emergency in your family
and withdraw the funds and take the tax penalty.
There are two things in your message that really raise red flags:
You can't shift to another money market fund, one that's 100%
backed by Treasuries. This should be easy as pie.
They won't tell you what securities the fund has invested in. Of
course this shouldn't be a problem.
Based on these two major red flags, I believe that your funds are
already frozen, meaning that even if you separated from the company,
they would make it difficult or impossible to withdraw or transfer
your funds.
If you have a lot of money in your retirement fund, all I can suggest
again is that you try to find a loophole.
If my suspicion is true, then both the investment bank and the
company are scared to death of panic withdrawals. If employees
discovered that their 401K savings are nearly worthless, there would
be a riot.
For that reason, you have some leverage. Get together with a couple
of other people, hire a lawyer, and make some demands, with the
threat of spreading the word that the money market funds are frozen.
As I listen to politicians on both sides of the $700 billion Bailout
of the World (BOTW) plan,
I enjoy seeing how much they're sweating.
If you ask them whether $700 billion is the right amount, they say
they don't know. If you ask them whether the bill is going to work,
they say that they hope so, but they don't know.
The reason that they're sweating is not because they're necessarily
concerned whether the bailout plan will work, but only whether they'll
be blamed for whatever happens. You can almost hear the gears in
their minds grinding: "Which way should I vote to get reelected in
November?"
The result is that we're hearing some pretty nutty arguments.
One is the "mark to market" debate.
Under this proposal, the reason that we're in so much trouble is
because financial firms are required to provide "mark to market"
valuations of the securities that they manage. If only that nasty
requirement could be repealed, then banks could return to claiming
high values for mortgage-backed securities, and the crisis would end.
There are several problems with this proposal:
This proposal is a license to lie. I've written dozens of
times that sickening stench of corruption that's pervaded financial
and real estate institutions for the last few years. Those who wish
to repeal the mark to market requirements are essentially supporting
a return to that stench.
The specific proposal is to repeal the implementation of an
accounting rule, FASB 157, that I wrote about last year in October when it was proposed, for
implementation on November 15, 2007. It was proposed because several
investment banks had already been forced to write down tens of
billions of dollars in mortgage-backed securities, and it was felt
desirable not to allow that to continue. Well, that answers the
question. There were massive asset writedowns BEFORE FASB 157 was
implemented, and so it's pretty clear that asset writedowns will
continue even if FASB 157 is repealed.
Market summary, 2-Oct-2008
So when a politician talks about repealing the mark to market rules,
it's not because doing so would actually change anything, but it
might get him votes.
A web site wrote to me today, recommending that I listen to an interview with Nouriel Roubini. She wrote, "I really enjoyed
this interview. This clarifies a lot of the questions I am hearing
and discussions with friends about why this Paulson bailout plan is a
joke. It's more entertaining and informative than most Bloomberg
financial interviews because Dr. Nouriel Roubini appeals to basic
common sense. The fact that our government hasn't enlisted the
majority of economists who agree with Roubini for an alternative plan
to Paulson's plan, is a complete failure of leadership."
But all of these people -- journalists, pundits, college professors
-- are just screwing around. They're just saying things to cover
their asses when everything goes wrong.
These people are arguing about a plan that will have no effect at
all. It's as if there were a one-mile-high tsunami heading toward
land, and the bailout plan was to line the beaches with buckets, so
that people could scoop up the water and toss it back out into the
ocean. Bickering and arguing over the number of buckets on the beach
is irrelevant, since the tsunami is going to wash all the buckets
away anyway.
The above graphic shows that investors are not impressed with what's
going on in Congress. The Senate has approved the bailout bill, and
the House of Representatives will vote tomorrow.
The supporters of the bill say things like, "We have to supply some
liquidity to restart the banks, so that they can get back to normal
and start lending to each other again."
I can't imagine what these people are thinking. They must think that
the world financial system is like a motor on a lawn mower -- all you
have to do to get it going is give it a spin.
Well, what made the motor stop spinning in the first place?
The last few weeks have shown a steady downtrend in the stock market
indexes. The downward trend is the most similar to the time just
prior to the 1929 crash than I've seen so far.
But the real crash is the continuing in the credit markets.
Here's a graph that a blogger posted, courtesy of Barclay's bank:
Credit market summary, 2004 to 2-Oct-2008
The Libor/OIS and TED spread graphs show that interest rates get
worse and worse every day. This is the lawn mower engine that the
politicians want to restart with a gimmick. But the credit markets
are getting more and more locked up every day.
The reason is the same that I've given before: As the massive real
estate and credit bubbles deflate, the world's deflationary spiral is
getting deeper and deeper. Each day, there's far less money (US
dollars) in the world than the day before because of asset
writedowns, deleveraging, and so forth.
The real estate bubble increased the total price of real estate from
about $15 trillion to $22 trillion, so the leaking real estate bubble
will take back $7 trillion from the world.
Last week, I quoted the Financial Times as saying that a partial deleveraging of investment banks
would $6 trillion in asset sales, and since those investments were
made on credit, that means $6 trillion less money in the world.
Extrapolating those figures, full deleveraging of investment banks
would come to $20-30 trillion.
And then we have the matter of credit default swaps. There are $60 trillion of those in
portfolios around the world (including a lot of overlap with the
$20-30 trillion figure of the last paragraph), and these are all
going to unwind at some point, losing more tens of trillions of
dollars in the world. And I don't even want to think about that
one quadrillion dollars in credit derivatives that are around.
The point I'm making is that we're talking about numbers that are so
huge, $700 billion is tiny compared to it. That's what I meant
above, comparing the size of a few buckets to the size of a
one-mile-high tsunami.
Panic selling on Monday became panic buying on Tuesday,
as Wall Street recovered about half of what it had lost on Monday.
I received the following from a web site reader today:
Market summary, 30-Sep-2008
"So how are you doing? I am sitting here watching
CNBC and the talk about fear in the markets, I do not see the real
fear I have been waiting for, fear where the people exit the
markets and the banks. The “follow the herd” has not happen yet, I
don’t know if we will be able to see the tipping point or there
will be a general panic from Main Street. There may be a couple of
days over the next couple months but the downturn now has turned
into severe downward spiral, I think October will be brutal. I
have been checking your site and blog, the only comment I have is
that the great depression will not happen again -- this time it
will be the Greater Depression!"
You're absolutely right. The "generational panic and crash" has not
yet happened, but it could happen any day now.
The people in Washington have no idea what's going on. They think
that the market is going down for psychological reasons, and that all
they have to do is "restore confidence."
But the evidence from 1929 refutes that. What is clear is that the
1929 crash was caused by forced selling -- people who had invested on
margin had to sell everything to meet margin calls, and selling
everything pushed prices down even farther. Investor psychology had
absolutely nothing to do with it. It boggles my mind that Ben
Bernanke, who is considered the world's greatest expert on the Great
Depression, doesn't understand that, and has said some unbelievably
dumb things over recent years.
These and other blogs have turned into nattering jokes. Shedlock is
on some weird crusade to stop the bailout, CalculatedRisk can't
decide whether or not there'll be a recession, and Roubini, who's
become an international television superstar, constantly flip-flops on
whether such-and-such a detail in the bailout plan is will PREVENT
systemic failure or CAUSE systemic failure. These people must be
getting along on their good looks, because it's certainly not their
brains.
What is it that makes these people, as well as Ben Bernanke and other
so-called "experts," such airheads? It must be Generation-X
perversion (even though they're not all Gen-Xers). All you have to do
is look at a couple of the graphs in "How to compute the 'real value' of the stock market,"
and you can see it right off. This isn't rocket science; it's
perfectly obvious to anyone who understands calculus. Don't any of
these bloggers know calculus?
There are actually lots of signs that a lot of forced selling is
already going on. The Lehman bankruptcy two weeks ago is apparently
having major chain reaction effects, according to a Wall Street Journal analysis. Pundits have been saying
that hedge funds are deleveraging like mad. And of course, banks
have been falling like dominoes, here and in Europe.
Furthermore, the credit markets were worse on Tuesday than Monday, with interest rates at fresh
historically high levels.
One day soon there will be a generational panic and crash because
there MUST be.
Ironically -- and this is perhaps the craziest thing of all -- the
pundits are smiling today, because they believe that the end is in
sight. As incredible as it seems, they're all disappointed that we
haven't seen a "panic crash" or "retail capitulation" yet.
No, there's no sign of real fear on CNBC. They're waiting gleefully
for a "panic crash" and "retail capitulation."
That's where the markets sell off wildly, and then the bubble can
start again. They're hoping for that, so that the champagne parties
can come back.
Why would they ever think that? Why would they think that if a
"panic crash" occurs, then it will mean that the markets had reached
bottom and were going up again? Where did they ever get such an
idea?
They got it because that's what happened in 1987. The market fell
23% on on one day, October 19, 1987. That's the pattern they've been
studying and remembering, and that's the pattern that they expect to
repeat.
There are several major reasons why the 1987 pattern doesn't apply
today:
The senior financial managers in 1987 were from the
Silent Generation that survived the Great Depression. These
people where very cautious. It's true that they panicked in
1987, but they had lived through the 1929 crash, and they could
tell pretty quickly that things were different in 1987. Today's
senior managers are Boomers. They don't have any idea what's
going on, since they were born after the Great Depression
ended.
The stock market was actually underpriced in 1987 (see
"How to compute the 'real value' of the stock market"). As of today, the market has
been way overpriced for 13 years, and the Law of Mean Reversion
applies today, where it didn't in 1987.
There is a huge real estate bubble, which wasn't the case in
1987, and its collapse today is accelerating. According to
figures released on Tuesday, house prices declined in July at
the fastest pace on record, signaling that the housing crash is
nowhere close to ending.
But for some reason that totally escapes me, these pundits and
bloggers are totally blind to what's going on.
It's really eerie to see what happened in 1929 being repeated, almost
as if everyone were reading from a script.
I've quoted the following paragraph from John Kenneth Galbraith's
1954 book The Great Crash - 1929, many times before, but it's a
like a mystical song that appears to be more and more meaningful, each
time you hear it:
"A common feature of all these earlier troubles
[previous panics] 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.
The fortunate speculator who had funds to answer the first margin
call presently got another and equally urgent one, and if he met
that there would still be another. In the end all the money he
had was extracted from him and lost. The man with the smart
money, who was safely out of the market when the first crash
came, naturally went back in to pick up bargains. ... The
bargains then suffered a ruinous fall. Even the man who waited out
all of October and all of November, who saw the volume of trading
return to normal and saw Wall Street become as placid as a
produce market, and who then bought common stocks would see their
value drop to a third or fourth of the purchase price in the next
twenty-four months. ... The ruthlessness of [the stock market
was] remarkable." (p. 108)
That's why the comparison of today to 1987 is the same mistake that
investors in 1929 made, making a comparison to the panic of 1907.
Investors are making exactly the same mistake today, totally
oblivious to the generational changes that make everything different.
This is what leads to what I've been calling the "Principle of Maximum
Ruin," where everyone gets back into the market, only to lose money
again -- the maximum number of people are ruined to the maximum extent
possible. In 1929, the markets fell for four years - to 10% of their
peak value, by 1933.
So those hoping for a "panic crash" or "retail capitulation" are going
to get their wish. As usual, be careful what you wish for.
I had lunch recently with my boss and his boss. They were discussing
the stock market, and I said, "It's going to crash. Everyone will
lose everything." They both laughed. I guess I was lucky they
didn't call security.
