NO Economic Depression, Time to Jump into Stock Market Investments?
Economics / Investing 2009 Feb 26, 2009 - 09:00 AM GMTBy: Andrew_Butter
Ten Reasons why it won't be a Depression or an "L": So is this the time JUMP IN? - Alarmist stories sell newspapers (and advertising). That's why the Big "D" and the Big "L" words are almost as good for that as pretty girls; (which is the formula the Sun Newspaper uses so well in UK ).
It sells politicians too, George "W" had the "WMD", but he only managed to blow $700 billion on that idea (so far). The 44th President has the Big "D" with the Big "L" in reserve; now there's a window to push pet ideas through as big as a barn door! He got $800 billion in his first month, and he only just started.
Personally I applaud any President of anywhere who forsakes the visceral pleasure of putting his hand in peoples' pockets so that he can blow up people he never met in strange far-away countries, and uses it instead for re-furbishing roads and schools, and improving medical facilities for poor people in his/her own country. It's about time, "Make Bridges Not War" that's what I say!
But although it's good "politics", before you go and jump off a tall building in despair, it's worth remembering that the year after the Great Crash nominal GDP in USA fell by 12% and peak to trough (nominal) was 45%.
By the way, ever since they "adjusted" the way that CPI is "measured" in 1987 to make it a meaningless exercise in political grand-standing (that's why they get the Department of Labor to do it, they tried the Department of Agriculture but they refused), I just go with nominal GDP; what's "real" is the way they did CPI before. And anyway in case you noticed, you don't tend to get a lot of inflation (however you measure it) when nominal GDP is tanking, so right now that's all fairly academic.
Fast forward to NOW and Dr. Doom is "only" predicting a 5.4% drop in GDP in 2009 (nominal again), that's probably "worst case" and well, he's been right before.
"Only" 5.4%?
That might explain why when you drive around you see a remarkable lack of soup kitchens (given the circumstances); I can't help thinking that if everyone really believed the Big "D" then why isn't the President allocating some of those billions on a rush manufacturing program - that's "good to go" isn't it?
The logic behind the Big "L" is that this fiasco is somehow similar to the recession that followed the Japanese housing bubble.
But at the risk of being politically incorrect, in my simple view, there appear to be some striking differences between Japanese and Americans:
The consensus bottom of house prices (regardless of the housing plan) is 40% to 44% peak to trough, and nah there won't REALLY be 40% foreclosures...THAT WAS A JOKE! http://www.marketoracle.co.uk/Article8126.html). Oil prices, food, costs of labor, computers, cars, are all down on 2007/8, so "real" deflation in 2009 might easily be 2% to 3% like it was (actually) in 2008.
So even if Dr. Doom is right (and there are not a lot of people arguing with him these days; it's a long time since I heard the "clock is right twice a day" jibe), then if "real" GDP falls 3% in 2009 (after taking away CPI from nominal), then re-calibrate that for "real" CPI, and you got borderline "real" GDP growth. Phew...all that "real" stuff is getting me really confused, it's almost worse than all that fair-value, hold to sell, mark to maturity, mark to quote, mark to model, hold my hand , hold the train ...etc!
The recession happened between 2005 and ended early 2008, just no one noticed thanks to the great financial three-card trick. You can always keep spending even when you are broke, so long as there are some suckers around who will lend you money, the unemployment and fall-off in output are well, just reality catching up, unemployment always lags recessions. No it's not dis-inflation, we got deflation, that's why no one is "warning" that the zero base-rate is dangerous (they should have dropped it there mid 2008 but that's another story...another of those "honest mistakes").
The Stock Market
Oh the stock market...I almost forgot; after having a sustained bull run (with a few hiccups), since about 1978, it finally stalled in 2000. And OK they managed to talk the dead donkey to stagger around until mid 2008, but the reality is, a dead donkey is well...a dead donkey.
Oh Diddums!...but it was a good run, a whole generation of stockbrokers who only knew one word..."BUY", and for thirty years they were RIGHT! Problem was, that was the only word they knew!
OK the recent fall (50% off the peak) is the biggest since the Great Crash, but at the peak in 1929 the DJIA was 193% above fundamentals (that's when the market is in "disequilibrium") ; in 2000 it was "only" 70% out of kilter.
OK also that's more than it ever was since the Big "C"; previously the maximum was 30% in 1970, but it's a long way from a sign for a Big "D".
By the way what I mean by "fundamentals" is the "Other-than-Market-Value" as defined by International Valuation Standards as is commonly used to work out what the price should be if gamblers were not borrowing money at less than the rate of "real" rate of inflation to play casino, or quivering in fear after they lost it all and went into hiding in case someone wants to break their legs (i.e. the market was working properly, with rational people buying and selling stuff they understand - that's the definition).
It's a good measure; if you consider periods of naked gambling as outliers it explains 99.5% of annual average changes in the DJIA since 1920 (if you use the whole dataset it gives 96.5%).
What happened recently by the way, is that in late 2000 Allan Greenspan devised an antidote for the hangover from the Dot.com Dumb-ass Casino Binge (DCDACB for short), using the time-old trick of lending money at less than the "real" rate of inflation. That kept the moment of truth well hidden for a "Biblical" seven years. But sadly, religion aside, there's no getting away from Bob Farrell's Rule which says that one way or another you got to take your medicine, and if you delay, well you just end up taking a double dose, like now.
"Technical Analysis"
I love the idea of Elliot Waves, they remind me of the De Vinci Code and I'm sure they are great for day-traders (I could never understand them). What they don't do is tell you when the market is in disequilibrium, so they say nothing about the long-term.
The "fundamentals" as worked out using International Valuation Standards definition of other-than-market-value tell you about long-term trends. It's simple:
• The market goes into disequilibrium when participants borrow money against the collateral of expected profits (rather than assets - and there are 101 ways to fool someone that expected profits are an asset - that's basically what a MBS is, (they are priced on the expected cash flow, when you start talking about the LTV you are toast); just like there are 101 ways to shoot yourself in the foot). Then everyone goes down to the casino and gambles like crazy. I can understand that, what I've never been able to understand is who in their right mind lends money to people like that? Clearly that's one of life's great mysteries and I may die without ever learning the secret of it.
• Then the "market value" goes through the roof and you can tell by how much by comparing that with the "Other than Market Value", which is the price that things would have sold for if the market had not gone crazy. (The test for if the market has gone crazy is simple, if the market-value is more or less equal to the other-than -market-value, it not crazy, otherwise it is). And because the mark-to-market value is high the suckers lend even more, so the whole thing is self-perpetuating.
• Then at some point the gamblers can't find any more suckers to lend them money, and the whole thing comes crashing down. That's like an earthquake and there are after-shocks as the market adjusts to the reality that all the gamblers went broke (and the suckers who lent money to them went broke too).
Here's a tip, those after-shocks can be pretty brutal.
By way of example, I remember, first time I went to Los Angeles they had an earthquake (Seven on the Reichter Scale). It was at five in the morning, beautiful dawn coming up, lovely and cool. So anyway I rushed downstairs into the car park half naked, and there was a whole crowd of people standing around half naked too. Well I got in a conversation with a remarkably pretty half naked person, who said "Oh yeah, this is how everyone meets people in Los Angeles , standing around half naked in a car park waiting for the after-shocks". Just thought I'd "share" that, plenty of nice things you can do before risking the after-shocks.
Here's a picture that explains all that (the left hand scale is the market price divided by the other-than-market-value, and the right hand scale is the change in DJIA on an annual basis (average of the year before compared to this year)).
This is what's going to happen Next:
• House prices on the S&P Case Shiller Index will bottom 40% to 45% below the peak in July 2006. When?...I dunno; Professor Roubani says by the end of 2009, me I think it could take longer. And don't expect much more than a flat-line for quite a while after that unless the Onmistakers forget (accidentally on purpose) to push up interest rates once the hangover starts to subside.
• The stock market turn will be when the Dow hits 6,600 and the S&P 500 hits 675. not far to go now; OK there might be a little bounce in between, but nothing to get too excited about unless you can figure out how Elliot Waves work (I can't). But sorry to say value investors have some time to wait until it's safe to jump in (and the gamblers well they will jump in anywhere so long as some suckers lend them money - "anyone wanna buy a MBS?").
The caveats for that are:
• The 10-year note will stay below 3.5 % for at least twelve months.
• It will take LESS than another six months for the Onmistakers to figure out how to value toxic assets in the absence of a liquid market.
Of course until they do, the credit market won't re-boot so I'm going out on a bit of a limb there.
After all it's been nearly six months they got the TARP money and they only just started to figure out that before you buy a toxic asset or nationalize a bank, you got to do a valuation (properly). But Voodoo Valuation standards don't tell you how to do one, which is why they opted for a "stealth" creeping nationalization instead.
This is the thing, if the market is not working that's Other-than-Market-Value (if you are using an internationally recognized valuation methodology like International Valuation Standards instead of them Voodoo Valuation Standards which are mandated under US GAAP, IFRS and the Basel II Accord).
Problem is that's a little harder than just looking up the price tag on a tin of sardines in the supermarket, you can't ask Joe Plumber to do one of those. (By the way, for an explanation of what is an Onmistaker and how to value a toxic asset (whilst driving fast and not spilling your drink.. http://www.marketoracle.co.uk/Article9045.html).
Oh and by the way by the way, they don't actually NEED to spend the TARP money buying toxic assets to re-start the credit market, all they got to do is ban Voodoo Valuation Standards.
But hey, once a Government got a budget and there is a blank cheque for more where that came from, well, there's no stopping them! And there is nothing better for urgently pushing something through Congress to "SAVE" things (like the World, Life as we know it, the American Dream etc), than getting the DJIA to tank.
Me I'm just going to go and hang around the car park for a while, sure the Elliott Wave geeks are going to clean up, but that's much too complicated for me!
By Andrew Butter
Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
© 2009 Copyright Andrew Butter- All Rights Reserved
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