Daily Investment Interpretations

March 5, 2009

2009-3-5 This just in: Thomas Kostigen's Ethics Monitor: The $700 trillion elephant in the room. (Derivatives)
    The markets fell sharply today, erasing yesterday's gains and plumbing new lows.
The NASDAQ, up 32.73 points (2.48%) yesterday, fell 54.15 or 4% today to close at 1,299.59, or about 14 points (1%) above its intra-day low last November. (The Dow and S&P 500 indices have already penetrated their November intra-day lows.). The Dow, having gained 149.82  points (2.23%) yesterday, shed 281.4 points or 4.09% today to close at 6,594. The S&P 500, up 16.54 points (2.38%) yesterday, ended down 30.32 points (-4.25%) at 683 today. Oil dropped to $43.70 a barrel, while gold added  $21.10 to settle at $927.800. The VIX rose 2.61 to 50.17, which certainly seems like a complacent response in the light of today's new lows.
    The market indices are now between 56% and 57% below their 2007 highs. You have to look back to the 1930's to find this great a percentage loss in these indices.
    Peter Eliades' model is pointing toward a Dow bottom of 4,000 or lower: Peter Eliades on why 4,000 could be next for stocks. He doesn't present this as any kind of sure thing... just where his model is pointing. He argues that the market is telling us that there's worse economic news ahead. He likens the present situation to that in early 1931. He's recommending a 10%-13% position in gold.
    I've wondered if the impending bankruptcy of Citi and the Bank of America won't free up the government to temporarily nationalize these banks. Investors have already lost practically everything they invested in these two banks. A taxpayer takeover shouldn't cost them much more than they've already spent.
    Peter Brimelow latest article is entitled: Veteran bear says the end is nigh - and that's good. The "veteran bear" is Walter Rouleau who has been publishing his "Growth Fund Guide" (GFG) monthly since 1968. GFG is saying that, historically, the super bear market might have a possible low during the latter half of 2009 or 2010. I don't know whether Mr. Rouleau is saying that there will be a cyclical bear market low during the next year- and-a-half, or whether he thinks that the super-bear market bottom will occur then. But Peter Brimelow quotes Mr. Rouleau as saying, "
Recent price action seems to suggest that we could see one or more declines and advances that could rhyme with [the 1929-32 bear market]". GFG is recommending positions in gold and in Asia.
    An horrendous bear market bottom was reached in 1932, when the Dow fell from its high of 381 in the summer of 1929 to 41 in the summer of 1932... a 9-to-1 decline. However, this was not the bottom of the super-bear market that began in 1929. That didn't occur until 16 years later, in 1948.
(The super-bear market bottom that occurred in 1948 was at a much higher level of the Dow than the 1932 cyclical bear market bottom. In the other two super-bear market bottoms in 1921 and 1982, the inflation-adjusted final low was the bottom for that particular super-bear market rather than at some time.) The parallel today would be a Dow Jones Index level of around 1,600 in the latter half of next year. Nobody expects that to happen, but of course, in 1931, nobody expected that the Dow would bottom at 41 in 1932.
    The Dow rebounded to 200 in 1936, approximately quintupling from its 1932 nadir. It might have continued to climb if FDR hadn't begun worrying about the budget deficits he was generating, and hadn't cut back on the New Deal, plunging the country back into the Depression.
    One major difference between the Great Depression and the present situation is that the Great Depression began in 1929 when the stock market peaked, whereas the current decline began after 7˝ years of super-bear market that began when the markets peaked in March, 2000. Have we been in a super-bear market since 2000? Here are the numbers. 
    The S&P 500 hit an intra-day high of 1,553 on March 20, 2000, and an intra-day high of 1,576 on October 8, 2007. In the meantime, we had about 21% inflation over the 7˝-year period. Dividends on the S&P 500 probably averaged no more than 2% over the interval, leaving us, if we had bought and held the S&P 500 index over the period, at or slightly behind where we would have been if we had put our money under our mattresses (and behind where we would have been if we had invested in CDs). 
    The Dow topped out at an intra-day high of 11,750 on January 10, 2000, and it hit 14,198 on October 8, 2007, a gain of about 21%. Correcting for the 21% inflation between March, 2000, and October, 2007, The 14,198 Dow level  in 2007 would have been equal to the 11,750 Dow level in 2000. Adding in dividends,  a buy-and-hold investor in blue-chip stocks would have experienced a modest gain. 
    The NASDAQ Composite peaked at 5,133 on March 8, 2000, and at 2,862 on October 29, 2007. We don't even need to run a calculation to decide that peak-to-peak, the NASDAQ would have lost 35%-40% for a buy-and-hold investor after adding in dividends and correcting for inflation. (The reason is that the dot.com bubble stocks were almost entirely listed on the NASDAQ exchange, so the NASDAQ Index took a terrible hit when that bubble burst.) And of course, all of this is before the current market decline reduced the popular indices to less than half their October, 2007, values. So I think it's reasonable to conclude that we
are currently immersed in the predicted 2000-to-2014-2018 super bear market. If past is prologue, then for the next 5-to9 years, buy-and-hold investors are probably going to get skunked.
    If the next super-bull market begins in 2014 to 2018, the markets might be expected to pole-vault upward, making up for lost time, with an average annual 13%-to-14% inflation-adjusted total rate of return over a 16-or-so year period (until 2030-to-2032?) to make up for lost time. (Given a 3% average annual rate of inflation, this would amount to a an average annual 16%-to-17% absolute total rate of return.) (Since the total rate of return includes dividends, the average annual rate of rise of the stock market might be a few percent less than the total rate of return, or something like 13%-to-14% per year if I assume that dividends approximately offset inflation.) 
    We can see this quantitatively in Jeremy Siegel's famous chart that shows that the stock market has averaged a rate of return of about 7% per year since 1801. If it falls 40% below its long-term total return as it did in 1982, at the beginning of the 1982-1999 super bull market and it ends 85% above the trend line as it did in 1999, then it will have ranged from 60% of trend line to 185% of its trend line, or over a range of about 3:1 spread out over a 17-year period, or about 6.8%-7% per year more than the 7% per year that is the long-term average in Dr. Siegel's chart, yielding the 13%-to-14% inflation-adjusted rate of return cited above.

    Other deviations from the chart's trend line include 41% below the trend line in 1974, 42% below the trend line in 1932, 80% above the trend line in 1968, and 87% above the trend line in 1928.
    Given a reading of 87% above the trend line in 1928 and a reading 42% below the trend line in 1932, we're led to a ratio of 1.87 divided by 0.58 between the 1928 Dow valuation and the 1932 bottom, or about 3.22-to-1. This is a far cry from the 9-to-1 ratio between the summer, 1929, Dow peak of 381 and the summer, 1932, trough at 41. Part of the discrepancy probably lies in the fact that Dr. Siegel's numbers were annual readings rather than readings taken at stock market extremes. Another factor may have been the fact that dividends became a much larger fraction of the total returns as the Dow fell to 41. A third factor might have been that a   modest level of deflation existed between 1928 and 1932.
    It might be worth mentioning that these timetables are calibrated for the U. S. stock market, and not necessarily for non-U. S. markets.
    And I realize that there are no iron-clad guarantees that the future will unfold like the past. Predictions like these make tacit assumptions about geopolitical stability and other conditions.

3-5 (Early Afternoon) To the GM bankruptcy warning (GM, auditor express doubts over survival; shares skid below $2) must now be added the impending bankruptcy threat for Citi and Bank of America: Citi falls below a buck a share, and Citigroup, Bank of America are sliding toward oblivion
3-5 (Morning) Apparently, the markets rose yesterday upon the announcement of a $585 billion stimulus plan in China, and investors' assumptions that this would be followed with additional stimulus measures, and they fell today when Chinese premier Wen Jiabao failed to present anything more in a follow-on speech given today. Also, GM expressed doubts today over its ability to survive as a going concern: Still weighing economic  stimulus, U.S. futures slip after China disappointment, GM warning
Paul Krugman's most recent commentary, Permanent Link to Return of depression economics, endeavors to explain graphically why we need a fiscal stimulus program in addition to the Fed's traditional recession-fighting tool of lowering interest rates. He's aiming this at Joe Scarborough, a former Congressional Representative from the state of Florida and currently the host of an MSNBC TV program called, "Morning Joe", who's comparing this current unemployment rate in this current deflationary recession with the 1975 and 1982 inflationary recessions, and asking why the government needs to do anything other what it did in 1975 and 1982--namely, lower interest rates. This has come after Dr. Krugman explained to Mr. Scarborough in this roundtable interview why the current situation is unparalleled since the 1930's. And here's the graph that tells it all at a glance:INSERT DESCRIPTION
(2)    In Permanent Link to Highly inaccurate, Dr. Krugman shares an "End is Near" cartoon in which he and Paul Voelcker are caricatured. He asks, "But where is Nouriel?" [Roubini]
(3)    In Permanent Link to Marginal marginalizers, he recalls the Bush Adminstration's tactic of labeling as left-wing fringe talk anything that questioned the Administration's economic agenda. 
(4)    In Permanent Link to How many banks?, he questions Treasury Secretary's Tim Geithner's claim that the U. S. has too many banks to nationalize banks. Dr. Krugman observes that the four biggest banks possess 64% of the assets of U. S. commercial banks.
(5)    In Permanent Link to Roots of evil (wonkish), he takes issue with Greg Mankiw, the Bush Administration's chairman of the White House Council of Economic Advisors, who challenges the current Administration's prediction of rapid growth in the recovery phase of our economic meltdown. Dr. Krugman demurs, arguing that the "unit root" model that Dr. Mankiw is using doesn't apply in the present situation. There can be a rapid rise in GDP when demand eventually materializes again because there is adequate (and unused) industrial capacity in this recession to permit a rapid ramp-up.
(6)    In Permanent Link to Hey, who you callin’ neo-Wicksellian? (wonkish), he observes that "
once you've pushed the short-term interest rate down to zero, money becomes a perfect substitute for short-term debt. And any further increase in the money supply therefore displaces an equal amount of debt, with no effect on anything. Period, end of story." He mentions two additional steps that the Fed might take: buying long-term debt (e. g., troubled mortgages) or risky assets, but this will help only by "taking some risk off the private sector’s hands". But these moves would have nothing to do with increasing the money supply "per se".
(7)    Permanent Link to Cold, he says,"
If this goes on much longer, I think I might give it all up, move to the U.S. Virgin Islands, and start a Ponzi scheme."
(8)    In Permanent Link to All your downside are belong to us, he's challenging the Administration's moves that rescue American International Group's shareholders without providing us taxpayers who are footing the bill any information regarding what we're getting for our money.
(9)    In Permanent Link to Imaginary notches, he explains what every taxpayer should know: that "
your income tax doesn’t suddenly shoot up if your taxable income rises one penny into a new bracket." Only that part of your taxable income that lies above the threshold at which the higher tax rate starts is subject to the higher tax rate.
(10)   In Permanent Link to Zombie financial ideas, he calls attention to the fact that every proposal the Treasury Department is floating involve bailing out the bank-stock shareholders at the taxpayers' expense. He ends it with, "
And the insistence on offering the same plan over and over again, with only cosmetic changes, is itself deeply disturbing. Does Treasury not realize that all these proposals amount to the same thing? Or does it realize that, but hope that the rest of us won’t notice? That is, are they stupid, or do they think we’re stupid?", and concludes with the editorial comment, "I don’t know which possibility is worse".