Daily Investment Interpretations

March 7, 2009

2009-3-7 The chart below, copied from the Business Insider article, How Far Will Stocks Fall If This Is Another Great Depression?, shows dramatically and ominously where things stand today, compared to where they were at the same points in time during the Great Depression's period of maximum market decline from September, 1929, to July, 1932. As of yesterday's close (March 6, 2009), 17 months after the stock market peaked on October 11, 2007, the S&P 500, at 683, was off 56.0% from its October 11, 2007, closing high of 1,554.... smack dab on top of the 1932 curve 17 months after the September 3, 1929, date (February, 1931) on which that 1929-1932 decline began!       
This chart is a shocker! It shows how precipitous this devolution has been, and how it differs from the classical recessions of the post-World War II era. This is a bit like watching the fall of a barometer as a hurricane approaches.
    Seventeen months was halfway through the bear market of 1929-1932. The equivalent today, adding 17 months to the present month (March, 2009) yields
August, 2010, as the market turnaround month. Of course, there's no reason to expect that the current market debacle will exactly match that of the 1929-1932 period. However, as a matter of curiosity, an 89% decline from the market's October 11, 2007 closing high would see the S&P 500 at about 170 in August, 2010. (It closed Friday at 683.) The Dow would be at, or about 1,600.
    Here's another intriguing chart from the Business Insider website. Right now, I believe the P/E ratio on the S&P 500 is around 10:1, or about the same as it was in February, 1931. At the bottom of the of the 1929-1932 bear market, it hit about 4:1, but, of course, earnings would have continued to fall between February, 1931, and July, 1932.
    The upper chart shows that the stock market fell slower this time than it did in the 1929-1930 bear market. This might have been because the 1929 market was perceived as a bubble, and it began with a crash, whereas this time around, it was considered to be fairly valued (even though the P/E ratio in October, 2007 was about 25:1!)
    Of particular significance are the 6 bear market rallies that occurred between 1929 and 1932, 4 of which happened between the 17th month and the 34th month of the 1929-1934 decline. I'm sure that during each of these 6 rallies, stock market gurus were proclaiming that the bottom had been reached, that the medicine the Hoover administration was administering was finally beginning to work, and that you needed to get back into the market before it took off and left you behind. These false starts would have destroyed whatever remained of investors' investment capital and faith in the stock market for a generation.
    Also of considerable interest might be the chart below, taken from the Charts.com website, that shows the explosive rise in the Dow after it bottomed in the middle of 1932. By February, 1937, it had more than quadrupled. Then, President Roosevelt, responding to deficit hawks, cut back on The New Deal, and, according to accepted wisdom, caused the economy to sink back into its depressed state. The reason I'm saying "according to accepted wisdom" is because some "insights" into what caused the Great Depression may be misguided myths. On Monday (March 2, 2009), Paul Krugman published a piece entitled, "Permanent Link to Friedman and Schwartz were wrong" in which he questions Milton Friedman's and Anna Schwartz' "
argument that the Fed could have prevented the Great Depression if only it has been more aggressive in countering the fall in the money supply." Dr. Krugman observes that this time around, the Fed has been exceedingly aggressive in countering the fall of the money supply, but so far, it hasn't interrupted the economy's descent. (He mentions that the Japanese government also tried to rapidly pump up the money supply when the Japanese economy entered its "lost decade" in 1990, but it didn't interrupt their fall, either.) In a later commentary, he notes that once you've lowered interest rates to zero, you've done all you can do with respect to pumping up the money supply. 
    Conventional wisdom also has it that World War II broke up the Great Depression. But recent research has led at least one group of economists to question this thesis. Their research points toward a recovery beginning in 1943, S&P 500 Timeline of the Great Depression.
DJIA chart

    The significance of the above chart for us is, I think, that if there were to be a dramatic stock market recovery beginning next February or March (five to six months before the economy hit bottom in August, 2010), it wouldn't necessarily follow that the stock market would continue to climb rapidly until it surpassed its October, 2007, highs. (And even if it did, it would probably be 2016-2017 before that happened--10 years after its previous, October, 2007 peak!)
    One interesting parallel: the time to buy would come within a year-and-a-half, although the stock market level at the bottom might be quite a bit lower than it is now.
    One tricky matter would be the bear market rallies--"sucker traps"--that could occur before the market makes its final bottom. Bear market bottoms generally occur with major washouts, accompanied by spikes in investor pessimism. There is generally 9:1-or-greater down volume to up volume on the turnaround day.
    I've tended to soft-pedal Dr, Martin Weiss' forecasts because he makes his money by being a "permabear", but he has some interesting information in his latest email. In it, he claims:
(1) At 61% year-over-year, earnings declines are now worse than they were in the Great Depression.
(2) Consumer losses are worse as well. Dr. Weiss argues that consumers weren't invested in the stock market to the degree they are now. Also, housing values have declined more because of the housing bubble.
(3) Debts are far larger. Dr. Weiss places total debt in 1929 at no more than 170% of GDP (GNP). Total indebtedness today approaches 350% of GDP.
(4) Derivatives. Dr. Weiss states the Office of the Comptroller of the Currency reports that U, S. banks currently hold derivatives with a notional (worst-case) value of $176 trillion. These derivatives are, I think, dominoes.... insurance policies against losses. If they started to come due--to fall, chain-style--the I. O. U.'s could immediately  dwarf  the national debt, which, as of 02:05:14 GMT, March 7, 2009, stood at $10,961,089,333,008.08. They would dwarf the "total net worth of U.S. households", which Representative Ron Paul placed at $40.6 trillion in a speech ("Neo--CONNED!") that he gave on the floor of the House of Representatives on July 10, 2003.
    Note that with a Gross Domestic Product of about $14 trillion, our debt-to-GDP ratio is currently pushing 80%. That's the highest level since shortly after World War II. A few trillion more and we start getting dangerously top-heavy. (It also means that we lack borrowing power for other emergencies.)
    Part of the money to finance our national debt has been supplied by China, which is now backing away from further lending. On the other hand, the current U. S. savings rate, which has just risen to 5%, might help fund the growing deficit.

(5) Giant failures. There weren't the failures of giant banks and other huge corporations that we've seen so far in this contraction. (In 1982, Chrysler survived on government loans, and was turned around by Lee Iacocca. It might be worth noting, though, that 747 of the nation's savings-and-loan associations failed, leading to the establishment of the Resolution Trust Corporation to dispose of failed savings and loan associations taken over by the government.)
(6) The U. S. is a debtor nation today. In 1929, the U. S. was a creditor nation with substantial foreign reserves. Today, we're the world's leading debtor nation..  
    Dr. Weiss contends that we could be staring into a deeper abyss than the Great Depression.

S&P 500 Price Growth- 1927-Aug 2008 -- Seeking Alpha

Cramer: Worst-Case Dow View

To be continued.

I'll discuss the two or three camps who claim (1) that the economy will bottom in the second half of this year, with the next bull market starting within the next few weeks (Sam Stovall, Audio: Stovall: We are close to a bottom in time and price), (2) that the economy will bottom in the first half of 2010, and (3) that the outlook is grim, with the bottoming of the economy occurring at some indeterminate point in the future (presumably, beyond the first half of 2010)