June 16, 2009
The markets fell again today on relatively low volume, though not as much
as yesterday. The indices each lost roughly 1¼
The S&P 500 and the Dow both closed below their 25-day moving
averages, with the S&P ending at
its 200-day average, and the Dow closing below
its 200-day average. The Nasdaq remained above both those benchmarks.
8,504.67, and the S&P 500 declined 11.75
to end the day at 923.72.
mentioned above, Oil ended
a barrel, while gold
The market fell sharply in the last 15 minutes of
trading, suggesting to me that investors waited to see whether the market
would rise at the end. When it didn't they dumped stocks in anticipation
of further losses to come. Of course, after losing 3¾ % in two days, the
market will probably soon stage a "dead cat" bounce, but right
now, its short-term trend is down. U.S. stocks forfeit rise; economy at issue
This is the first two-day pullback since the end of
March, and it's certainly overdue.
As the market worsens, Paul Krugman's insights look
better and better. In a set of three lectures that he gave last week in
the UK, he explains that economists had thought until now that depressions
couldn't happen here again. Economists had learned their lessons,
and by now, had everything under control. Monetary manipulation would
always pull the economy out of a funk. Demand could be taken for granted;
the limiting factor would always be monetary supply. It's intuitive that
you can always get people to spend if you print enough money and make it
easy enough to borrow.
Until they don't.
The key to this was what happened to Japan during its
"lost decade". During the 90's, Japan printed money by the
bushel basket, but it didn't pump up the economy, nor did it cause the
inflation that everyone "knew" would have to happen. Instead,
the money sat in bank vaults because (1) no one wanted to borrow money to
expand their businesses because business wasn't that good, and (2) banks
were afraid to loan money to most borrowers because they weren't sure that
the borrowers could pay them back. The Japanese lowered their interest
rates to zero, and nearly doubled their money supply and it did nothing.
It generated no lending and no inflation. The Japanese economy continued
to stagnate. And this flies in the face of all existing economic theory.
All our economic texts will have to be rewritten. The models have failed.
The bottom line: we're in unexplored territory, in a
"liquidity trap". This is a situation in which the interest
rates that banks have to pay to borrow money is zero. They can loan out
this money at a 5% or 6% interest rate but (1) potential borrowers are too
insecure about their own financial futures to want to borrow, (2) consumer
demand has fallen off so companies are closing plants rather than building
them, and (3) banks are afraid that borrowers won't be able to repay their
loans, understanding that it takes a lot of interest to make up for
every defaulted loan. Consumer demand declines so companies lay off
employees, resulting in further declines in demand.
Breaking this vicious circle requires either waiting
until durable goods wear out and must be replaced, forcing renewed
production (as in the Panic of 1873), or the government steps in to become
the employer of last resort. During the Great Depression, government
intervention led to a dramatic rebound (the stock market quintupled) from
January, 1933, through January, 1937, until President Roosevelt, in the
wake of his 1936 re-election, gave in to the deficit hawks and cut back on
the New Deal. It was too soon. The country plunged back into recession
until World War II broke it up.
A Parenthetical Remark: It's a popular pastime to bemoan the money
the government is borrowing as a debt that we'll pass on to future
generations. In fact, about a third of the money that the government is
borrowing for TARP and for the government's fiscal stimulus program will
come back in the form of taxes as the money changes hands in the economy.
Further, this money isn't being given away but is being loaned against
tangible assets. Hopefully, part of the two-thirds of this money that
doesn't return to the government through taxation should be recovered when
the loans are repaid, as has happened in the past. Then, too, recessions
and depressions reduce government tax receipts (currently about $3
trillion a year). Decreasing the lengths and depths of recessions may help
offset the costs of stimulus programs. And finally, the infrastructure
investments the U. S. government made at least during the Depression...
roads, dams, power plants... were of lasting monetary value to the nation,
and were purchased at rock-bottom prices.
The markets have continued to drop today, with the S&P 500 falling
below its 25-day moving average. Its 25-day average is flattening out, but
hasn't yet sloped downward. I have taken the precautionary step of selling
my January, 2010, calls, and have sold some previously recommended,
outperforming China stocks that are no longer followed by the Cabot China
and Emerging Markets Report. Now, with the highest-risk stocks no longer
in my portfolio, I'll wait to see what happens next. (This still leaves me
Note that the Chinese market index, FXI, is down 2½ %
at the moment..
Flip-flopping moving averages point to momentum
See Michael Ashbaugh's Technical Indicator