Following the market peak in October of 2007 (one year ago), stock averages began a steady downtrend into the month of October 2008. In October 2008, the stock markets crashed, and major averages would have ended down over 30% for the month, had it not been for a furious 3.5 day rally commencing on Tuesday, October 28th at 2 PM and ending on Friday, October 31st. This 3-day rally advanced the major market averages about 15 - 20%. Still, most averages were down around 15% percent for the month.
As an example, the Russell 2000 Index was trading about 440 at noon on Tuesday, and closed at about 540 on Friday. The Dow Jones Industrial Average was trading around 8200 mid-day Tuesday, and closed over 9300 on Friday. Most of the 3-day advance occurred in just 2 hours, between 2 PM and 4 PM on Tuesday, October 28th. The INDEXES rallied about 10% in just 2 hours. Anyone thinking about a coordinated intervention in the markets orchestrated by Big Government and Big Money?
Much has happened in the past year. Trillions of dollars have been lost on bad real estate loans and investments tied to those loans, the US brokerage industry collapsed and disappeared, US banks would have failed were it not for trillions of dollars in Government intervention, Trillions of dollars have been lost in the value of US real estate, and Trillions of dollars have been lost in the US stock markets. And stock, real estate, and banking losses of similar magnitudes occurred overseas as well, in the U.K., continental Europe, Australia, etc.
Heck, the totalitarian stock markets in Russian and China lost most of their value in the past year, and everyone's favorite emerging market, Brazil, lost 70% of its value peak to trough.
Oddly enough, just 6 months ago perceptions were astonishingly different. While it was known that the US economy was slowing down, and bad real-estate assets were weighing down the books of many financial companies, the conventional wisdom was that world wide growth would continue, spurred on by hyper-growth in the so-called emerging markets like the BRIC countries.
That perception fed the final phase of the commodity rally, which was a classic climax run to the top. The last great burst of enthusiasm for commodities began in the summer of 2007 and ended in the summer of 2008. Results of this final push up in commodity prices saw gold top $1000, oil top $140, copper top $4, along with soaring prices for all commodities during the year at some point.
Prices for all these commodities have come off anywhere from 25-75%, with gold holding up relatively well only about 30% from its peak, currently trading at about $720 per ounce. Oil, once over $140 per barrel, now trades around $68 per barrel. We have since come to find out that the price spikes of these commodities were largely driven by demand from speculators following and fueling an uptrend. No surprise there.
Stocks too are a commodity, and represent nothing more these days than electronic flashes on a computer screen. There are many sophisticated models about what stocks are worth based on current and future earning projections, profit margins, stability of business, etc. But truth be told the amount of stock issued in the past couple of decades has been astronomical, fueled in part by the granting of massive amounts of stock options to company insiders, initial public offerings of companies with no earnings, and, the IPOs of many foreign companies, such as those in China.
Another reason there is so much stock on the market these days is that when the appetite for stock was nearly insatiable in the 1990s and, for some market sectors, the 2000s, stocks were bid up, split, and bid up again, increasing the share count, or the float (number of shares traded on the open market, as opposed to shares held by company insiders such as founders).
I have a question. What exactly is a share in a company in the People's Republic of China worth? If I buy shares in a Chinese energy company or a Chinese bank, what exactly are my shareholder rights? Isn't China a totalitarian communist police state? Sure, if China were a democratic country with individual property rights these companies might be worth something. And if China reforms to a freer society and government these companies might have some free market value.
But Jim Rogers, who wants to place a big chunk of his assets in China, and who would have moved to China had it not been, so he says, for the poor air quality, seems to have forgotten some of the harsh lessons of history. What history teaches us is that one day we may wake up and China has invaded Taiwan, trading on its stock exchanges is suspended, and foreigners will be expelled or imprisoned. Come to think of it, this is precisely what has already occurred in Russia just this year, following its invasion of Georgia. Ask British Petroleum (NYSE:BP) what's it's like to do business in Russia (its assets were essentially seized, and its people were expelled from the country).
Stock ownership only makes sense in countries where the political and legal structure support the rights of private property, as represented by stocks, which themselves represent fractional shares of ownership in companies. I would argue that a share of stock in Russia and China is worthless, unless they pay a dividend. But even that could be changed by government edict at any time.
Anyway, the governments of the world, led by the USA, are filling the Trillion dollar voids of bad debts and bad assets and bad balance sheets to prevent the bankruptcy of most of the banks, remaining brokers, and other companies holding the bag for the reckless loans of this decade. The governments will of course succeed. A company can't go bankrupt if the government essentially gives it money to offset its worthless loan portfolios or level 3 paper or whatever.
If you owe $100,000 to your credit card company, and are getting ready to file for bankruptcy, and Hank Paulson knocks on your door, and gives you a check for $100,000, you are once again solvent. Or maybe Hank calls you up and says that he's called your bank and talked to it, and you now only owe $10,000, he'll take care of the rest, either by having the loan forgiven or by assuming $90,000 of the loan himself. Again, you're instantly back on your feet.
In any event, the credit bubble burst, the economy is in the tank, stocks are in the tank, interest rates are almost zero, and Governments are pushing piles of money everywhere to keep the system SOLVENT (not liquid). This is similar in style but much more massive in scope to our most recent recession following the bursting of the stock market bubble of the 1990s. The bubble of the 2000s included real estate, the Wall Street brokers, homeowners, the real estate market, as well as the stock market.
The negative wealth effect is bigger by several fold, I would imagine. The effects would seem to be easily predictable. The US has led much of the world into a deflationary recession that will last into next year. But with all the money being dumped into the financial system coupled with near-zero percent interest rates, that money will seek a better return than Treasury bonds, and, as risk appetite slowly returns, various asset class will begin to re-inflate.
I believe that the price of Treasury bonds will go down, the prices of stocks will stabilize and go up, commodity prices will stabilize and go back up, housing prices will stabilize and go back up, and eventually interest rates will go back up. There's nothing mysterious about it. It's just the inevitable repeating of economic cycles, boom and bust, that sort of thing.
My guess is that the worst is over, unless President Obama becomes President Carter, and runs the economy into the ground with high taxes and disincentives for individuals to work and disincentives for businesses to operate or to grow. That's a very big unknown, and a very important unknown. The power to tax is the power to destroy!
But deflation will rapidly revert to inflation sooner rather than later. The least risky way to make money, I'm guessing, would be precisely how money was made following the last recession: commodities and stocks in commodity based companies, and owning currencies in countries with better monetary polices, more robust economies, and countries rich in commodities the world needs.
You don't have to be a hero and pick the bottom in these asset classes, just wait for the charts to turn up. Wait a little while until the moving averages have gone from down sloping to sideways or even turned up. Wait until important resistance levels have been broken. If the next up cycle lasts a few years, there should be plenty of money to be made once it's clear the system has held together and is rebounding.