Will We Have a Good 2009? Not If History Is Any Guide

Well, 2008 is finally over and we can all celebrate starting with a fresh investment canvas. But will we have a good 2009? What should we expect after such a dismal year that was 2008?

Many analysts are predicting that the economy will pick up late in 2009, and that the US dollar will weaken dramatically again later in 2009. But if history is any guide, this may well be wrong. Many have concluded that the current financial mess is very similar to the "Great Depression". If we are to compare a chart of the Dow Jones from October 1929 to October 1931 (see chart at Wikipedia, 1929 crash), with a 5 year chart of the Dow from 2003 to 2008, it is eerily similar.

In fact, if history is any guide, we are due for a major bear market rally going into 2009, followed by a return to the current bear market pattern later in 2009, and onto new lows. So what would drive such a rally into the new year? For starters, a weaker US dollar. There is little the Fed can now do to prevent a breakdown in the US dollar, and with rates not moving anytime soon, it would be hard to see any notable further strengthening at this time.

The second driver of a rally would be the extreme oversold level of nearly every stock in nearly every sector; as investors, we have been trained to buy stocks in oversold conditions and sell in overbought conditions.

The third driver will be short covering. Shorts have had the best of it for over a year now, and at some point you must cover. Watching the market grind higher and higher day after day will be too much to bear for most and short covering will be a self fulfilling prophecy as the year starts out.

You may wonder where basic fundamentals fit into the rally going forward. Well, there wont be any; instead, we will see a rising amount of failing businesses and an increasing amount of credit default swaps (CDS) really come to the forefront of the crisis. At this point, when it becomes apparent that around 20-25% of companies will fail, panic will set in again and those holding the wrong way bets of CDSs will really feel the pain.

I believe we will see that many companies which we think may be starting to look like a good investment will now be found holding CDSs of companies that are failing. Therefore, we will now have two companies failing, and maybe another who holds swaps on the second! The bear will again be woken and the market will step down again, day after day, week after week.

At this stage, the Fed will have to let these companies fail. The complexity of who holds what against which company will just be too hard for any bailout, yet again. Anyone caught holding these CDSs will suddenly need a load of US dollars, and again we will see a mad scramble for the US dollar and further strength return to the currency. When the dust finally settles and the weak players are cleared out, we can finally build a new base for a better stock market and economy in general.

If my analysis is correct then this flies in the face of the majority opinion at this time. I do hope, however, that I am very, very wrong.

Disclosure: no positions

Comments

[Against Aph...:]

I agree. It's nice that the media (and government) woke up to the fact that we were in a recession--if a year late. What continues to be very troubling is the naive acceptance of the misappropriation of funds in TARP. We have acknowledged some of the crises, but still fail to provide more than a bandage solution to any of them.

Just yesterday, I heard another pundit prattling (I believe on Fox News) about how "nine times out of ten the market rises after a bad year" and that the "worst thing you could do is try to time the market and miss it". What they failed to mention was that the one time it was not up was during the Great Depression, and that going long after the first year, you would have lost something like 43% of your remaining money.

Another interesting point that everyone seems to be missing is that the Great Depression didn't happen overnight. While they label this just another measly recession and not a depression, the markets are down more in the first year of this "recession" (38%) than they were in the first year of the great depression (30%).

Yes, maybe down years following immediately after down years are a 1 in 10 rarity, but so far we are positioned more strongly that way than even we were during the beginning of the great depression!

It would be fantastic if what I'm saying turns out to be a false alarm. I just find it very reckless to ignore the danger.

I'm afraid that until there is more caution and some real solutions--hard choices made, that there is still room for the markets to fall.

Jan 04 09:54 AM

[NOWHEREMAN:]

Everything said presupposes a dollar drop. If the dollar rises, what then? If the Treasury Bubble persists because of the CDS and rising bankruptcy outlook, will the stock market rally?.

You look at 1929, I look at 73- 74. If you use 1929 as your guideline, the Dow is heading below 2,000. IMO

Jan 04 09:55 AM

[ArtfulDodger:]

Mr. Paul:

You say “when it becomes apparent that around 20-25% of companies will fail...”

Holy guacamole! I don’t think anybody has (or can) make a serious case for such a failure rate—at this point.

I don’t think you can take that cursory a view of the years 1929-31 and come to such a dire conclusion. Different situations and different times require unique analyses. And surely the years 2008-10 are wholly different in myriad ways from 1929-31.

E.g., America was a manufacturing nation then; it is not today in comparison. The Fed slammed on the brakes before the `29 Crash and held its foot there for years; that’s not happening today. The Hoover Administration pushed through a huge tax increase; that’s not happening today (at least yet).

Our problems are vastly different today from then. Who was concerned about oil and energy then? Who was concerned about the value of the dollar and gold then? Who was concerned about foreign competition?

The dollar was still backed by gold; our coins were still real silver. The national debt was tiny relative to GNP.

The differences go on and on.

So Mr. Paul, you may well be right about so many businesses busting out, but you can’t reasonably predict that by the chart you present.

I think this shows just how deceptive charts can be. For just because one chart looks similar to another doesn't mean there is a repeat coming. I dare say that you could take a chart of let’s say hog jowls and find a similar pattern.

Jan 04 11:48 AM

[Against Aph...:]

Good point nowhereman,

The dollar strength throws a bit of a curve ball. History also never repeats itself exactly the same way. Thought the dollar strength is IMO undeserved, it is a force to be reckoned with and will hopefully stall or soften our economic fall.

On the other hand, if the government continues to abuse the support other nations have vested in our dollar, (as they have increasingly for the last 30+ years), the government will at some point see an abrupt abandonment of that support.

I have seen no confirming signs so far, but hopefully under Obama (and Volker) there will be policy smart enough to use this temporary dollar strength wisely and as part of a real solution rather than just as an opportunity to procrastinate and exacerbate the problems.


On Jan 04 09:55 AM NOWHEREMAN wrote:

> Everything said presupposes a dollar drop. If the dollar rises, what
> then? If the Treasury Bubble persists because of the CDS and rising
> bankruptcy outlook, will the stock market rally?.
>
> You look at 1929, I look at 73- 74. If you use 1929 as your guideline,
> the Dow is heading below 2,000. IMO

Jan 04 11:51 AM

[nmelendez:]

Very frankly, i believe we are on the eve of a Tech boom, especially alternative energies. The Dow will still go down to 5000 but once it picks up again, a year later it will be boom time. I see more good than bad coming outta this bust, and yes we will come out ahead in 2 or 3 years. I am waiting for the fall liquidation to jump in.
Instead of an industrial revolution we wil have a REAL technological revolution.

Jan 04 01:05 PM

[NOWHEREMAN:]

nmelendz: a tech boom, in what kind of Technology?

If Alt. Energy, fully agree.

Jan 04 04:39 PM

[John Lounsbury:]

Maxe Paul - - -

Nice first article on SA. I look forward to more.

Jan 04 06:10 PM

[Maxe Paul:]

You make a very valid point/s, the 20/25% bankrupt rate is a guide only, maybe we will see 10% maybe we will see 30% (highly doubt it of course). My point being that if over the coming 6 months we see these high bankruptcy figures this will be the "depression" nail in the coffin.

It is certainly going to be tough for any business's over the next 6 months/year, and only the toughest will survive, especialy retailers IMO. The figure i am referring to is also all business's, not just listed companies on the stock market, most will be small family run business's, retailers and further (weak) banks.

There is little dought that the Fed has already prevented many cases of companies that we can debate whether or not they should have saved, but i believe we will see a tipping point where the high percentage (of big companies) will prevent further bailouts, and become a spiral. I very much hope i am wrong of course.


On Jan 04 11:48 AM ArtfulDodger wrote:

> Mr. Paul:
>
> You say “when it becomes apparent that around 20-25% of companies
> will fail...”
>
> Holy guacamole! I don’t think anybody has (or can) make a serious
> case for such a failure rate—at this point.
>
> I don’t think you can take that cursory a view of the years 1929-31
> and come to such a dire conclusion. Different situations and different
> times require unique analyses. And surely the years 2008-10 are wholly
> different in myriad ways from 1929-31.
>
> E.g., America was a manufacturing nation then; it is not today in
> comparison. The Fed slammed on the brakes before the `29 Crash and
> held its foot there for years; that’s not happening today. The Hoover
> Administration pushed through a huge tax increase; that’s not happening
> today (at least yet).
>
> Our problems are vastly different today from then. Who was concerned
> about oil and energy then? Who was concerned about the value of the
> dollar and gold then? Who was concerned about foreign competition?
>
>
> The dollar was still backed by gold; our coins were still real silver.
> The national debt was tiny relative to GNP.
>
> The differences go on and on.
>
> So Mr. Paul, you may well be right about so many businesses busting
> out, but you can’t reasonably predict that by the chart you present.
>
>
> I think this shows just how deceptive charts can be. For just because
> one chart looks similar to another doesn't mean there is a repeat
> coming. I dare say that you could take a chart of let’s say hog jowls
> and find a similar pattern.

Jan 06 02:21 AM