Where Are We on the Roadmap? 74 comments
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Recently, there have been increasing calls from economic forecasters for a prolonged recession, or an L-shaped recovery (see here, here and here).
A roadmap to the future?
The latest study from Reinhart & Rogoff, whose paper was presented at the recently concluded American Economic Association shindig in San Francisco, sheds some light on the future based on past events. They studied banking-related downturns in the pre-World War II era, as well as a couple of pre-war episodes for which they had data. Their main conclusions are:
First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.
Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.
Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.
These conclusions aren’t all that different from the IMF study published earlier. Both agreed that financial related economic downturns tend to be deeper and more severe. The IMF study indicated that average recession length of 8.4 quarters (see Table 4.2 on page 9), whereas the Reinhart & Rogoff study showed an average of 1.9 years.
Where are we now?
If history is any guide, given that the U.S. recession began in early 2008, then on average the recession will end in late 2009/early 2010. Reinhart & Rogoff showed that equity prices had an average decline of 55% and the S&P 500 has neared that mark on a peak to trough basis.
This environment suggests that equity markets are in a bottoming, base-building process. We should be prepared for a test or even small breakdown from the lows seen late last year, but the downside is limited. If the average recession ends in late 2009/early 2010, then the timing of the final bottom should occur sometime in 2Q or 3Q 2009.
This analysis seems right to me at a gut level. Equity valuations are relatively attractive. Long term sentiment is washed out. The sentiment level is similar to the first half of 1982, when every day the market saw another piece of bad economic news and the market seemed to suffer the Chinese water torture treatment of declining every day, until no one wanted to hear about the stock market.
Under these circumstances, investors with long-term horizons could start raising their equity allocations now, on a dollar-average basis. Traders have to be mentally prepared for the grind ahead and the opportunities that come with the final bottom this year.
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On Jan 17 11:18 AM secmaven wrote:
> Preparations for war and war will lead our economy out of it slump.
> It was always thus.
On Jan 17 12:42 PM Rob Viglione wrote:
> Our empire is suffering from the throes of its own continuous growth
> model. Rome's depended on plundering new provinces; our depends on borrowing and spending, pursuing a half-a$$ Keynesian inflation model.
>
Um: that would only make sense if you've read neither a history of the Roman empire nor an economic history of the United States.
Rome had cycles of expansion and retrenchment, decay and renewal. They did very well after _losing_ various provinces, indeed the Eastern Roman Empire lasted a thousand years after the West was lost!
As for the United States, go look at a chart of debt as a percentage of GDP. We've had debts comparable to the level that we'll have once the bailouts are done-- and survived and paid them down. I might add that other nations have debt/gdp ratios far higher than the US does.
Regarding dollar cost averaging. That is all good and fine except when your income is under threat, your house value is dropping, and your credit card limits have been cut for no apparent reason. The simple fact is brokers and dealers have their heads in the clouds telling people a 30-50% loss will recover after a few years maybe will recover faster if you keep dumping money into it.
These are the same brokers that tell you to sell your losses and not chase bad money with good money. Isn't that what they have been doing dollar cost averaging for the past year. It is perplexing that when it comes to investing where they get fat commission checks they change their tune so quickly.
How do they know it is the bottom? They don't. I'm quite sick of people advising others what to do with their money without hard evidence. Especially when they benefit whether or not such an investor wins or looses.
If they are serious, I would like to see their personal investments for the past 2 years and see what they are doing now. I guarantee, they are not dollar cost averaging to any degree they were before if at all. Most likely they are tapping their 401Ks, especially if they are out of a job.
Get wise, advise people to be safe in a downturn. This isn't the 1987 crash...
Links: www.nber.org/cycles/de...
seekingalpha.com/artic...
A little pit of nit-picking, but using the formula you laid out, could save a month or few off your recovery horizon time-line.
On Jan 17 12:15 AM Crocodilian wrote:
>
The prudent are staying aside for now is my best advice,,,MarvinMBA
> There is no sector that will take us out of this. I REPEAT... there
> is no sector that will take us out of this. Unless there is a magic
> wand that will create a magic set of beans that will take us all
> off this Earth.
>
Why?
The United States has had debt levels comparable to the ones we're going to run. US National debt as a percentage of GDP was %120 in 1946. There were similar levels of debt in Germany, the UK, France, Japan.
So here, on this very Earth, we've successfully negotiated similar straights.
. . . without any "magic beans"
Last year i made 3500 doing the trading. I personally do not believe in following the lemmings. I am also not a trader. I am long term investor but at this stage i am just accumulating capitol as Marvin suggests.
If you really look at the roadmap, we may consider, as one rock song put it, that we are on the highway to hell.
Even with this new bad bank concept that they floated on Friday... So they put all of this stuff in there. The BEST and most OPTIMISTIC estimates put the bad debt percentage of CDS's at $10 trillion. Worse case, perhaps twice that -- and debt confined to the United States.
Next, according to the Federal Reserve, there was a loss of about $8 trillion in ONLY the asset classes measured by the data from Q4 2007 through Q3 2008; the data excludes the worst quarter of 2008, Q4. (p. 113)
www.federalreserve.gov...
If you were to add all debt classes from Q4 2007 to Q4 2008, you might be looking at a loss of around $15 trillion. ADD ALL ASSET CLASSES... The figure becomes worse... I can tell you right now, Q1- Q4 2009, may even look to be worse than 2008.
So do the math... Best case... Q4 2007 to Q4 2008 $25 trillion... US GDP... About $14 trillion...
And this show ain't over yet...
There will be plenty of naysayers... It reminds me of the stages grief according to Elizabeth Kubler-Ross:
1. Denial
2. Anger
3. Bargaining
4. Depression
5. Acceptance
Get ready for the anger (civil unrest), as that will be coming next. I think people are starting to come to the conclusion that Paulson and Bernanke have been lying to them all along about the banks being solvent... Won't be a nice world in the not too distant future.
On Jan 17 02:57 PM MarvinMBA wrote:
> The USA is in denial...we are in a DEPRESSION not a recession believe
> it or not. This is a replay of the 30's with the financial and real
> estate and job loss downdrafts. Its going to take a long time to
> pull out of this. Buying into equities could be years premature in
> my opinion. Its going to be a long road to recovery and the new administration
> is going to have its hands full with major dislocations in almost
> every domestic and international arena.
> The prudent are staying aside for now is my best advice,,,MarvinMBA
You stated, "The United States has had debt levels comparable to the ones we're going to run. US National debt as a percentage of GDP was %120 in 1946. There were similar levels of debt in Germany, the UK, France, Japan."
Were other conditions comparable? Particularly, were those economies based as much on consumption and services and as little on manufacturing as ours is today? Or is that, in your view, irrelevant or immaterial?
Thanks.
Or the first half of 1931.
I am glad to see others have come to recognize the changing appraisal of the Roman Empire. In the past, blame for the collapse was placed on everything from lead poisoning to the growing number of "foreigners". After an early expansion they ended the practice of extending citizenship to the people of newly conquered lands. So, many of those "foreigners" were people who were born to several generations within the Empire, lived and died as subjects without ever being included in the dream. To whom would they owe their allegiance? They never tackled the problem of their huge slave population. The tax burden was not fairly spread.
In the end, as the invaders approached Rome, not enough people gave a damn anymore. No longer could they find their "Horatius" to stand upon the bridge.
We are not at that point. We have problems, but we have somehow managed to be MORE inclusive, MORE open. But we really need to tackle the problem of great wealth driving government policy, feeding itself in secrecy, in dark places.
I WANT my government to be solvent. I don't want to be a spectator in the Coliseum, hoping a loaf of bread will be thrown my way so I won't go hungry as someone less fortunate dies for my my entertainment.
The measures of economic contraction are interesting and may be of some value in determining where we are in our crisis. Housing looks like its nuts on.
Assuming the Obama administration creates a "bad bank" to absorb toxic assets, the FDIC continues to provide backstop guarantees and Treasury continues to provide liquidity, I think the financial markets will stabilize. One problem down.
Then we can move on to dealing with the recession which has been continually underestimated by most economists, particularly those employed by institutions that have a vested interest in a rapid recovery.
As with all of you I have gut feelings as to where we are.........but I feel more comfortable in stating that when the economists and analysts begin forecasting events worse than what is realized, I think we will have turned the corner.
If...
Rudyard Kipling
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:
If you can dream - and not make dreams your master;
If you can think - and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to broken,
And stoop and build 'em up with wornout tools:
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: 'Hold on!'
If you can talk with crowds and keep your virtue,
Or walk with kings - nor lose the common touch,
If neither foes nor loving friends can hurt you,
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds' worth of distance run -
Yours is the Earth and everything that's in it,
And - which is more - you'll be a Man my son!
For all you perma-bulls and eternal optimists out there, "sold to you - below bid".
"Roger Knights - - - You are correct, but why make the comment. December is in the fourth quarter. Tour criticism is like calling someone out for referring to the "last week in December" when the exact date is December 31. Is the distinction important?"
Yes. The reason is that dating the start of the recession from “the fourth quarter” implicitly backdates it by two months, to Oct. 1. This in turn enables a bullish commentator to imply that the current recession has run 15.5 months (as of mid-January 2009), and thus that we are nearer to the end of the average recession by two months than we actually are.
The author of the article here didn't use that phony arithmetic, but an author of a bullish article posted a day or two earlier did (probably unthinkingly and thus innocently). I should have made my point on that thread, where it was directly applicable. But, as often happens, I was too slow-witted to think up a come-back on the spot.
Regardless, your comment about degradation and decay is well put, I must say.
On Jan 17 12:42 PM Rob Viglione wrote:
> Our empire is suffering from the throes of its own continuous growth
> model. Rome's depended on plundering new provinces; our depends on
> borrowing and spending, pursuing a half-a$$ Keynesian inflation model.
>
>
> It would be tough to argue that the majority of America's growth
> over the last several decades has been attributable to sustainable
> expansion of output. We produce a smaller amount of real goods every
> year, supplanted by peddling junk financial assets and other services.
> This is even more true when we normalize by subtracting out war materials
> which we have an obsession with spreading around the world. The amount
> of real value America contributes to the global economy is shrinking
> every year.
>
> The root cause? Rome expanded due largely to unprecedented legal
> structure at the time, enabling enterprising individuals to produce
> value as they deemed fit, and opening new trade venues as the Republic/empire
> expanded. At its height, Rome acted as an enormous free trade zone
> that (for the time period) protected property, enforced contracts,
> and adhered to the basic elements of free society Capitalism that
> made America great. Subsequent despotic emperors eroded all of these
> competitive advantages. By the time of the Hun, Goth, Vandal, and
> other Germanic invasions the inhabitants of the empire were enslaved
> serfs, eager for change, or at least unwilling to risk their livelihoods
> to defend their masters.
>
> America grew for similar reasons to Rome, but we took it much further.
> We created rule of law that protected the individual, making him
> sovereign to his own life. This enabled unprecedented growth through
> liberation of the individual. This was the world's first and best
> example of Capitalistic expansion. In all aspects of American life
> we have and are in the process of further reversing this trend. it
> does not bode well for the American empire.
One key point that may separate the doomsayers and Croc's point here is to compare the US to other major powers during the crisis period. In 1946, we were the pre-eminent power, strongest of the weak, and poised to rise in stature and prosper in future times. Other countries had all but destroyed themselves in the most destructive form of consumption - war. In short, we had no competition.
Today, not much has changed. We are still the world's lone superpower, and most other countries derive their prosperity either from our security blanket and/or open markets. Some of the details are a little different - we have consumed beyond our means, through mortgages and conflict, but war in no way threatened our economy - Iraq and Afghanistan were comparatively small parts of our budget compared to WWII spending. Our economy is still regarded as one of the healthiest in the world, with Europe poised to enter an economic crisis worse than our own, and Asia's export model backfiring into a possible outright recession (which may be much, much more painful for them than for us, given their high rates of growth from which they're falling). Militarily, short of MAD, we have no equal, period.
So, I'd say that the doomsayers have a good point, in that we essentially nuked our economy - but luckily for us, the world's prosperity is most dependent upon our own, and must brace for the impact of our profligacy, instead of standing on their own merits. It may take a while, perhaps longer than what Mr. Hui projects, but more than likely, we'll be the first ones out of this crisis.
On Jan 17 04:00 PM rmiggie wrote:
> Crocodilian,
>
> You stated, "The United States has had debt levels comparable to
> the ones we're going to run. US National debt as a percentage of
> GDP was %120 in 1946. There were similar levels of debt in Germany,
> the UK, France, Japan."
>
> Were other conditions comparable? Particularly, were those economies
> based as much on consumption and services and as little on manufacturing
> as ours is today? Or is that, in your view, irrelevant or immaterial?
>
>
> Thanks.
On Jan 17 04:00 PM rmiggie wrote:
> Crocodilian,
>
> You stated, "The United States has had debt levels comparable to
> the ones we're going to run. US National debt as a percentage of
> GDP was %120 in 1946. There were similar levels of debt in Germany,
> the UK, France, Japan."
>
> Were other conditions comparable? Particularly, were those economies
> based as much on consumption and services and as little on manufacturing
> as ours is today? Or is that, in your view, irrelevant or immaterial?
>
>
> Thanks.
A very good question. The answer is that our situation is much _more_ favorable than the situation of the world in 1946.
In 1946, people in the formerly "developed" world were starving, and in many cases had no shelter. Our problem in 2009 is that we've got too much shelter, and we're dying of obesity, not starvation.
The challenge for US policy makers in 1946 was extreme -- and scary; we had a monstrous war debt, and millions of servicemen coming home, for whom their were no jobs . . . in fact the single largest spike in unemployment before 2008 was in 1946, the demobilized soldiers.
You're quite right that our economy has vastly over-emphasized consumption-- but that's already correcting. The consumer has stopped spending, and government spending is about to go way up. Genuine investment spending will take a while to recover, but it will.
Moreover, we're at peace, and have modest military expenditures, and face no military threat comparable to the old Soviet Union. The late '40s saw the emergence of the Cold War, and the Korean coflict-- defense spending as a % of GDP was much higher then than it is today.
The most challenging comparison in 2009 vs 1946 is the fragility of the financial system, but as we effectively nationalize the weakest links, the dangerous of systemic shocks goes down.
Although the US faced no such financial problems in 1946, the rest of the world was in disastrous shape financially . . . the UK remained on rationing for years . . . some rationing did not end until 1953!