Four Horsemen of the Bear Market

I'm sure that readers are familiar with the term “Four Horsemen of the Apocalypse” from the Bible's Book of Revelation. It seems to me that the “end times” for the long-standing bull market in stocks was caused by what could loosely be called “The Four Horsemen”.

While not an apocalypse, the stock market is back to where it was in 1997. 1997 was, of course, the year that Alan Greenspan made his now-famous utterances about “irrational exuberance”. “Irrational exuberance” sure seems to have been wrung out of the stock market.

Here is some data which should not be taken lightly. On a total return basis, Ibbotson data shows that the S&P 500 has now underperformed long-term Treasury bonds for the last five-year, 10-year and 25-year periods, and by substantial amounts.

In the future, if the long-run expected returns on bonds were expected to be higher than the expected return on equities, capitalism as we know it would grind to a halt. After all, who would buy stocks when they “know” that the returns on bonds is better?

So, who are the “Four Horsemen” that helped kill the bull market? The four culprits are – Wall Street, the Federal Reserve, Washington D.C. and the media.

Congress Gone Wild

Over the past 40 years, Washington – both political parties – has followed a ruinous policy and has progressively transitioned America from a “producer” economy to a “consumer” economy. Instead of accumulating wealth, America is rapidly depleting its wealth.

One way to measure this depletion of wealth is by looking at the long-term value of the US dollar, which affects everyone, not only investors. I believe that the best way to look at the dollar's long-term decline is not by comparing its value to other declining currencies, but versus the value of gold.

Since 2000, the US dollar has depreciated against gold by an average of 16.3% annually. In the past three years, versus gold all holders of US dollars have suffered a 60% erosion of their wealth. That's before taxes and that's not counting any investment losses.

Bankers Gone Wild

Now let's look at Wall Street. The top three Wall Street money center banks have a total of $100 trillion in exposure to derivatives. And that is just the tip of the iceberg as far as problems on Wall Street. Wall Street bankers seem to have lost their collective minds. Why?

A major part of the problems on Wall Street has stemmed from their distorted and perverted incentives system. The capitalist system is all about incentives. People are rewarded handsomely when they take risks and win. But when people take risks and they lose, they should have to pay the penalty.

What we have now in America is something completely different. The incentive system put in place by Wall Street has produced the worst possible economic system. We have capitalism for the profits and socialism for the losses. Heads – Wall Street wins, Tails – taxpayers lose.

Media Gone Wild

Everything connected to Wall Street seems to have become corrupted, including media. CNBC is such an obvious target, with people Larry Kudlow and Jim Cramer, but I wanted to talk about another media company – McGraw-Hill.

A prime example of problems with how the media has covered this financial crisis is the recent controversy surrounding the publication of Barry Ritholtz's book “Bailout Nation: How Easy Money Corrupted Wall Street and Shook the World Economy”. Barry Ritholtz, by the way, is the author of a popular finance blog, “The Big Picture”.

In 2008, the book was to have been published by McGraw-Hill. But they dropped the book. Why? Ritholtz claims that he butted heads with McGraw-Hill over some passages he wrote about bond-rating agencies. McGraw-Hill happens to own ratings agency Standard & Poor's.

Bond-rating agencies, of course, accepted huge fees from investment banks for rating many types of securitized bonds as “AAA”. Many of these securitized instruments contained nothing but garbage in them. However, the AAA-rating allowed Wall Street to sell these securitized instruments all over the world and are a major contributor to current financial markets woes.

According to Newsweek, in his original draft Ritholtz dubbed the acceptance of fees as “payola” and called the ratings agencies “pimps”. Apparently, this did not sit well with McGraw-Hill. Why? Because the author was truthful?

The Fed Gone Wild

Finally, there is the Federal Reserve. In an effort to combat the current downturn, Ben Bernacke and the Fed seems intent to compound Alan Greenspan's previous mistakes and has gone full-time into the creation of funny money.

The Fed seems to believe that monetarism can fight a financial crisis caused by excess liquidity and debt by churning out even more liquidity. The Fed seems to be ignoring the fact that the strong growth and low inflation seen for the past two or three decades was simply a credit-driven illusion induced by deficit nations like the US.

The flood of cheap goods from the emerging markets is the main reason that the historical link between the supply of money and inflation has been weak. It seems absolutely absurd to continue to assume that the exponential growth in the monetary base will not eventually produce some very nasty side effects, namely inflation.

Yet, this is what the Fed, Wall Street and Washington wants investors to assume. They want investors to focus on the very short-term deflation and to ignore that in the longer-term, in a fiat money system, deflation simply cannot exist. If investors continue to focus on short-term deflation, they will continue to purchase (foolishly) US Treasuries at near zero per cent interest rates, which is exactly what the policy makers want.

Instead of pursuing its current policies, the Federal Reserve and other policy makers should be focusing on trying to create a new paradigm where economic growth is created by something other than a flow of cheap credit. Until that happens, the bear market in stocks looks to continue to linger.

Comments

[TeresaE:]

Beautifully constructed and true.

Only addition I would make is to your paragraph concerning the federal government led switch from producer to consumer.

Our public educated minds have to be TOLD what this means.

OUR jobs were sent off shore to increase profits and thus taxes for Washington. Easy credit was created to fill the gap caused from removing entire sections of the middle class.

The house of cards has fallen.

Thanks for the article, too bad the "experts" and politicians still do not see, nor believe, the error of their ways.

Mar 13 11:50 AM

[The Greates...:]

An excellent article, you can not spent your way out of debt. Economics 101, which some of our law makers must have slept through during college.

Mar 13 11:54 AM

[The Greates...:]

I leave you now with this thought, all the big bail outs are going to the big name finical institutions on Wall Street, the working class (middle) got to keep a little more of their checks. But that working class is shrinking everyday due to job loss. Job loss floods the job market, lowing working wages because of the competition in the labor fields, benefiting the larger companies that do hire. (Lower wages means a bigger bottom line) So, if your big enough, it is a win, win situation all around. An also hard time squeezes out competition, creating more monopolies in big business. The consumer loses all the way around, write, call, email and fax your representative today, let them know your watching. Have a nice day.

Mar 13 11:57 AM

[Alex Filonov:]

We can rant all we want, sure. How do I make money from this article?

Mar 13 12:04 PM

[henarl:]

Superb article. You could not have chosen four more deserving perpetrators as your horsemen. One hopes not but apocalypse may yet turn out to be an apt term for our economy.

Mar 13 12:15 PM

[anarchist:]

Alex, I think the bottom line here is that the "bear" has lots of reasons to stick-around. It shouldn't be difficult to figure out how to make money if you believe (GID, SH, DOG, etc.)his bottom line and if indeed the bear takes a bigger bite.


On Mar 13 12:04 PM Alex Filonov wrote:

> We can rant all we want, sure. How do I make money from this article?

Mar 13 12:19 PM

[Pat Shuff:]

And the horse it rode in on.

Alexander Hamilton said: "Your people, sir, is nothing but a great beast"

Mar 13 01:36 PM

[Tomcat101:]

Obama is the lesser-known fifth horseman.

Mar 13 01:38 PM

[hpcooperjon:]

IT'S O.K. TO USE THE FOUR HORSEMEN IN YOUR ANALOGY BUT OF COURSE THE INDIVIDUAL HORSEMEN DO NOT CORRELATE WELL THE THE EXAMPLES GIVEN. THE FIRST HORSE, THE ANTICHRIST, THE WHITE HORSE, COMES BRINGING PEACE BY MEANS OF THE SWORD, THINK "PAX ROMANA". THE RED HORSE IS HIS WAR TO UNITE THE WORLD UNDER HIS RULE. THE BLACK HORSE IS THAT OF THE FAMINE WHICH WILL FOLLOW THE END OF THE WAR IN WHICH MILLIONS UPON MILLIONS WILL DIE AND NO ONE WILL HELP. AND FINALLY, THE PALE HORSE, THE COLOR OF DEATH WHICH COMES TO A LARGE PART OF THE EARTH VIA NUCLEAR WAR AND STARVATION. WHEN WILL THIS HAPPEN? WHO KNOWS? BUT THE STAGE IS BEING SET. SORRY TO WAX PHILOSOPHICAL IN THIS SETTING; OR MAYBE NOT.

Mar 13 01:48 PM

[terryg8:]

Well, let's see. He predicted inflation in the near future, right? Seems to me that commodities and commonity driven companies would be a good place to start. Then there is the ultimate commodity, Gold. You could also find a more stable currency and bet it against the dollar. As an example, the Canadian dollar is very commodity driven and has been weak against the dollar. There would be a play. Now, I am not saying you should do any of this but if this article seems to make sense to you, there would be some plays to consider. You see, not everyone is going to connect all the dots for you unless you want to pay them to do that.


On Mar 13 12:04 PM Alex Filonov wrote:

> We can rant all we want, sure. How do I make money from this article?

Mar 13 04:08 PM

[terryg8:]

Excellent article that makes much sense to me.

Mar 13 04:08 PM

[Moon Kil Woong:]

hpcooperjon. Yes I'd swich the order to fit batter.

Congress is the antichrist of monetary policy who are the architects of this mess by not regulating money supply as the framers had invisioned but passing it to the President and the Fed. Also Congress is the one sporting all the fancy deficits leaving the Fed will trillions of treasury notes to play with every year. In the end the root of all this mess including the lack of regulation of derivatives, the fed, the ratings agencies, and our money supply. So financial antichrist seems quite fitting.

The Fed is the white horse tying all banks together and preaching prosperity through artificial interest rate manipulations and money supply expansionism while using its sword to cut the value of the dollar into shreds.

The bankers are the red horse. Although they aren't preaching war yet they sure know about plunder which is essentially financial warfare. Right now they are too busy plundering their own country to bother plundering less economically endowed nations.

The black horse being the media is a bit of a misnomer. The author is pointing to the ratings agencies, derivatives, and brokerages/investment banks. In keeping with the black theme letsd just say the fourth horse is the black ink used for financial lies. These lies are in the trillions and are what will lead to financial armageddon unless they are fixed. They also are driving millions out of their homes and into the poorhouse. Although this isn't starvation, we aren't technically in a depression yet.

All and all, yes, I think the author hit many key points about what is wrong with our current financial system. Like many people are saying, we can all hope the end of the financial world analogies will subside in a year or two and we can sit around and talk about our lingering recession or the resurgence of free market capitalism. To me these are our two most probable paths, not a complete economic meltdown.

Even so, financial reform would make me sleep much better at night.

Mar 13 04:17 PM

[Alex Filonov:]

'in the longer-term, in a fiat money system, deflation simply cannot exist'

Ever heard of Japan in 1990s?

Mar 14 01:53 AM

[Old Trader:]

Screw the horses..when do I get MY pony?!?!?


On Mar 13 01:48 PM hpcooperjon wrote:

> IT'S O.K. TO USE THE FOUR HORSEMEN IN YOUR ANALOGY BUT OF COURSE
> THE INDIVIDUAL HORSEMEN DO NOT CORRELATE WELL THE THE EXAMPLES GIVEN.
> THE FIRST HORSE, THE ANTICHRIST, THE WHITE HORSE, COMES BRINGING
> PEACE BY MEANS OF THE SWORD, THINK "PAX ROMANA". THE RED HORSE IS
> HIS WAR TO UNITE THE WORLD UNDER HIS RULE. THE BLACK HORSE IS THAT
> OF THE FAMINE WHICH WILL FOLLOW THE END OF THE WAR IN WHICH MILLIONS
> UPON MILLIONS WILL DIE AND NO ONE WILL HELP. AND FINALLY, THE PALE
> HORSE, THE COLOR OF DEATH WHICH COMES TO A LARGE PART OF THE EARTH
> VIA NUCLEAR WAR AND STARVATION. WHEN WILL THIS HAPPEN? WHO KNOWS?
> BUT THE STAGE IS BEING SET. SORRY TO WAX PHILOSOPHICAL IN THIS SETTING;
> OR MAYBE NOT.

Mar 14 02:08 AM

[Tony Daltorio:]

Because the Japanese had so much national savings, they did not flood their system with money (they mainly used government stimulus programs)and felt they could tolerate flatish inflation/deflation.

However, the US has no savings and will have no choice to but to flood the system with tens of trillions of dollars which will destroy any long-term deflation.

Go back in history and you will see many examples. I know this will probably surprise you but financial history goes back further than the last 10-20 years and people day-trading tech stocks.


On Mar 14 01:53 AM Alex Filonov wrote:

> 'in the longer-term, in a fiat money system, deflation simply cannot
> exist'
>
> Ever heard of Japan in 1990s?

Mar 14 11:09 AM

[Alex Filonov:]

Japan tried to flood economy with money. Japan has government debt well above 120% GDP and counting. Account surplus was shrinking and became account deficit. Still Japan was technically in deflation for the most part of 1990s and whatever they call inflation after that can only be seen through the microscope. This year might see deflation again. Japan is an example of stubborn deflation in fiat money system.

As for history, there were periods of inflation and deflation in the world in different money systems. For example, deflation in USA after 1933, when dollar became fiat currency. Thing is, inflation and deflation are not pure monetary fenomena, they also depend pretty much on societal mood.


On Mar 14 11:09 AM Tony Daltorio wrote:

> Because the Japanese had so much national savings, they did not flood
> their system with money (they mainly used government stimulus programs)and
> felt they could tolerate flatish inflation/deflation.
>
> However, the US has no savings and will have no choice to but to
> flood the system with tens of trillions of dollars which will destroy
> any long-term deflation.
>
> Go back in history and you will see many examples. I know this will
> probably surprise you but financial history goes back further than
> the last 10-20 years and people day-trading tech stocks.

Mar 16 01:26 PM

[Le Philosophe:]

Good thinking, wrong focus.............. The reason we are experiencing economic trials is globalization and labor disequibrilibriums in the system. Money is flowing out of high labor rate economies and into low labor rate economies. Such unequal realities cannot exits without other consequences. Not to belittle the other issues which uncovered unsustainable positions like Credit Default Swaps which were backed by air (another word for actuarial opprobrium).....Collat... Debt Obligations guaranteed by failing mortgages ....Structured Investment Vehicles backed by CDS's and CDO's... AAA ratings errors (Fraud, if you like, ala Ritzholtz)... Easy credit ... Liar loans....(Did you get yours?)... poor regulatory regimes.... leverage gone wild (now correcting in a free market near you).... It just seems ironic, if you look at the stock markets around the world that the Chinese market situated in the oppressive opprobrious communist country is more optomistic than the Western capitalist markets where unfettered freedom reigns supreme.......... How do you make money on this, a longer term investor would buy things these low wage rate economies need and cannot provide themselves ...... commodities may be a good play............. just an idea................ Are the four horseman doing their dead level best to quell the carnage and support the system. In my humble opinion the Fed and Treasury are doing everything they can within their frame of reference and legal constraints to cancel a financial collapse, congress has no clue (this is the horse to fear), the media makes news-concocks and illucidates conflict and controversy (Why else do we pay attention), and Wall Street makes money everyway it can, their unmittigated montra. Its all human nature. There is no way to stop it and if anyone should try, there will be plenty of counterparties to take the other side of that trade any day.......Alfred North Whitehead was correct. Reality is a "creative advance into novelty"

Apr 04 09:45 AM

[Darrell DiZ...:]

Excellent article. There are hints every man can take to the bank. Like on how the US dollar is shrinking against gold year after year.
Notice how the government is mum on this fact. GDX is your self defense against the Fed inflating their way out of this severe recession. Now that we have had the spend, get ready for the tax.

Thanks, and hats off to Tony Daltorio. Someone should throw you some big bucks so we can get you on CNBC. Keep up the great work.

Darrell Z. DiZoglio of RighteousResumes.com
My site is loaded with everything you need to know to get hired.

Apr 08 07:49 PM