4 Possible Market Scenarios 61 comments
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When you come to a fork in the road....Take it
(Yogi Berra)
Where are we going? Or, more to the point, where is the US economy going? Todd Harrison of Minyanville.com thinks that we have two possible outcomes: hyperinflation or deflation and depression.
I think that there are more possibilities and they are more nuanced. It's more like a real fork in that we have four scenarios. They are listed below in reverse order of probability, estimated by me. As usual, I retain the right to be wrong and anybody is free to disagree with me.
Short note about money mass. People are talking (I'd say shouting) about the huge amount of money issued by the Fed and how it can cause high inflation. But they completely ignore the even bigger amount of money destroyed in the crisis (credit contraction = money destruction) and sharply reduced money velocity. They also ignore the carry trade and the role it can play in the crisis.
Inflation and stagnation = stagflation
First of all, I should say that I don't believe that hyperinflation is possible in the US in the near future. There are several different definitions, but the lowest defines hyperinflation as 100% or more in three years, the highest as 50% a month. I lived through 30% a month inflation and it's not pretty. But you need high wage inflation to get hyperinflation, and US companies don't raise wages and salaries now. They are more likely to cut them.
High inflation (up to 15% a year) might be possible. There are two possible sources of such inflation: wage inflation and commodity inflation. Wage inflation is off the table, commodity inflation needs a growing economy, which is not here. However, a combination of excessive money supply and commodity shortages, real or perceived, can create high inflation. The Fed, in such a case, will be forced to raise rates and maybe reserve requirements, killing any possibility of recovery for a while.
We don't have any inflation to speak of. In Q4 2008 we had significant deflation. Inflation in the first two months of 2009 is very low. People are cutting expenses, prices are falling on many goods.
Probability: less than 10%
Japanese disease (Zero growth with zero inflation or low deflation)
This is much more dangerous. Japan fell into this trap in 1989 and still can't get out. There was hope, triggered by increased trade with China, but it was killed by the current crisis. This is probably the longest depression in modern times in one country. This year we are 'celebrating' 20 years since it started.
We started in 2007 almost like Japan: real estate market crash, total inaction of the government and Federal Reserve, multiple claims by the powers that be that the "crisis is contained". Which led me to believe that we are going the same way, and I wrote an entry which predicted that by 2009 interest rates will be below 1% (here). But the latest developments show that the US is not Japan. Companies are laying off workers, banks don't pretend that everything is OK, bankruptcies are on the rise, so there is a normal reaction of economic subjects to the crisis.
It's still a possibility, especially if there is a lack of political will. The biggest unknown is the interaction between inflation and the carry trade. In the case of Japan, the carry trade consumed most of the money issued by the Central Bank. The Fed's declaration of quantitative easing is a very good development; in Japan it took the government and the Bank of Japan more than 10 years to start it.
Probability: around 15%.
Great Depression 2.0
I've written about this possibility many times. This article explains my views on the problem and has links to my other articles. I'm starting to believe that we have a fighting chance to avoid this scenario. Ben "Helicopter" Bernanke is doing his job. The only problem I have with it is that he is late every time.
Probability: around 30%.
Great Recession
I think it was Melissa Lee from CNBC who coined this definition first. Maybe I'm wrong. In this scenario, decisive actions of the government and Fed prevent the US economy from falling into scenarios 2 and 3 and lead to relatively quick, also painful, recovery in the beginning of 2010 or even at the end of 2009. This scenario seems to be more and more likely to me lately. The government and the Fed are not kidding, measures adopted are radical and decisive. Do they have enough political will? It looks like the Fed is fighting to increase money mass with all the tools available (well, I'd like to see temporary reduction of reserve requirements, which would increase money mass and also improve the situation of many banks, making them liquid immediately). It's a little bit scary, because the Fed might be forced by some information we don't know yet, so I'm waiting for the minutes of the last meeting with impatience.
The best proof of this scenario would be if the current stock rally continues for some time. If the Dow Jones can keep running over its 13 days moving average and bring it over the 50 days MA, it will be a huge success. But even if this rally is another bear market rally, even if we get new lows in summer or fall, things aren't looking as bad as they did at the beginning of March. Bonds are improving, and those are more important than the stock market. Historically, bonds recovered first during recessions. If we don't get any unpleasant surprises, stocks should be up from now to the end of the year.
Probability: 45%.
Conclusion
I'm changing my stance because the facts have changed. I was thinking Great Depression 2.0 scenario for more than a year. Now I think that we can get away with Great Recession.
From an investment point of view, this is a change from bear market behavior to bull market behavior. In a bear market, you sell the rips. In a bull market, you buy the dips.
I am going to put more money to work in April and May. Mostly in tech, because there are a lot of tech companies which are swimming in money and don't need credit. But also in financials, because they are beaten almost to death and government is clear that they won't be allowed to fail.
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On Apr 03 02:40 PM paulsjj wrote:
> >(credit contraction = money destruction)<
>
> Wow! If I put $100,000 in a Mutual Fund and it drops 50% than $50,000
> Dollar Bills just disappear?
50,000 dollar bills certainly just disappeared out of your hands. Can you identify someone else who is now holding them?
They will certainly be happier this month than last. Will the New Bull continue at the same pace as March? Unlikely but up it will go. Job holding Consumers will drop below 90% but they will be allowed to dip into their rising 401Ks just like they were able to use Home Equity lines.
The Banks are already paying the Government interest, none of the Big Boys have "defaulted". Some smaller entities have decided to pay back early because conditions have been attached which they did not agree to initially.
30% gains here and there, a new 2009 high in the Nasdaq (wow, that has to be Major manipulation) and the Unnoticed Index which leads Bull markets, The Dow Transportation index which is now up 40% off its lows.
The Recession will get worse, stock prices do not start moving up Afterwards.
Long FAS, DXO, DYY and a host of other unbuyables like the BAC Pfds(BAC paid $400 million in interest to the Government last Quarter)
CTB
dow 5000 is still in sight
just u watch
Trillions of disappeared out of housing and Equities all over the world. Trillions more have to be written off based on coming Commercial RE, Auto loans and CC. There is cascading effect on housing values with 5.1 M unemployed with no end in sight. There is a generational attitude change re using credit. This not a liquidity problem but insolvency! Heli cop Ben can keep on printing, till China and rest of the World lose their patience. There is a dead zone between the stable Lender and qualified borrower. You cannot force either one of them to increase the velocity of money. Just look at Japan!
Deflation, leading a variant of Depression 2 followed by inflation. Emerging Mkts will recover first. Tech sector is also a good bet. We have yet to see the bottom!
How about a 50% chance the economy stabilizes at a reduced GDP with modest but sustainable growth. Growth would come from population increases and new technology rather than from extravagant consumption fueled by excessive debt and asset inflation.
www.planbeconomics.com.../
Echoing your point on "supply inflation", college tuition is one item that I highlighted elsewhere in SA to become the first most visible of such.
Of late, just appearing on the news web today, even the top of the top Ivies are tightening their belts and directly and indirectly raising fees. Now given the top of the cream is in such dire straits, think about the squeeze in the between, i..e., the public ivies, the middle-tier public, the other first-tier ivies, and the second-tier private.
In the coming several years, Middle Class Americans will greatly feel the supply inflation effects in the form of direct and indirect taxation.
Teutonic
On Apr 04 05:01 PM ed233 wrote:
> Your article failed to include something very important. The most
> important of which is supply inflation. Remember the US is a consumer
> driven economy. Supply inflation will be something the Fed will be
> helpless to combat under circumstances where demand is strangled
> because the US consumer will be tapped out. When real unemployment
> reaches above 17% then the price of goods will be out of the reach
> more than a third if its population. This factor alone is enough
> to prolong a great recession. In Japan's case it was lack of demand
> due to its population engaging in excessive saving. In the US you
> have savings by fewer numbers per capita vs. Japan but you also have
> the potential for a prolonged high unemployment rate which will be
> difficult to remedy when the government becomes financially impotent.
> It is the demand side that the government is failing to address.
The charts tell the whole story. There is another option to your "one of four" scenario, and that is that we get MORE than one of those scenarios following in close succession.
Personally, I think we get the Great Recession first. It will be much like passing through the eye of a hurricane. Things will seem to be getting better for a while. Then, a year or two down the road, we get the back end of the hurricane, which will be even worse than what we've exprerienced so far. It will probably take the form of Great Depression 2.0. And maybe something else after that.
As I said, the charts tell the story. This is a higher degree bear market than '02. In fact, the closeset parallel is the last great depression. We will have a huge counter-trend bounce at some point that could be viewed as a bull market within the Great Bear (just as they had after the '29 crash) -- maybe we're getting that now. But the worst is yet to come.
If you can envision a recovery where the consumers get renewed confidence that their jobs will be around, and have the bulk of their debt paid down, maybe you can project ahead to when the revenue picture improves for these companies.
Until then, the declining revenues are likely to provide a number of air pockets for these high-flying stocks.
Buying cash-rich tech stocks because they are cash-rich is not a sound decision in the face of massive future uncertainties. The only thing that is (nearly) certain is that these companies will survive until the next boom. AAPL could almost certainly withstand the financial collapse of the United States, but that does not mean one would make money owning it.
If you want to gamble on a recovery emerging because stocks are rising, you may as well buy housing stocks or TBTF banks. The returns for them are likely to be much greater in a recovery scenario.
Not so much if the recovery does not materialize.
I would be watching for large-scale insider buying at these cash-rich tech companies as a sign to acquire them. I have not seen any signs of this yet.
On Apr 03 01:08 PM Francisco Martin wrote:
> The only way out of a recession is a drastic spike in consumer confidence
> and consumer spending. Both are feeding off each other. In other
> words - highly unlikely for 2009.
1. Great Recession (now)
2. Head fake recovery leading to Great Recession Redux
3. Stagflation as the world recovers without us and oil prices zoom up again.. then, as entitlement spending causes deficits to balloon to undreamed of levels while taxes go up we get (drum roll here)
4. Depress-flation , i.e.stagflation on steroids.
On Apr 04 06:59 AM Alan von Altendorf wrote:
> Brad Setser reports that foreign central banks are out of tradable
> reserves, which calls into question the ability of the US Treasury
> to roll its existing and sell $5 trillion new debt this year and
> next, not counting Social Security and Medicare deficits that no
> one expected before 2040, but are going to bite us in 2010 on falling
> employment tax revenue. Employment and real wages matter more than
> government spending or make-work socialism. Okay, free market is
> dead? Then war it is.
Slow recovery from here until the end of this year, maybe far into 2010, despite dismal earning reports.
Then inflation starts to kick in (like in 1940) making the stock market drop maybe around 40%, followed by double digits inflation for years, but not hyperinflation.
My guess:
- 1-2 years of Great Recession, but with markets somewhat recovering
- A couple of years of stagflation