Why Stocks Will Collapse This Fall

Thus far, 2009 has been a virtual repeat of 2008 for financial markets.

So far, both years have had:

• A Crisis/ Market low in March (Bear Stearns & March collapse to 666)
• A Government/ Federal Intervention (Bear Stearns & Stimulus Package)
• Gold testing/ breaching $1,000 in the first quarter (March & February)
• Stocks rallying into the summer on worsening fundamentals
• Stocks rallying close to their beginning of the year highs in May/ June
• Commodities rallying into the Summer on the China story/ inflation concerns
• Various government figures using the rally to claim that the “worst is over”
• Stocks rolling over in earnest in June as fundamentals take hold
  

Even the charts are similar… except for the fact that 2009 has been like 2008 on steroids.

The Fed claims that it cut interest rates and pumped trillions into the market to lower volatility and return stocks to “normal” trading action. Looking at 2009’s performance compared to 2008, I’d say their efforts have been a complete and utter failure. The stock market has become more volatile with larger swings (the chart has been rebased to 100).

As I’m sure you’ll recall, stocks completely collapsed in the fall of 2008. I think that stocks will suffer a similar fate in 2009. My reasoning is simple:

1. The Fed’s moves have not solved the critical issues facing financial markets.
2. The economic and financial fundamentals have worsened dramatically.

The primary issue facing the financial markets is system solvency. In extremely simple terms there is too much debt, too many crummy assets, and not enough capital. Debt permeates our entire economy from the consumer level to the federal government. Debt became so out of control that at its peak, people could buy the largest single asset of their lifetime (a house) with no money down.

Since that time, Americans have done the sensible thing: deleveraging by paying off debt ($40 billion in credit cards debt Feb-May) and raising capital (saving their money). The In contrast, the Federal Reserve (the alleged back-stop for the financial markets), has done quite the opposite: issued more debt and spent even more money. Small wonder volatility has worsened.

The other critical issue facing the financial markets is accounting. To this day, no one knows the real value of the assets sitting on the banks’ balance sheets. No one knows if the banks are even solvent (I have my doubts). No one knows what the financial markets would look like without the Fed’s props in place.

To use a metaphor, the Fed has propped up a collapsing home with a few stilts and buttresses. Has the foundation improved? NOPE. Is the structure more stable? Definitely NOT. Do we even know the extent of the rot or damage that needs to be fixed? NOPE again. Have we spent a ton of money on the issue? YEP.

Now, on to issue #2 (economic and financial fundamentals are worsening dramatically). Sentiment and trading patterns may dictate short-term moves, but ultimately the market is driven by earnings. Well, earnings have fallen off a cliff. Consumers are not spending as they used to (they probably won’t ever again).

Year over year, retail sales are the worst seen in the post–WWII period. The last few months have shown the rate of collapse is slowing… but getting horrendous at a slower pace isn’t a sign of a turnaround.

Moreover, unemployment is rising which means even less spending (who goes on shopping binges to celebrate getting fired?). And this is happening at the same time that oil and other commodities are rising (which means operating costs will go up).

In very simple terms, higher costs + lower sales = much, much lower earnings. It’s simple math, but Wall Street analysts don’t seem to get it. Neither do any of the “green shoots” crowd.

So in summation, we have a MORE volatile stock market, rallying even harder on worsening fundamentals, with no real solutions to the structural issues plaguing the financial system.

If this isn’t a recipe for a potential Crash, I don’t know what is.

Comments

[newamericanow:]

We will not solve the financial crisis with the moves being made by this administration. Giving the Federal Reserve more power is not like having the fox watch the chicken coup, it's more like having the pedophile in charge of the orphanage. People need to wake up! This is going to get really bad really fast. Read my blog on the above link and follow the link there to my youtube channel. Good luck to all and God bless.

Jun 18 02:26 PM

[woodsey:]

I'm too old for this; more depressed each day. Tom Paine where are you?

Jun 18 02:37 PM

[John Lounsbury:]

Graham - - -

I agree with the pessimistic outlook for the economy, but I am not sure I'm quite as negative. The stimulus spending has really not gotten much underway and that will provide some support against collapse. Barring some serious unexpected economic shock, I have given the following rough probabilities for the U.S stock market (using DJIA):

20% probability: Year-end 9000 or higher, with low between now and then around 7500.
50% probability: Year-end between 7500 and 9000, with low between now and then around 6500.
20% probability: Year-end between 6500 and 7500, with low between 5500 and 6500.
10% probability: Low less than 6500.

Just some notes on a napkin for after dinner conversation.

Jun 18 02:51 PM

[ain't no fo...:]

There are a lot of negative technical divergences setting up that must be watched closely. In addition to the momentum oscillators lagging the price movement on the major equity indices the past 6 weeks, which is always important to watch, volume is just plain horrible.

What liquidity there is is evidently being generated by the quant funds computers trading back and forth with each other - the individual investor seems to have just disappeared. I track NYSE volume daily - over the past 6 months it has averaged about 8 billion daily by my count method, but has been dropping dramatically over the past 6 weeks to around 6 billion daily, and even 5.5 much of the past 2 weeks. TODAY, on the day before Quad witch, we just touched 4 billion as of 2:45, and this is a day when they should be winding down some of the positions, pulling volume up.

So, we have an incredibly thin market that has been run up on air and JPM/GS buy programs, and which can be just as quickly run down the same way when the mini-bubble is pricked.

In other words, I am personally being very careful here, staying with very small positions and not holding much overnight - looking for a couple of things to indicate the dye is cast.

Jun 18 03:00 PM

[thotdoc:]

What exactly is your plan. I'm not crazy about what is going on, but I don't have a plan that's better. What's your plan?


On Jun 18 12:48 PM awake09 wrote:

> I may be going out on a limb here, but the DC scenario we're witnessing
> signals a self-destructing federal government. If you hate B Hussein
> and his House and Senate cronies, just give them another year. Conservative
> candidates will be looking much better by then, able to tell the
> populace "I told you so" and able to succeed without the kindness
> of Big Media.
>
> Everything cycles-- the celebrity president can't keep the act up
> indefinitely.

Jun 18 03:43 PM

[Old Trader:]

Fwiw, maybe my perspective is somewhat skewed by personal circumstance, but I'm self-employed, running a small industrial supply firm I started 21 years ago, and a few months ago, I realized that things felt just like they did when I started, running on a razor's edge. Like many. if not most entrepeneurs, I was under-capitalized, and spent my days running around, trying to convince potential customers to shift their business from their current suppliers to me by the standard methods, offering better service, competitive pricing, and stocking, in small quantities, those hard to find and harder to get "odd ball" items. Naturally, it was an uphill battle.

Today, its razor's edge time, again, but now, its not that my customers (the majority of which are long-time ones) are telling me they can get it 10, 15, 20% cheaper somewhere else.....they're just not buying because they are struggling for business too! Because I still call on my accounts in person on a regular basis, I know they're being honest and not just engaging in the usual BS used to get rid of "pesky" salespeople. I see the empty parking lots (both employee and customer parking) and the short-staffed production areas, because hours have been cut back.

Tough to feel "bullish" under those conditions, regardless of what "surveys" say. I run my own "survey" on a daily basis, and it ain't lookin' pretty.

Jun 18 04:48 PM

[Henry Buttal:]

Graham,
Nice discussion. Also glad you got your logo fixed.

Old Trader, I hear what you are saying. I am in Texas, and we have it better than most, but it still isn't great. To add to what you are saying, my concern is for Quarterly reportings is that companies can short term support profits by cost cutting, but as time goes that become more like pushing on a string. If things are bad, it eventually shows.

Mad Hedge, thanks for the ideas. I am long too much, but cutting back because I see many of the same things. I am not too worrried by a 600 retest, but could see us back in the low 800s over the summer.

Jun 18 06:50 PM

[derryl:]

On the other hand the market may have become somewhat disaster-proofed and there may be no crash this fall despite ugly fundamentals. After facing the 'end of the world' last fall, 'ugly' seems quite manageable.

Jun 18 10:43 PM

[TeresaE:]

Because our government is using academia and the mainstream media to convince badly educated citizens that everything is fine.

It ain't, and you will be as shocked as any of them.


On Jun 18 06:32 AM Sanjeev Sharma wrote:

> if things are so grim for people, why is the consumer confidence
> data up ?

Jun 19 01:27 AM

[TeresaE:]

Thank you again Graham.

We need more truth-tellers than propaganda spreaders.

As you can see by some of the comments you receive.

Jun 19 01:28 AM

[Davewmart:]

An excellent article.
it would be interesting to see the 2008 graph with the rest of the year left in, or even perhaps including a projection for the 2009 figures, tracking the 2008 as it has done to date but appropriately amplified.
I'm guessing that might see the Stock market down 80%

Jun 19 06:38 AM

[will28307:]

Go chase an ambulance. It will be cheaper for you pessimists.

Jun 19 01:32 PM

[ken3602:]

Consumer confidence data is up because the market was pumped up and media and green shootiests kept talking about a V shape recovery since April. Most of them would probably get financial or economic information from CNN or local news. Majority of ordinary people don't even watch CNBC! (I am not saying they should...). So consumers are by the way more confident but not spending. Since they stopped spending, they become more confident. That is how the data got up this year so far. a FEDEX outlook is much more reliable source than this consumer confidence data.


On Jun 18 06:32 AM Sanjeev Sharma wrote:

> if things are so grim for people, why is the consumer confidence
> data up ?

Jun 19 04:55 PM

[CAPITALIZER:]

Next week we will get a taste of what is to come with a record auction of treasuries. The last one was "awful" and stocks tanked after the auction. This one will come to a total $104 billion, the most debt ever sold in treasuries in a single week. In the next couple of quarterly earnings the "green shoots" crowd may also see that the emperor has no clothes.

Jun 19 08:51 PM

[Northstar10000:]

A crash will come. How will it look. Market will be down for 5-7 weeks in a row. On the low for the week you will get a day that rolls over down 1000 plus on the Dow. Next day attempted rally fails.
Two days latter down 1500 markets shut down. Won't reopen for a week while they round up the rescue squad.

Jun 20 12:15 AM

[goldmember:]

On Jun 18 10:54 AM Lilguy wrote:

> We haven't had (nor do I foresee) a Bear-Stearns, AIG, or Lehman meltdown

Are you foreseeing California? The financial earthquake in California will trigger the collapse of world markets to unprecedented levels -- the only question is when.

Earthquakes are caused by the buildup of pressure along fault lines, until the pressue causes the plates to jump along those lines. Similarly, California more than anywhere else perhaps in the world is where the weakening fundamentals are building up pressure. When investors wake up one morning and realize that California is defaulting and there is no bailout, they are very likely to jump to their phones and scream "Sell everything!", and if they all do it at the same time, the earth will shake then, that very day.

Unless the federal government DOES intervene, in which case the pressure will shift somewhere else, buying a little more time. This is what I believe will happen, and no later than November, when it's obvious that record amounts of Americans will not be purchasing any Christmas gifts this year, the quake arrives.

Jun 22 06:40 PM

[Permacritical:]

I lived in California twice. I really like the place visually and conceptually, but normal people can't afford it thus I rejoice when they fall and all those state, county, and city employees get axed via outright job loss or drastic cuts in their easy street benefits, especially the cops.

Jun 26 12:28 PM

[Northstar10000:]

The only way you can have a crash above 8000 on the DOW is with some outside unpredictable event. Barring that there is an excellent chance of a crash when the DOW breaks 7800. I'm looking for a thousand point day, followed by no bounce at all, followed by a continuation fall below 6000. Got Puts !!! Obama magic time @%$@

Jun 28 10:27 AM

[marcovth:]

It's staying a bit under the radar screen, but the flu pandemic is slowly getting worse and it follows the trend if the 1918 pandemic.

If the market will not crash by economic factors, it will crash by the coming panic of a deadly, deadly flu !

www.flutrackers.com/fo...

Jun 29 08:20 PM

[Peter Iwano...:]

sry but i dont believe the hype on that


On Jun 29 08:20 PM marcovth wrote:

> It's staying a bit under the radar screen, but the flu pandemic is
> slowly getting worse and it follows the trend if the 1918 pandemic.
>
>
> If the market will not crash by economic factors, it will crash by
> the coming panic of a deadly, deadly flu !
>
> www.flutrackers.com/fo...

Jun 30 09:43 AM