We have been calling for the market to roll over into 2012 as we head into what we believe historians will call a Depression. Yet everyday the market is open lately, it seems like a good day as stocks shoot to the moon. Talking heads come on TV and say the recession is over and that housing is bottoming. Is it therefore time to buy stocks aggressively?
We must look at the real question: Is the bottom ACTUALLY here, and is it time to get long stocks for the long term again? Have we made a mistake by selling as the Dow got to 9000 and above?
This chart shows market rallies from the low points of each of the crashes and what the market did after the low point. The blue line is the current rally, the green line is the 2000 dot com crash, the red line is the Oil Crisis crash, and the blue line is where we are now. Keep in mind that each crash had it's own issues, and that no crash will act the same as a previous one. As you can see though, so far we are tracking the rally that looked like the bounce from the Great Depression. So we are at a very interesting point. Do we continue to go up like the previous two rallies after recessions, or do we start to fall from here like the 1930's? This is the million dollar question of which we do not know the answer. What we can do though is compare these economic times to that of previous periods.
First of all – I ask, are things any different now in psychology than they were during the 1930's when the market rallied 50% from it's initial low? Judging by these quotes below, it looks eerily similar:
"There is no cause to worry. The high tide of prosperity will continue." — Andrew W. Mellon, Secretary of the Treasury.
Sounds like Ben Bernanke in 2007 and 2008 saying that housing would stay strong and that there were no bubbles.
Now lets look at what the gurus were saying during the great rebound during the end of 1929 through the middle of 1930.
December 28, 1929
"Maintenance of a general high level of business in the United States during December was reviewed today by Robert P. Lamont, Secretary of Commerce, as an indication that American industry had reached a point where a break in New York stock prices does not necessarily mean a national depression." — Associated Press dispatch.
January 13, 1930
"Reports to the Department of Commerce indicate that business is in a satisfactory condition, Secretary Lamont said today." - News item.
January 21, 1930
"Definite signs that business and industry have turned the corner from the temporary period of emergency that followed deflation of the speculative market were seen today by President Hoover. The President said the reports to the Cabinet showed the tide of employment had changed in the right direction." - News dispatch from Washington.
January 24, 1930
"Trade recovery now complete President told. Business survey conference reports industry has progressed by own power. No Stimulants Needed! Progress in all lines by the early spring forecast." - New York Herald Tribune.
March 8, 1930
"President Hoover predicted today that the worst effect of the crash upon unemployment will have been passed during the next sixty days." - Washington Dispatch.
May 1, 1930
"While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States - that is, prosperity." - President Hoover
Is anyone reading this as scared as I am that our current heads of state and heads of business are saying nearly the same thing today? These were the remarks that came out during the massive rally from an initial low in November 1929 through May of 1930. Eventually the market started to roll over again and go down, but they didn't believe it yet:
June 29, 1930
"The worst is over without a doubt." - James J. Davis, Secretary of Labor.
September 12, 1930
"We have hit bottom and are on the upswing." - James J. Davis, Secretary of Labor.
"I see no reason why 1931 should not be an extremely good year." - Alfred P. Sloan, Jr., General Motors Co.
June 9, 1931
"The depression has ended." - Dr. Julius Klein, Assistant Secretary of Commerce.
Were we in fact at the bottom and things had turned up for the better? People who bought into the good news and invested proceeded to lose 90% of the value of their investments after this “recovery” everyone was certain was upon them, had taken place. Assurance was coming from the supposed smartest people in the land. Today we are getting the same rhetoric. Do we buy into it? I'm not willing to bet 90% of my wealth that the government is right in determining that the worst is behind us.
Let's determine if we are really looking like the 1930's or instead if this is just another garden variety recession like we've seen during the past 30 years.
Lets again look at some graphs:
The red line is unemployment rates and the blue line is inflation rates. Grey areas are recessions. When comparing this recession to the recession of the 70's we can note: The Paul Volcker Fed raised interest rates when unemployment was low and falling, and inflation was high and rising. Today unemployment is high and rising, and inflation low and falling, although rising long term interest rates and commodities are pricing in future inflation. So we are near the exact opposite of the 70's economy for the time being. It's apples and oranges.
This is a chart of durable goods orders, a typical good indicator for judging the economy. You can see that although we went a bit lower than the drop during the dot-com bomb, we seem to be turning back up and bottoming near the same area as happened then. Maybe business is turning up and the economy will begin to get better yet again. Orders are rising so therefore production so be rising to in order to meet this increased order demand.
Well, not so fast:
Production remains in a free fall. This begs for caution that the economy has bottomed. Production fall off is 3 times worse than it was in the dot com collapse, and about 6 times worse than it was during the 70's bear market. It is actually about as bad as it was during the depression of the 1930's.
This chart shows that personal consumption, which makes up 70% of our economy is much worse than both the 2000 and the 1970's recessions. It again mimics the Great Depression in velocity.
Lastly, unemployment this time matches that of the Great Depression instead of that of the 2000 or 1970's recessions:
So you can see there are many economic indicators that are similar to that of the Depression, not the typical big recession of the recent past. Factor that together with the stock rally we have recently seen looking very similar to that of the rally during the 1930's and this case begs the stance of being VERY cautious at this juncture.
What do I see as what probably happens from here? I think what we have seen, and what we will see can be summed up simply by Casey Research:
1. Shock. For most people, last fall’s revelation that the world’s biggest financial institutions were really just a band of beggars was a frightening surprise.
2. Panicky reaction. The shock wasn’t a little one. It was off the scale. So the reaction wasn’t measured or proportionate, it was extreme and indiscriminate. One element of that panicky reaction was the near total unavailability of financing for international trade, hence the “pent-up orders for goods.”
3. Relief and catch-up. THIS IS WHERE WE ARE NOW! When the feeling of shock passes and the immediate facts aren’t as terrible as expected, people begin to catch up on the spending and other activity they had postponed, but which was a normal part of the economy. Lenders returned to the credit window and resumed financing for export goods that had been waiting on the docks. Compared to what had been feared just a few months before, the tentative revival in economic activity looks like… look closely now and you can see that it looks like… like… green shoots! In reality, it’s just postponed orders, not new demand!
The demise of Lehman Brothers and the near-death experiences of so many of its fellow giants shocked the U.S. economy into near paralysis. The money blasts from the Federal Reserve and the Treasury calmed the panic, and by springtime many businesses and consumers had taken a half step back from the spend-nothing-lend-nothing attitudes that had prevailed during the winter. That half step produced what looks like the beginnings of economic recovery. Instead it’s just a feeble attempt at business after business had stopped.
What emerges when green shoots illusion fades (and proves that it was nothing but illusion) is…
4. Ugly facts. While the wavelet of panic and relief is rippling across the economy’s surface, the underlying mechanism of contraction continues. Borrowers that two years earlier had looked like good risks no longer are. Each weak borrower (in many cases with the cooperation of its weak lender) can postpone the day of reckoning for a while, but not forever. Time runs out and then another credit crisis erupts. That’s what the Bundesbank chief was warning against. Take a look.
If such ugly facts are indeed a-building, when will they become apparent?
In Germany’s case, Hartmut Schauerte, state secretary of the Ministry of Economics and Technology, refers to the need for many businesses to roll over their loans and points to the time of maximum stress. "The most difficult phase for financing is going to be in the first and second quarter of 2010."
Perhaps it’s only a coincidence. In the U.S., forecasts from credit analysts dealing with the commercial mortgage market range from gloomy to mortuary. Press for details on timing and they will cite the first or second quarter of 2010 as the time when owners of tall, $100 million buildings will start giving their lenders the bad news they should have faced up to months earlier.
If this truly is the beginning of a great new multi-year bull market, then we will have plenty of time to get back in fully invested and enjoy massive gains for years to come. For the short while, we would rather lose opportunity than capital while we wait for this “recovery” to prove that it is exactly that, a true recovery and not just a short term blip that we have been saying we would see. When we see demand pick up rather than just a slowing in the rate of decline, when we see foreclosures stop rather than just a slowing in the rate of decline, when we see job losses turn to job gains rather than just slowing in the rate of decline, then we will know we are out of the woods. Thankfully we caught the majority of this rally this year, but now we are at the point where we need to be extremely cautious and make the economy prove that the stock market and the masses is right about the bottom being in.
This is the American government force feeding a recovery in which big business gets fat and the rest of the US is left out and starves.
Bottom line - if this is a new multi-year bull market - you will have plenty of time to get in. It makes more sense to wait a few weeks or months to make sure this rally is the real deal, and not a massive suckers rally.