When Recession Becomes the Norm, What Happens to Stocks?

It's possible that stocks will not be worth their trouble for another many years. We could already be in a range that holds for so long that people simply move beyond stocks as a place they consider storing their money. The stock market could become a distant report for specialists only, much the way most people view esoteric investments like cattle futures. How much does the cattle report factor into the lives of most people you know?

It's already like that here in Japan. For the first five years of the lost decade of the 1990s, individual Japanese investors tried scooping up bargains on every minor bottom. The more nimble among them probably made a few yen in the bounces of 15% in autumn 1990, 40% from summer 1992 to summer 1993, 48% from summer 1995 to summer 1996, and so on. Each was heralded as the start of a new bull market, all proved false. The three bounces just mentioned were followed by respective drops of 45%, 21% then a spike followed by another 32%, and 43%. After eight years of fighting it out in the trenches, most stock investors saw their accounts worth less than half what they had been at the end of the initial drop.

Small wonder, then, that people gradually packed up and left. That was 11 years ago, and the Japanese stock market trades today at a level 20% lower than it did at the end of that example. When the news of plunging markets covered papers, magazines, and websites last year, few in Japan cared. Why would they? They hadn't had money in stocks for more than a decade and don't plan to ever put any in again. If anything, last year's headlines just confirmed that they'd made the right decision. "Gambling is fun," one engineer told me, "but it's not the right way to plan for the future."

Such a sentiment could take hold in America, too. The same factors that killed Japan's equity market are present. Banks blew up, government screwed citizens to bail out banks but didn't bail them out enough to actually get things moving again, the unresolved bank debt was moved from banks to the country's balance sheet and an increasing portion of tax revenue was siphoned off to service that debt, so a new normal took hold with a lower rate of growth and a much less enthusiastic population, most of whom never really understood what the hell happened. How did life go from golden bathtubs to goldfish for dinner because of some banker's mistake? It did, though, and it's happening in America, too.

During the savings and loan scandal of the late 1980s, a regulator named William K. Black exposed government connections to bank fraud when he accused then-house speaker Jim Wright and five US senators, including John Glenn and John McCain, of doing favors for the S&Ls in exchange for political contributions. Black wrote a book about the experience, aptly titled "The Best Way to Rob a Bank Is to Own One." Last April, he appeared on Bill Moyers Journal to discuss the subprime mortgage crisis. Among his many excellent observations, the following comment caught my attention:

In the savings and loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the savings and loan crisis -- didn't matter which party was in power -- the US Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the savings and loan crisis, because it worked really well. Instead you're covering up the bank losses because, you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." The Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets.

Yes, the bad assets are still there. The citizens of the United States unwillingly ponied up a national fortune via government's big bank connections such as former Goldmanoid Hank Paulson serving as Bush's Treasury Secretary. The Obama administration has employed many of the same people with banking industry connections, so the only thing that has changed is the name on the White House -- which matters little because it changes every four or eight years but the industry interests that control Washington never change. We have made a permanent growth impediment out of the ungodly sum of debt created by bank fraud. It is hanging over the United States the same way it has hung over Japan for two decades. The difference is, we're less than a year into our overhang.

This is treated as last year's story, but it's not. It's this year's story and, I'm afraid, next year's and the year's after that and so on possibly for a long enough time to remove stocks from the list of financial options in the mind of most individual investors. The problem is that few people ever grasped what had happened even when it was the hot news of the day. Now that it's already labeled history, fewer still will keep track of the long-term effects or why things just aren't quite as good as they used to be. As they say in Japan, "How long does a recession have to last before we stop calling it a recession and just call it the economy?"

Japan, too, had its periods of improvement over the last two decades. There were moments of good-times-are-here-again hope with this economic data growing more than expected, this company beating estimates, that bank getting squeaky clean, and so on. Overall, though, it's been a down trend across the board. The good news is that people adjusted. What else can you do when the new normal isn't just a slogan but is actually the new normal? If it's normal, you'd better get used to it, so that's what people did. People will do so in the US, too, but that doesn't necessarily mean good things for stocks.

You have every right to be angry. This is the biggest failure of American leadership we've seen in our lifetimes, though few see it that way yet. This is the culmination of a growing corporate ownership of America that began after World War II and spun out of control. About one-third of US tax revenues go toward a defense establishment strong enough to wipe out the Third Reich, but impotent against a bunch of box-cutter-carrying terrorists from our oil ally, Saudi Arabia. Our response? Launch an unrelated war in Iraq that's slated to cost $3 trillion before it winds down -- and it won't wind down until the new war in Afghanistan ramps up.

Even Robert Gates, Director of Central Intelligence under the first President Bush and Secretary of Defense under both the second President Bush and President Obama, pointed out the need for a more reasonable defense budget when he wrote last January, "As much as the US Navy has shrunk since the end of the Cold War, for example, in terms of tonnage, its battle fleet is still larger than the next 13 navies combined -- and 11 of those 13 navies are US allies or partners."

This is not a political discussion, it's an economic discussion. Notice how much of the opposition to health care reform has centered around the inability of the country to afford it. Why is there never such consideration for military expenditures? It's the same Treasury paying, and the same Treasury paying off banksters, too. There's an endless supply of money for meaningless wars and bank heists, but not enough for health care. You know how much the proposed health care reform would cost? About $100 billion per year for ten years. You know how much Paulson's Troubled Asset Relief Program (TARP) cost? $700 billion. Poof! Just like that, the banks got the dough. For health care's smaller cost, angry mobs turned up at town hall meetings to scream "socialism" at the very idea.

Is the country heading for bankruptcy? It sure looks that way. Is it because of social spending? No. It's not really because of military spending per se, either. The country is heading for bankruptcy because corporations control government and the nation's treasure is redirected to where it most benefits corporations, not citizens. Government military spending helps corporations because they want to sell the most expensive weapons systems to government. Government health care spending hurts corporations because it reduces profits at private insurers and lowers the price people pay for medicine and equipment. Lobbying by corporate interests in both cases has garnered more government military spending and less government health care spending. In these and other cases, corporations win and citizens lose.

This is not a discussion about the military or health care, though. It's a discussion about America's culture of corporate control. The same way government is manipulated to benefit corporations in those two sectors, it is also manipulated in the banking sector. There, the culture of corporate control has finally gone too far and made public the private debt disaster that bankers created. That overhang will crimp stocks for years.

Coming back to Japan, one reason people got tired of stocks is that none of the usual ways of analyzing them made sense anymore. It became a guessing game of what stimulus would come from government next, when it would peter out, what new shenanigan banks would try to prop up their balance sheets and how many people it would fool, when that would peter out, and so on. Gambling, indeed. Fundamentals? Please. Cash from government to banks to pour into the stocks they own to drive up those prices so the stocks could be dumped at a profit looks to the casual observer like a rigged game. Once the public sees the stock game as being rigged, it starts to pull out and leave the game to the big guys with government connections. Stock markets began as a way for companies to get financing to grow their business ideas. That's not what they are anymore. They're a competition of connections. If you have as many family members working at the Treasury as Goldman Sachs (GS) has, then you might just stand a fighting chance. If not, maybe other assets will prove better for you.

Are we there yet? No, and there's a chance the US will pull out of this funk the way it pulled out of the 1970s. For that, though, it took the vision and strength of Ronald Reagan. As popular as Obama may be, he's no Reagan. His first half-year in office has proved that, and his dropping poll numbers betray that even the political babes who fell for the hope gambit have realized that nothing's any different. Those who've been around longer knew from the get-go that the same people who ran things at the beginning of January would still be in charge at the end of January, and so it was. Having a Sunday morning celebrity for a president is good fun, but doesn't get much done.

Edward Lucas wrote in the Telegraph last Sunday:

Mr. Obama has tactics a plenty -- calm and patient engagement with unpleasant regimes, finding common interests, appealing to shared values -- but where is the strategy? What, exactly, did 'Change you can believe in' -- the hallmark slogan of his campaign -- actually mean? The President's domestic critics who accuse him of being the sinister wielder of a socialist master-plan are wide of the mark. The man who has run nothing more demanding than the Harvard Law Review is beginning to look out of his depth in the world's top job. His credibility is seeping away, and it will require concrete achievements rather than more soaring oratory to recover it.

Comments

[logicalthought:]

To be a bit more specific, I think we're going to see some major PE multiple compression once it sinks in that while earnings may not worsen much from the current poor levels, it will be years before they can significantly improve. I also think we'll see a convergence between GAAP earnings and the highly abused concept of "operating earnings" (as companies run out of "special, one-time write-offs"), and thus we're going to see a 10x to 12x multiple placed on perpetual S&P 500 GAAP earnings in the $45-$50 range, returning the S&P to levels somewhere between 450 and 600. The only question in my mind is whether this will happen quickly (via a new crash) or slowly (via death by a thousand cuts).

The short-term interesting question with which I've been wrestling (and it's raised again by this article) pertains to whether or not U.S. retail investors have now given up on stocks (and thus this bear market rally can end now), or if there's one last throw of the dice left in them, in which case this market could run another 10% to 20% or so, until they're all-in for, probably, the last time for at least seven or eight years.

Sep 27 08:22 AM

[Albertarocks:]

This is an excellent article.

I don't think there's much doubt, you've pretty much identified what is most likely to happen with the American markets. Not only is Wall Street failing to practice what they preached to Japan, they're doing much more damage to their own economy than the Japanese did.

And there's another factor that nobody seems to be talking about which has to do with a supreme (and growing) level of aggravation amongst the retail investor community. I honestly think that's why we haven't seen the retail investor jump into this phony rally with any enthusiasm. And I don't think we will. Frankly, I think the retail investor is fed up with the "FED up-rally" and with the blatant and purposeful destruction of the USD. Is it possible the retail investor has been burned enough times that he's caught on to this phony FED driven rally? I think so!

So if Japan experienced a lost decade, and what the FED and Wall Street bankers are doing is several times worse than what the Japanese government and Japanese banks did, I maintain that it's entirely possible that in North America we could well experience a lost quarter century.

This cannot end well folks. That's undoubtedly why at the G20 summit, Gordon Brown acting as a soul-less minion for the Rothschild is pushing so hard for a one world currency. And naturally, their plan is that the Rothschild cabal would own and control that gem as well.

Personally, I think the American people should take back control of their own currency, one which is backed by gold, sanctioned by the people and owned by the people... the AMERICAN people, not offshore bankers. Who needs the FED? Look at all the "good" they've done for America and the world.

I don't think the stock markets two or three years from now are going to even be recognizable by today's standards.

Sep 27 01:59 PM

[chap08:]

Hmm. I think it's a bit early to criticize Obama for a lack of "concrete achievements". Regardless of political bias, think about what you're saying. How long has he been in office exactly? Has any other President ever inherited such an outright mess??

Anyway, the main point I wanted to make was about defense spending, which you are right to highlight. Let's face the truth. We are bust, or pretty dam close to bust. We can no longer afford this ridiculous defense spending. That is why one "change" that IS evident, is important. In dealing with the world, we can either put the emphasis on bullying them (let's call that the Cheney doctrine) or we can put the emphasis on talking to them (the Obama doctrine). If you can't afford the military, then there is only one choice. There is plenty of evidence around (Guantanamo Bay, missile shields etc.) that this change is happening.

Sep 27 02:18 PM

[sako shooter:]

Chap08,
I wish the world understood talking, but it does not. The world understand power. Always has, always will. I don't recall bullying anyone before 9/11. If my memory serves me right, the jihadists attacked us.

What we need is less government, less rent seeking, less regulation and more free market. Free markets promote transparency. Government intervention and regulation promotes rent seeking, back room deals and creates the conditions to allow corporations to run the country. Unfortunately, what we are going to get is more governemt, more rent seeking, more back room deals, more corporatism and less capitalism. Hence, without regulatory reform, we could well be looking at a lost decade.

I love normative terms like ridiculous defense spending. Is your freedom ridiculous? Retention of freedom in a Hobbesian environment is not cheap. The Czech's would be happy to give you a long dissertation on freedom, or the lack thereof. Milan Kundera vividly describes life under tyranny. Thankfully, there are public goods out there and we can coerce taxes from you to pay for national defense. It is one of the few things government should do for America. A strong military has fended off those who wish to destroy us in the past, and shall defeat the jihadists. Unfortunately, the enemy gets a vote and wants to win as badly as we. It might take another decade to finish this long war, but we must prevail. As for the Navy, all that tonnage keeps commerce flowing and would be tyrants at bay. I am happy to pay for liberty.

I don't see anything changing about Gitmo and as far as missile shields go, Putin and Ahmadinejad are laughing at Obama, while Poland, the Czech Republic and Israel are re-evaluating their relations with Obama. Idealistic, naive dreamers get run over in the world. Someone soon is going to run over Obama. Most likely Iran or Russia, or both. Obama will then be staring a real crisis in the face. Most interesting to see how he reacts to a real crisis without a teleprompter at 0300.

Sep 27 03:28 PM

[conceptwizard:]

Those who are still long the market should consider that the S&P is priced for 4% real GDP economic growth, which is unattainable. 1% to 2% late next year might be attainable. The market is 26 times operating profit, which is very expensive. The market is 4 times overvalued, just as it was in the dotcom tech bubble. Trailing P/E is now 24 times earnings, which is absurd. The Baa corporate bonds were pricing GDP contraction of 10% at the widest spread levels, not 2.5% as the stock market was discounting at the lows. Even at that the market is pricing in 2% GDP growth, not 4%. It looks like the first stop down will be 7800 not 8500 on the Dow. That is a 20% market correction.

Sep 27 03:46 PM

[E Nuff Sed:]

I don't buy the gloom and doom story line based on the Japanese experience. Demography is destiny.

Japan is stagnating because if its aging demography and lack of immigration. Same is true with countries like Spain, Ireland and Italy but to a lesser extent because of positive impact of immigration.

You points on US defense spending and Health care reforms are true per se, but peripheral to your argument of stock market stagnation.

Sep 27 04:38 PM

[zorro6204:]

Could be. One thing I decided very early on in the crash was to buy yield only. A stock like Microsoft, which pays virtually nothing, is worth only what someone else will buy it for. But a security that distributes profit, such as a REIT or MLP, will always hold its value in the long run based on the cash flow stream. Besides, what good has that retained cash done for Microsoft's stock price?

Sep 27 04:40 PM

[Denis Gould:]

Wow great article. I think the Japanese parallel is an important one. In Japan the concept of the individual is secondary to the concept of the team, group, or society. It leads to a far more cohesive society which can tolerate an extended period of subdued economic performance without social unrest. They also have an attitude that creating and sustaining employment is a goal in itself for companies. So even after 20 years of stagnation the unemployment rate is Japan is well below where it is in the US.

A ruthless attitude to job cutting and a less cohesive social structure suggest a lot of problems if economic growth cannot be restored to the US in short order.

Sep 27 08:21 PM

[buddhabill:]

At this point, is there any risk in buying March '10 puts about 10% OTM on the major indices? Is there any chart in history that has gone so vertical for so long without a significant correction?

Responses appreciated, this is a serious question based upon the above article and japan's experience in the beginning of their lost decade+, plus the oft-mentioned chart similarities with the big 'D' of 80 years ago, etc.

Sep 27 09:37 PM

[Mr. Ed, Jr.:]

"This is not a political discussion, it's an economic discussion. Notice how much of the opposition to health care reform has centered around the inability of the country to afford it. Why is there never such consideration for military expenditures? .....'You know how much the proposed health care reform would cost? About $100 billion per year for ten years. You know how much Paulson's Troubled Asset Relief Program (TARP) cost? $700 billion. Poof! Just like that, the banks got the dough. For health care's smaller cost, angry mobs turned up at town hall meetings to scream "socialism" at the very idea."

Well, it sure reads like a political discussion. Actually, not so much a discussion as a very biased monologue.

I think it was this goofball far left sentence that tipped me off...

"Government health care spending hurts corporations because it reduces profits at private insurers and lowers the price people pay for medicine and equipment."

In the USA, why should there ever be a government run program that intentionally "hurts corporations" ? Since when is that the role of government ? Oh, sure, plenty of government programs "hurt corporations", but that is usually the unintended consequences of corrupt politicians and know-nothing bureaucrats

And the notion that such a program would lower prices is very shallow. Of course, government subsidies can create the illusion of something for nothing, but "We the People" pay for it-- make no mistake about that.

If you are truly in favor of "lower prices", why not join the "angry mobs" and demand that the government stop interfering and allow ALL healthcare insurers to compete across state lines ? The "angry mobs" would also like the government to help all of us with tort reform. It is not uncommon for a surgeon to have a 6 figure annual medical liability premium. Virtually every doctor now orders more lab tests than are needed because if they ever miss a symptom, they will be sued. The costs are passed on to the rest of us.

Your $100 billion per year costs are also not real. Sure, the CBO says that, but the rest of us know that once the bill gets passed, there is no way to keep the lid on that. Congress will forever be changing it and selling out "We the People" to any and every lobbyist with a checkbook.

But there is another issue involved, and the healthcare proponents never mention it when they are dismissing the "angry mobs". It is liberty and freedom. No matter what other countries may do, the vast majority of Americans don't need or want some half-witted bureaucrat making health decisions for them.

The "angry mob" has never objected to lending a helping hand to those who are unable to help themselves. No matter how some try to portray the debate, Americans of all political views have never failed to step up and help those who really need it-- whether it be in this country or ANY country. That is an American tradition, and it is who we are as a people. Those who truly cannot afford decent healthcare should receive help. That has never been the issue.

But the "angry mobs" do not want the healthcare system in this country turned upside-down in order to get that help for the less fortunate. Especially when we have our very own version of government-run healthcare in Massachusetts, and it is a mess.

First, fix the healthcare mess in Massachusetts, and a few other recent government messes, like TARP, Fannie and Freddie, and the Fed handing out trillions of our dollars and telling us that who it went to is none of our business. There is no compelling need for another mess-- we have plenty right now.

Angry mobs, indeed.

Sep 28 04:23 AM

[chap08:]

On Sep 27 03:28 PM sako shooter wrote:

> Chap08,
> I wish the world understood talking, but it does not.

Sako shooter, I have some sympathy for your view. But, briefly, what I was trying to say was this:
1. We have to cut all areas of govt spending. If we don't do it now, the IMF or Chinese will be telling us what to do down the line. This isn't about the best solution, it's about what we can afford.
2. We have to be smarter about what wars we fight. $3 trillion in Iraq was too much because $1 in Iraq was too much.
3. When we do fight, we have to be smarter about how we do it. 9/11 meant that we had to do something in Afghanistan, but history shows that Afghanistan is about as easy to occupy as Russia is. We need 80/20 solutions based on intelligence, smart weapons and surgical strikes. In a world of asymmetric warfare, we need to learn how to fight more asymmetrically.
4. Winston Churchill said that "to jaw-jaw is always better than to war-war". He was right. That's why we need to make an effort to show some humility to the world and respect for its institutions. The John Bolton approach to the UN will not work.

By the way, statements like "we must prevail" are also normative and make a lot of unstated assumptions.

Sep 28 06:05 AM

[buoy:]

It is convenient to use Japan as an example... however, US is hardly like Japan.

Sep 28 09:05 AM

[ctjaeger:]

Lot's of interesting comments on here. The thing I'm seeing is a government run amok, the author has this right. The more complex the regulatory framework, the easier it is for elected officials and bureaucrats to reward their faithful donors. This is one reason why the tax code will, in all probability, never be scrapped and replaced with a more efficient method of taxation.

It is difficult to keep politics out of the discussion, but just as we can't really afford to create another bureaucracy with 30% - 40% waste/fraud rate (Medicare) we can't afford to continue to do business as usual in DC.

Keeping the USD as the reserve currency should be of paramount importance to DC. We simply cannot continue to deficit spend at the rate we have for the past several years. Strengthening the dollar is important and our nation should be focused on spending cuts - in all areas - and enacting meaningful regulations that can be enforced while repealing stupid regulations that "look good" but either aren't enforced or where the unintended consequences damage the economy more than the intended objectives.

Sep 28 10:21 AM

[jerrydd:]

While I agree with the author on the stock market future, trying to blame it on Obama is rather off. Or on Clinton who balanced the budget and raised real income.

Let's put it squarely where it belongs, in Repub, Bush hands. It's their energy, war, debt, tax , lax regulation policies that instead of raising wealth 25% in 8 yrs as it should, cut it 35%. That's over a 50% cut in US wealth in 8 yrs. Our economy was great when they took over and the pits by the time they were run out. Now they are trying to make it fail by blocking everything to make it better.

And it was Bush to bailed out the banks, AIG, car companies, Obama just had to clean up the mess to keep us out of the repub caused depression.

Obama is winding down the Iraq war as he said and finding a viable way in Afghanistan. Has already started cutting back, recovering parts of the bailouts and working on new regulations to keep the fiasco from happening again. Sorry he hasn't done it as fast as you might want but maybe you should talk to your repub, wall street buddies about that as they are fighting against it tooth and nail.

Next he is trying to fix the energy problem but again is having problems with your buds, the repubs, wall street. By making oil, coal pay their real costs, not even including CO2, it will stabilize energy costs about where they are now if his Cap and Tax went forward. The Cap and Trade is congress' plan, not his. With such a plan of his, the tax on oil to pay it's full price will mostly come from Iran, Russia, oil dictators in the form of lower oil costs.

When business screws up so bad as in health care, it's the gov job to step in. If business can't beat gov, then they have no business being in business.

Are the Dems perfect/ No but a dam sight better than Repubs!!

So either help Obama make our country great again or we will soon be broke, has beens.

Sep 28 10:48 AM

[Brad Denny:]

Somewhere along the line, Jason said that his post was going to be about economics, not politics. Insofar as he stuck to economics, I would give his post high marks for insight and connecting the dots, but then he had to go on and sing the praises of that half witted movie actor Ronald Reagan as president while trashing Barack Obama on the basis that Obama is a "Sunday morning celebrity."

Good grief. Ronald Reagan was a Saturday night shoot em up hoot owl who couldn't remember the difference between reality and the films he had acted in. The last time I checked, no human being was perfect, but Obama's record so far in dealing with the problems bequeathed to him by the previous 30 years of maladministration in Washington has been superb. I would hate to think of where we would be with Reagan as president.

Sep 28 11:04 AM

[mikebrah:]

To further this point a little bit, I would like to add that the author spends most of the article bemoaning the fact that corporate interests control America, especially the military-industrial complex and that our debt levels are unserviceable. He then follows that by praising Ronald Reagan for ending the troubles of the 70s. But the Reagan administration is where this very trend began. He ramped deficit spending, and exploded the defense budget. He kicked it into high gear on a path that was unsustainable. The fact the author criticizes all the current symptoms of a problem yet praises the biggest architect of said problem destroys credibility IMHO.

MM

On Sep 28 11:04 AM Brad Denny wrote:

> Somewhere along the line, Jason said that his post was going to be
> about economics, not politics. Insofar as he stuck to economics,
> I would give his post high marks for insight and connecting the dots,
> but then he had to go on and sing the praises of that half witted
> movie actor Ronald Reagan as president while trashing Barack Obama
> on the basis that Obama is a "Sunday morning celebrity."
>
> Good grief. Ronald Reagan was a Saturday night shoot em up hoot
> owl who couldn't remember the difference between reality and the
> films he had acted in. The last time I checked, no human being was
> perfect, but Obama's record so far in dealing with the problems bequeathed
> to him by the previous 30 years of maladministration in Washington
> has been superb. I would hate to think of where we would be with
> Reagan as president.

Sep 28 12:00 PM

[Jimbo:]

I hesitate to endorse anything that would appear on a Bill Moyers program but I have to agree that both political parties have been creatures of the Bankster-gangsters. Until the public rises up and demands a disconnect, the fraud will go on. We can begin with a constitutional amendment allowing only 12 years total service in Congress and have severe penalties for lobbying after being in Congress. Until this reform happens, we will continue to have fraud.

Sep 28 12:51 PM

[CES:]

OK.OK> But what should I do with my MONEY?

Sep 28 02:21 PM