Has a 2008 Stock Market Crash Begun?

Based on this horrendous start of the trading year, it appears as though an accelerated stock market crash may be underway for 2008. What's changed from last year? Frankly, I was surprised to see continued enthusiasm at the tail end of 2007 given the complete disintegration of the housing market, the lack of liquidity in the credit markets and waning prospects for continued growth locally. The recent unemployment numbers pegging the rate at 5% was a surprise to even the most pessimistic economists. Some would say we're actually already in a recession now. When the revisions are in and you look back, we may have already begun a true economic slowdown in the fall.

What else is working against an up year in 2008?

• This is an election year. The uncertainty that an election year brings is often a hindrance to U.S. market performance. This is especially true for particular sectors. For instance, remember what happened to ethanol stocks during the last mid-terms? What do you think will happen to defense and pharmaceutical stocks if there's a Democratic win? The market dislikes uncertainty and given some of the wacky ideas being posited already, there will be some winners and some losers no matter who wins. Politicians are a unique class of human beings in a genre altogether unfathomable to most of us.

• Oil is at close to $100 per barrel. The ripple effects have not fully propagated through the entire complex. Recall post-Katrina the outrage over gas prices when oil spiked? Gas prices are roughly where they were when oil hit around $70 per barrel. Now, oil's hovering around $100. Gas prices will eventually increase and consumers will feel the pain. Let's face it, we're not changing our consumption patterns. We're Americans. Based on the research I've seen gasoline prices are relatively elastic until you approach $4 a gallon (note the difference in views between consumers of gas in the U.S. and Europe?). If gas stays in say, the $3.50 range, you might see it stay there for a long time due to this inelastic behavior and you'll finally start to see an economic slowdown. The uber-commuters with the 100 mile commutes and the SUV drivers will eventually have to curtail spending in other categories to maintain their commutes. To date, the economy's been resilient in the face of $3 gas, but it will not be sustainable.

• Global and military competition has become so pervasive that we barely even notice it. Although things seem to be going better in Iraq, they're getting worse in Afghanistan. The Iran and North Korea relations are not rosy. The Turks are on the verge of invading northern Iraq. Did you even know that China recently attempted to blind a U.S. satellite with a ground based laser? In addition, last year, they shot down an orbiting satellite. Satellite are the eyes and ears of the U.S. military which provides a good deal of the deterrent that exists in the world. This is the sort of national defense threat that used to garner the front page (could you imaging the Russians doing this in the '80s?) attention, but it pales in comparison to all the other threats in the world. I don't think there's an imminent war brewing with China; they're testing out this capitalism thing. And they're raking it in. But when the glory days are over and Vietnam and South Africa are the new factories to the world, China may start asserting their influence more prominently. Let's just say it's unlikely the world will get any safer in the near term and this risk will be built into equity prices for some time until there's more sustainable stability worldwide several years from now.

What is working in favor of buoying the U.S. market?

• Sovereign Wealth Funds: With oil prices close to a staggering $100 per barrel, many governments have been lavished with funds they never foresaw and have simply exceeded their comfort levels of investment in reserves and hence, are seeking a new locale to stash their hordes. You'll continue to see not only investments in U.S. funds like you've been seeing from China and Dubai, but you'll see outright purchases of U.S. assets.
• The weak U.S. dollar: Believe it or not, even though the weak dollar is a sign of the weakening of the perception of the stature of the U.S. in the world, it is a huge boon to multinational earnings when they convert profits back to dollars and like I mentioned above, this further propagates the sale of U.S. assets. Heck, the Canadians are buying U.S. banks (Commerce!). There's a fire sale on U.S. assets and if you are holding the beneficiaries, you'll continue to see the 25-50% premiums roll in.
• Global economic expansion: Even though the U.S. economy itself is slowing, the continued growth in markets that we export to could offset the local slowdown. Our exports to Latin America and Europe are strong. As China has opened itself up to capitalism, our exports there have soared.

What's the takeaway here? Now, more than ever, it's a good time to be in investments of low correlation. This site abounds with such investments, from sovereign debt funds to investing as a lender through Prosper.com (for instance, my returns through Prosper far exceed the S&P500 last year).

Comments

[EverydayFinance]

To follow up on this article since I posted, I bought in to SKF, the ProShares ETF for 2x Short Financials have risen close to 20% while the markets worldwide have continued to decline precipitously. Hedging like this is a great way to realize some profits in a downturn and go bargain hunting again. This was my rationale as posted at on Jan. 11:

I also believe the financials have not reached bottom. Following today's $15 Billion writedown from Merill Lynch and $440 Million charge from American Express from the subprime mess and credit card delinquencies, respectively, it's evident the hits will keep on coming. Therefore, I like a short position in Financials. If I'm wrong and this is the bottom, imagine the relief and rally that will ensue for the major indices and internationals alike.

Dan at everydayfinance.blogsp...