A true Bear Market is characterized by falling price earnings ratios. Serious bear markets usually end with P/E ratios in single digits, often in the six to eight range. According to the estimate of Standard & Poors Corporation, based on reported earnings as of December 23rd, the S&P 500 price stands at about 18 times 2008 earnings.
If the P/E ratio falls to nine times earnings, then the S&P 500 could to fall to about 450. In recessions during the last forty-five years, earnings have fallen by ten to twenty-five percent. If that is factored into the equation as well, you can imagine that we are still in for a lot of pain.
I say "we" and not just "investors" because the recession will produce more job layoffs, serious distress for state and local governments, and enormous federal deficits.
Investors would be wise to sell on rallies and keep cash in short-term U.S. Treasury securities. This is a good time to invest with the philosophy of Depression era comic Will Rogers' who said, “I’m more concerned about the return ‘of’ my money than the return ‘on’ my money.”
In my next post, I will spell-out why deflation is the problem we now face and why the government can do so little to stop it.
Never forget, times of financial stress are also times of financial opportunity.
Labels: bear, deflation, economy, stock market
¶ 5:16 PM 0 Comments
Keynesian thought is that recessions are bad and should be fought vigorously with low interest rates and deficit government spending, even on make-work projects, to “prime the pump” and stimulate economic growth.
Monetarist thought is that recessions are bad and should be fought vigorously with consistent and predictable money supply growth irrespective of interest rates or government spending.
Austrian thought is that recessions are normal and a natural part of the business cycle. In a boom, investment and production tends to get out of alignment with consumer preferences so that a retrenchment is beneficial as well as necessary.
U.S. economic policy is entirely dominated by Keynesian and Monetarist thinking. Alan Greenspan and Ben Bernanke “successfully” steered the U.S. through more than twenty years with only two relatively short and shallow recessions by keeping interest rates artificially low and the money supply growing at a rate that was probably at least double the rate needed to match economic and population growth.
Low interest rates produced low saving rates. With little savings in the U.S., we turned to China and the Gulf States of the Middle East to finance our government deficits. At the same time we neglected our factories, preferring to purchase imported goods, and paying for them with plentiful paper dollars. We thought we could have capitalism without capital, without production, and without risk of failure.
These policies led to the development of an economy based more on consumption and less on production. This is a sure route to excessive debt, much of it used to finance imports.
Keynesian and Monetarist policies can make an economy grow when it otherwise would not. However, preventing recessions is like trying to only breathe in. The U.S. economy is collectively exhaling now and will for some time.
Where will we go from here? The pursuit of Keynesian and Monetarist policies following a collapse will bring stagnation. Witness the eighteen years of stagnation in Japan since its stock market bubble burst in 1989. Stocks there have recently touched a twenty year low.
We’ve seen this movie before. Government spending did not end the unemployment problem in the 1930’s – all it did was to create an enormous debt. That was the opinion of Henry Morgenthau, Treasury Secretary under Franklin Roosevelt.
Economic theories are blind. They operate based not on the stated intent of bureaucrats, but on the incentives inherent within them. Austrian economic theory is like tough-love. In return for pain in the short run, it will yield prosperity in the long run, especially when combined with sound money.
Bureaucrats and congressmen get their perks and raises; we are the blind mice whose tails are cut off.
Labels: Austrian, economy, Keynes, monetarist, recession
¶ 5:34 PM 1 Comments
Humpty Dumpty sat on a wall.
Humpty Dumpty had a great fall.
All the king's horses and all the king's men
Couldn't put Humpty together again.
The government’s efforts to revive the economy are all coming to naught. I believe this situation will continue. I will explain why, in my opinion, everything has changed.
For the last twenty-five years, real disposable personal income has grown at an average rate of about two-and-a-half to three percent per year. That means that in twenty-five years, the purchasing power of the typical household has doubled. Americans live much better today than they did twenty-five years ago. That is the good news.
For the last twenty-five years, household debt has grown at an average rate of eight to nine percent per year. That means that in twenty-five years, the debt burden of the typical household has doubled three times. That equals an eight-fold increase. This is the bad news.
Think of it this way. If income has gone from $25,000 to $50,000, then debt has gone from $50,000 to $400,000. I have watched these numbers (published along with a host of others, mostly in graphic form, by the Federal Reserve Bank of St. Louis), for years and asked myself, “How long can this go on?”
(http://research.stlouisfed.org/publications/)
The answer, it seems, was until 2007. By then the growth rate of household debt had fallen from 12% per year to 9% per year on its way to near 3% per year today, a level so low, it has been seen only once in the last thirty-five years. If you wonder how we recovered from the bursting of the dotcom bubble, the answer is that we borrowed and spent furiously, growing our debt at eleven to twelve percent per year for three straight years beginning in 2003.
When debt growth dwarfs income growth for a long enough period of time, the economy falls off a wall. It simply has to. Too many people are far too deeply in debt. Banks are more cautious (they’ve been burned); consumers are more cautious (job uncertainty and market chaos).
And now, neither the Fed, nor the Treasury, nor the President will be able to get the economy going again by getting consumers to splurge on cars or houses because we already owe so much. We have over-borrowed, over leveraged our assets, run our credit to the max. The sub-prime crisis and all the rest is just the beginning of de-leveraging (debt reduction through paying it off, having creditors write it off, or discharge through bankruptcy) that is likely to continue for a number of years to come. Think of it as the seven lean years.
This is one powerful reason why everything has changed. But it is not the only reason. In fact, there is a second reason that may be even more powerful, and I will explain it in my next post, perhaps as soon as tomorrow.
If you found this helpful and informative, please leave a comment or reply to me (Was it too short, too long, too arcane? How can it be improved?), and forward it to someone else that you believe may also be interested. Thank you!
Labels: consumer, debt, economy, leverage
¶ 8:48 PM 0 Comments
Lets do a simple back-of-the envelope calculation and then you tell me if oil is high or the Dollar is low. When I owned my first couple of cars, gasoline was generally about 39.9 cents per gallon. When there was a price war, I once saw it at 19.9 cents, but most of the time between 1965 and 1972 it was within five cents one way or the other of forty cents per gallon. (That all changed in 1973 with the Arab Oil Embargo.)
The Treasury stopped minting 90% silver dimes in 1964 but most of them were still in circulation between 1965 to 1972. That meant that for four silver dimes you could buy a gallon of gasoline. Today, silver dimes minted in 1964 and earlier, of no particular numismatic (collector) value are sold on eBay for about $1.40 to $1.50 each.
So, you can still buy a gallon of gasoline for less than its 1965 price provided you pay in pre-1965 silver coins and can find a gas station owner creative enough to take genuine silver coins in payment.
Politicians still like to blame "the Arabs" for the high price of oil but the truth is that the 1973 Arab Oil Embargo came about because the purchasing power of the Dollars in which Middle Eastern producers were being paid had been steadily eroded to the point where they had to do something or submit to this form of legalized robbery. (Crude oil traded at $3.25 per barrel from 1945 to 1973.)
As long as the U.S. Federal Reserve keeps pumping up money and credit faster than the growth of production in our economy, oil and everything else priced in dollars will keep going higher.
Not because the things you buy are inherently more valuable, but because the Dollars with which you pay are inherently less valuable. Call it cheap money!
Labels: Dollar, economy, Federal Reserve, inflation, money, oil
¶ 8:47 PM 0 Comments
