It seems we just closed out 2008 with a "sigh of relief"--only to find ourselves in for a turbulent 1st quarter! January went on record for posting the greatest decline in US stock market history. February ranked 3rd for the greatest decline.
During the course of one brief quarter we experienced both a bear market AND a bull market. What a rarity.
Any time a market moves 20% down from its peak or up 20% off its low, it is labeled a bear or bull market, respectively.
And if you are an investor who was rattled by the severe decline and the rumor of a Dow falling to 6,000 or lower in early March--and cashed in at that time--you missed one of the most historic rises in the stock market in the heart of March.
There are some interesting similarities today with the stock market trends of past, significant economic downturns.
Dshort.com has assembled stock market returns by superimposing the 2007-09 S&P 500 index with the Dow Crash of 1929 and the S&P 500 declines in 1973-74 and 2000-02. The current market decline is measured from December, 2007--the month when the National Bureau of Economic Research (NBER) says this recession began.
Here are some observations:
The past declines lasted 21 (1973-74) to 34 (1929-32) months. Currently we are in month 17 of this recession.
In many past recessions (not just the ones viewed here), the stock market has tended to recover some six months prior to the end of the recession.
The current decline (blue line) reached its early March low point five months ahead of the 1973-74 downturn (red line). This is NOT to imply, however, that the US stock market will not again dip down to that early March point, or lower. Only time will tell.
During the lowest point of the current decline in early March, we were 16 months ahead of the much slower decline earlier in this decade (green line).
We are a long, long, long way from the bottom reached during the Great Depression (gray line).
Recently I wrote about three recession scenarios: L U V
Depending on which scenario you believe, you may be led to a certain view about when the current stock market swoon will end.
During one of my presentations last year at church, someone asked me for the definition of a depression.
In an informal sense, a recession is two consecutive quarters of negative economic growth, or decline in the Gross Domestic Product (GDP). (For more on GDP see my late January article, That GDP.)
Although there is no formal definition for a depression, most economists agree it is a prolonged slump with a 10% or more decline in real GDP.
With this in mind, here is a graph comparing the decline in real GDP for the current recession with other recessions since 1947. Depression is marked on the graph as -10% at the very bottom.
Even though the current recession is already one of the worst since 1947, it is only about 1/3 of the way to a depression (factoring in a likely bad 1st quarter, 2009).
The next graph compares the current recession, with estimated decline for the 1st quarter of this year, with the more severe recessions of the last century.
Keep this in mind so that you have proper context when you hear the next pessimistic prognostication about a Second Great Depression.
I recently published an article with accompanying information about the possibility of a V-shaped recession. This is the more optimistic viewpoint--and it is supported by the consensus view of GDP growth in the second half of 2009. Of course, the consensus could be wrong.
Enter counterpoint: Nouriel Roubini, a professor at New York University's Stern School of Business, says We could end up ... with a 36-month recession, that could be "L-shaped stagnation, or near depression. He puts the chance of a severe U-shaped recession at 66.7 percent, and a less severe L-shaped recession at 33.3 percent.
He has a reputation as the most pessimistic economist in the academic world. He deserves it. His most recent paper is Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.
We are in the 15th month of a recession, says Roubini. Growth is going to be close to zero and unemployment rate well above 10 percent into next year. He sees no hope for the recession ending in 2009 and will more than likely last into 2010.
I believe it is important to consider all sides of this economic debate. It is also important to not get too emotionally invested in outcomes: either by being blindly optimistic about recovery or irrationally pessimistic about depression.
Here is a recent interview worth watching.
By the way, how are Roubini's own funds invested?
They are 100 per cent in equities. In the long run stocks do best and he is not yet close to retirement, so he keeps putting more money into index funds each month, according to an article in the Financial Times by John Authers.
President Obama is expressing a more positive view of the US economy. This is constructive, because it is fear which is, in part, hurting our chances for a faster recovery from this recession.
What I don’t think people should do is suddenly stuff money in their mattresses and pull back completely from spending. I don’t think that people should be fearful about our future. I don’t think that people should suddenly mistrust all of our financial institutions because the overwhelming majority of them actually have managed things reasonably well.
During this New York Times interview the president sounded another upbeat note about the economy by suggesting that a surprising number of banks will pass so-called stress tests the Treasury Department is conducting to see if they could weather a prolonged and deepening recession.
When asked how soon he thought the US economy would turn around he said, I don’t think that anybody has that kind of crystal ball. We are going through a wrenching process of de-leveraging in the financial sectors – not just here in the United States, but all around the world – that have profound consequences for Main Street. It is going to take some time to work itself through.
Christina Romer, chair for the Council of Economic Advisors, was more specific in saying, Sometime in the second half of the year...I expect that's when we'll start to see positive GDP growth again and a little after that we'll start to see employment going up rather than going down.
In early February I wrote about three possible recession recovery scenarios: L U V, where a U-shaped recovery is quite pessimistic, V is optimistic and an L viewpoint has been held by many economic commentators.
Recently the Federal Reserve published the following chart. This shows a consensus view that we'll have a decline in GDP this quarter and in the 2nd quarter of 2009, and then there will be growth.
If you look carefully, the shape of this recessionary decline is a V.
If the consensus is correct, we have to tough it out four more months before entering the 3rd quarter. Let's hope they are right!
Perhaps it's fashionable these days to talk and write about how bad things are in the US economy. Yes, many of us are hurting...in many ways.
Every day it seems we are inundated with information about new lows, reports that have never been worse and a near-depression economy. People are becoming to believe this. And as long as we do, we actually perpetuate the pain.
It's happened in the past--and it's happening now, starting with fear that gripped Americans last fall, and as I have written recently, continues today with proclamations from government officials...even at the highest office.
We are also starting to see healing across America. Some of these reports get lost among the other economic news--and it's easily lost because negative headlines always "sell" in the news media. Let's take a look at some important movements, including an update of a few that I have written about in previous articles.
The TED Spread is a common measure of fear and risk in the capital markets. When this measure declines, it is a VERY important indicator that liquidity is being restored...which was the intention of the $700 billion TARP program.
This should then be observed in an increase in consumer loans. That is happening.
We would like to see an rebound in manufacturing. The Baltic Dry Index underscores that positive movement. The index measures the demand for shipping versus the supply of dry bulk carriers.
That means we should start to see a turn around in the ISM Manufacturing Index. We're seeing a glimpse of improvement.
Yes, we have a long, long way to go yet. We appear to be on the road to recovery.
And it's easy to forget that just 10 days ago commentators were remarking about doom & gloom in our economy. Now that the stock market has rallied a bit, some people think all is OK.
It's not likely that either extreme point of view is correct.
In coming articles I'll share more of the optimistic & pessimistic viewpoints...so you can examine the breadth of thinking on this vital subject.
We were pulled into this recession by problems that bankers had with defaulting sub-prime mortgages, and other difficulties in the banking industry.
Some think we'll start to recover with leadership in the financial/banking sector of our economy. We did witness some positive signs this past week, and the stock market responded quite favorably.
Be careful with your interpretation of the stock market, however, as this may simply be a short lived rally within an existing bear market--lasting only a week or a couple of months before the next stock market decline.
The spark that ignited this latest stock market rally was comments from Vikram Pandit, CEO of Citi, telling employees they will turn a handsome profit in the first quarter, their best money gain since 2007. This was followed up by similar comments from Ken Lewis of BofA and Jamie Dimon of JPMorgan.
Why are they so rosy all of a sudden? Has the sky cleared--and all the woes been erased by the $700 billion TARP bailout of last fall?
No, those mortgage defaults are still on their mind. While TARP and other government measures are helping--and we may see revision to the mark-to-market accounting rule that I wrote about a few days ago--there are still significant hurdles for the banking industry.
BUT, there is some very good news that banks are now starting to report. Banks make money on spread. They borrow at low interest rates--and then lend at 1, 2, 3 or more percent higher rates. This is a significant source of operating profit, and since last year, they have gone about their normal business of leveraging for profit.
Here is a chart showing how much banks pay depositors, in general, for short-term certificates of deposit (CDs)--and how much they charge home owners these days--who are happy to either obtain new credit or refinance their homes at relatively low interest rates.
Looking at this chart another way, in terms of spread, here is why banking CEOs are so pleased with their bottom line these days. This spread of over 4 percent means big bucks for banks--and it reveals a possible turning point--which we will all applaud as we look for a recovery from the current recession.
Have you ever heard of this arcane accounting term? Mark-to-market accounting rules, enforced by the SEC and the Financial Accounting Standards Board (FASB), require a company to value -- or "mark" -- assets on its books based on the price they would bring if they were sold today.
Mark-to-market accounting existed in the Great Depression and according to Milton Friedman, it was responsible for the failure of many banks. Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when FASB 157 went into effect in 2007, reintroducing mark-to-market accounting, look what happened.
According to my favorite economist, Brian Wesbury, two things are absolutely essential when fixing financial market problems – Time and Growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away.
Because these accounting rules force banks to write-off losses before they even happen, we lose time. This happens because markets are forward looking. The accounting rules force banks to take artificial hits to capital without reference to the actual performance of loans.
This affects growth. By wiping out capital, fair value accounting rules undermine the banking system, increase the odds of asset fire sales and make markets even less liquid. As this happened in 2008, investment banks failed and the government proposed bailouts. This drove prices down even further, which hurt the economy. It’s a vicious cycle.
Former FDIC Chair William Isaac places much of the blame for the sub-prime mortgage crisis on the Securities and Exchange Commission and its fair-value accounting rules, especially the requirement for banks to "mark-to-market" their assets, particularly the mortgage backed securities.
You may recall John McCain's criticism of the SEC during the Presidential race last fall. He even called for the resignation of the SEC chairman Christopher Cox.
Under the mark-to-market rule, declining housing prices don't just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities.
When a company in financial distress begins fire sales of its assets to raise capital to meet regulatory requirements, the market-bottom prices it sells out for become the new standard for the valuation of all similar securities held by other companies under mark-to-market. This has begun a downward death spiral for financial companies large and small.
Panic sets in and no one wants to buy mortgage-related securities, which drives their value under mark-to-market regulations down toward zero. Balance sheets under mark-to-market suddenly start to show insolvency.
This downward spiral shuts down lending to these companies, so they lose all liquidity (cash on hand) needed to keep company operations going.
Stockholders--realizing that they will be wiped out if the companies go into bankruptcy or get taken over by the government--start panic selling, even when they know the underlying business of the company is fine.
In theory, if banks no longer had to account for these valueless assets on their books, their balance sheets would suddenly improve and -- this is the important part -- private capital would start to flow back into the banks. Right now, an estimated $9 trillion to $10 trillion of private capital is sitting on the sidelines because it doesn't want to invest in sick companies.
Again, in theory, if mark-to-market were temporarily lifted, the big banks could get well almost overnight.
Tomorrow Rep. Paul Kanjorski (D-Penn.), will convene a hearing of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises to talk about mark-to-market.
The downside? If mark-to-market is lifted for good, or is made too lax, companies could create balance sheets that are pure fiction, giving potential investors zero insight into the health of companies.
FASB 157 may ultimately be the right standard, but it was reimposed at exactly the wrong time. This isn't an ordinary period and FASB 157 is creating more stress than it needs to for the financial sector and the broader economy.
Short-term assets should not be given arbitrary values unless there are actual losses. The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline, says Steve Forbes.
He goes on to say, If this rigid mark-to-market accounting had been in effect during the banking trouble in the early 1990s, almost every major commercial bank in the U.S. would have collapsed because of shaky Latin American and commercial real estate loans.
Mark-to-market accounting is the principal reason why our financial system is in a meltdown. The destructiveness of mark-to-market -- which was in force before the Great Depression -- is why FDR suspended it in 1938. It was unnecessarily destroying banks.
Finally, it would be worth your while to listen to Brian Wesbury discuss the issues pertaining to this vital topic. Notice in his comments how the stock market reacted to rumor of a suspension--in early February. Investors are telling us how pervasive this rule is in hindering constructive recovery of banks.
Unfortunately, Treasury Secretary Tim Geithner provided no details in his news conference--and our stock market took yet another hit, affecting millions of Americans' retirement savings.
What does the New York Feds know that you don't about US recessions?
Their research since the late 1980s reveals that the slope of the yield curve is a reliable predictor of future real economic activity. Specifically, the Fed model uses the difference between 10-year and 3-month Treasury rates to calculate the probability of a recession in the United States twelve months ahead.
You will notice in the chart how closely the Fed model correlates with recessions of the past 4 decades.
The Fed's data show that the recession probability peaked during the October 2007 to April 2008 period at around 35-40%.
The Fed model shows a recession probability of only about 1% on average through the next 12 months. The New York Fed's Treasury spread model predicts the end of the recession in 2009.
I find it interesting that the Fed model has accurately predicted the last 7 recessions dating back to 1960.
According to my favorite economist, Brian Wesbury, "Some early warning signals suggest an economic recovery should start taking hold by mid-year."
Recently I published a L U V article about the pattern of this recession. Based on this information, the V outcome predicated by Brian Wesbury is possible.
I haven't really been able to sort out exactly why there has been this degree of pessimism. George Bush
Consider the excerpts from this Time Magazine article.
Why are Americans so gloomy, fearful and even panicked about the current economic slump? Ten years ago we would have thought this was paradise, and now we're whining about it," says David Wyss, chief economist for the consulting firm DRI/McGraw Hill.
Many, many business leaders share this lack of confidence and recognize that we are in real economic trouble," Says University of Michigan economist Paul McCracken. "This is more than just a recession in the conventional sense. What has happened has put the fear of God into people."
Americans are so uneasy because they feel economic turmoil on two levels, one relatively superficial and the other much deeper. The deeper tremors emanate from the kind of change that occurs only once every few decades.
Many economists agree that the U.S. will face at least several years of very modest growth, probably in the 2% to 3% range, as consumers and companies work off the vast debt they assumed.
The reckless borrowing made a reckoning inevitable. "You can't spend eight years priming the pump and getting all your growth through debt in the private, corporate and public sectors and expect to come out of it overnight," says John Bryan, chairman of Sara Lee.
"We're not going to get any momentous return to growth anytime soon," concurs an Administration economist. "People are smarter than we give them credit for. They've known we couldn't keep borrowing our way to prosperity forever."
While some economists have described the current slump as a near depression, that phrase overstates the case if it is taken as a comparison with the period 1929-33, when the U.S. economy contracted by nearly a third.
In some respects, the current recession is more painful than the numbers show because this slump is so different from most. The current unemployment rate appears to be well below the level reached in the 1981-82 recession, when joblessness peaked at 10.8%. But experts say the comparison is misleading because the labor force is growing far more slowly today than a decade ago, which means that fewer people are seeking jobs.
Another factor that has aggravated unease in this recession is that there has been no sense of leadership, let alone prescience, from Washington. Consumers were blindsided by the failure of the White House and most economists to foresee the length of the downturn. "Everyone was told it was going to be mild," says Stephen Levy, director of the Center for the Continuing Study of the California Economy.
Consumers will have to open their wallets before any recovery can get rolling, and that is by no means ensured.
So far, though, no reprieve from layoffs is anywhere in sight.
At the very least, the current malaise has raised the public's consciousness about the need for real leadership and accountability in both Washington and corporate America. People are smart enough to know when they are being squeezed.
OK, I did leave hints in this excerpt of a Time Magazine article. Did you pick them up? Here was a major hint:
The current unemployment rate appears to be well below the level reached in the 1981-82 recession, when joblessness peaked at 10.8%. But experts say the comparison is misleading because the labor force is growing far more slowly today than a decade ago...
First of all, the quote was from President George Bush.
The Time article was published January 13, 1992 (ie, "today" in this article) by John Greenwald.
Here are trends in unemployment rates--including that 1990-91 recessionary period, and today (2008).
Time will tell if/when we reach the unemployment rate of the 1990-91 recession, or of 1973-74, or of 1981-82...let alone the peak of the Great Depression which reached 25.6%.
Regardless, financial setbacks are not fun, and we tend to be a gloomy sort when things aren't going our way.
Around the globe, 18 of 24 countries surveyed by Pew describe current economic conditions as bad. The negative economic outlook is worse as the median percentage rating their national economy as "bad" rose from 50% in 2007 to 61% in the latest survey.
Two notable exceptions, China and India, remain upbeat about national economic conditions, although Indians are less positive than they were a year ago. Some of the most negative evaluations of economic conditions come from citizens of advanced Western countries.
Larry is an avid golf & racquetball player. He enjoys developing web sites. He is president of Fox Valley Huskers, a Nebraska football fan club. He enjoys topical studies in diverse areas as ancient history, energy, German language, macro-economics, psychology, religion and science.
