Evans-Pritchard, again:
… UBS is also gearing for a big rebound, convinced that the Fed’s move to shoulder $30bn of Bear Stearns liabilities has changed the game.
In its latest report -”Ready for a Rally” - it said financial shares rose 448pc in the 12 months after the Swedish rescue in 1992, 88pc after Japan’s Revitalisation Law in 1998; and 82pc after Roosevelt’s Emergency Banking Act in 1933.
The pessimists at Société Générale remain sceptical, even though the Fed has gone nuclear. “We expect global equity prices to fall by up to 75pc from their peaks as a deep global economic downturn unfolds over the next few years,” said Albert Edwards, their global strategist. He fears a 50pc collapse in earnings, compounded by an “Ice Age derating of equities”.
It may echo the Lost Decade in Japan, where stocks fell 80pc. The yields on state bonds kept falling as debt deflation engulfed the banks, thwarting efforts to nurse lenders back to health by the usual device: “steepening yield curve”. The authorities were left chasing their own tails. Having lived through this, Japan’s chief regulator Yoshimi Watanabe has advised Washington to go for a quick taxpayer rescue, rather than trying “to fix the hole in the bathtub”.
Whatever happens, there will always be tactical rallies. Mr Edwards cites four Wall Street bounces above 25pc in the 2001-2003 bust. The buying cue is when investor gloom nears black despair. The put/call ratio on options is now at a bearish extreme of 0.90.
“That would historically suggest that a joyous 25pc spring rally is close at hand,” he said. Yet Mr Edwards remains wary as long as analysts cling to their belief that earnings will rise 11pc in 2008. This is not the sort of “washout” level of gloom required to clear the air.
Still, the oldest adage on Wall Street is “never fight the Fed”. In short order, Ben Bernanke has slashed interest rates by 300 basis points to 2.25pc, and invoked the emergency clauses of Article 13 (3) of the Federal Reserve Act for the first time since the Great Depression to take on direct credit risk.
The Bush administration has told the housing agencies Fannie Mae and Freddie Mac to absorb $200bn of extra mortgage debt. It has implicitly nationalised them in the process. The network of Federal Home Loan Banks has mopped up $900bn of mortgage securities. Congress has rushed through a $170bn fiscal blitz.
This is not to be sniffed at. It is worth a good spring rally, until the inexorable logic of a 25pc house price crash prevails once again.
Bernard Connolly at Banque AIG, who foresaw this crisis with uncanny accuracy, believes central banks will resort to full-throttle reflation, setting off a fresh boom in shares and gold. But this will occur only after the economic slump has spread to Europe and beyond.
The authorities will wait too long to act, believing their own decoupling myth. Unemployment will ratchet up. Civil unrest may rock Latin Europe.
In the end, the whole industrial world will stoke a fresh credit bubble to put off the day of reckoning, for another cycle.
The capitalist system is now so deformed by debt that it requires ever lower interest rates to keep going. It survives on perma-bubbles. Monetary rigour at this late stage would endanger democracy. …
Volcker and Thatcher proved that democracies can weather more pain than conventional wisdom will ever expect. Other than that I have nothing to add …
80% does seem to be the magical number - Japanese Nikkei, NASDAQ etc. If you do look at the long-term DJIA (since its conception), the long-trend support seems to be around 3,000 - about 80% correction from its top of 14,000 in 2007.
I was just kind of surprised when I got some flack for pointing it out. Even more surprising that no one expects a crash down the line. We’ll see.
Shankar
Shankar,
I think it’s just that apocalypse predictions are a dime a dozen. While a few have come to pass recently, and are thus gaining lots of prominence, the fact remains that there has been an infinitely greater number of bad apocalypse predictions than good ones. The odds are just never in favor of that forecast.
While there’s lots of uninformed commentary around, there was always a decent-sized bearish minority contingent of financial commentary. That tells you right there that although the bulls ran the show for the past five years, they didn’t control it to the point that they set themselves up for a fall of such epic magnitude.
The crash of ‘29-31 was accompanied by a huge number of policy blunders (suspension of gold-dollar convertability, Smoot-Hawley, a *huge* tax hike, as well as the grab bag of regulatory idiocy that comes with every financial crisis).
While there are a lot of things to be worried about in today’s market, and a lot of stupid choices by stupid policy actors, it’s pretty tough to make the -80% case (imo), even if its track record weren’t already so poor.
You can make a much more convincing apocalypse case for China, in my opinion. China has all the elements of a Japan-style crash, all the *surpluses* (the worst crashes are in the countries running *surpluses* which obscure yet-larger future *deficits* as was the case in the US depression, 1991 Japan etc), all the “it’s a foregone conclusion that China will take over the world economy in X years” hubris.
Ok, Eric. I Got it.
Just a food for thought - The policy blunders during ‘29-31 that you talk about, are about to be implemented again. To begin with, there is no gold-dollar convertibility. Tax hike is almost assured with the huge spending that is going on. And there is a backlash against globalization and world trade, at least in developed countries. In particular, the US population is aging rapidly and that is a fairly disastrous for any economy (look at Japan for example).
You are absolutely right about China though. Chinese, in my opinion, have made bigger policy blunders in the last few years that they’ll have to pay for over the next few years. In fact, China has a bigger issue going forward - its population. But it is not the large population I am referring to - its the rapid aging of that population. Chinese instituted strict birth control policies and as a result their population growth is projected to be falling off the cliff starting 2017 or so. Again, not so good. (FYI - I do expect Chinese Index to drop below 2,000 over the next 12-18 months. Full Disclosure - Have been short on China via LEAP Puts as well as double-inverse ETFs for over a year now.)
So, if I had to venture a guess, I would say that we are looking for a severe recession in US and perhaps a global recession over the next 2-3 years. Having said that, I do think that life will still go on, we will come out of it much stronger (whenever that might be).
One thing I would absolutely agree with you is regarding precious metals over the next few years. And perhaps agricultural commodities (?). Again, I mean secular bull-run over the years, if you neglect few technical corrections along the way.
In general, I have observed (and I am not that old) that the reality is much worse than the majority hopes for and not as bad as the apocalyptic minority fears for. Reality - it usually stands right in the middle.
Hope this helps.
BTW, you probably were right on the mark about your thoughts on Lehman. They just announced $3 billion preferred issuance to cater to demand and squash rumors.
Huh?