Thursday, November 6, 2008

Obama Market gains? I think not

I was just watching a soundbite interview between a guy named Seigal and another guy. I don't know who either of them are, other than to say that Seigal was an older guy and the other guy was younger. It appeared Seigal was less prejudiced against political comparisons. Seigal hit a lot of the disparity between returns under Democrats and Republicans in the markets being more on timing than actual performance of the administrations. I don't know where the market was January 20, 1969, but I bet the prior 8 years didn't come close to the 8 years that preceeded it. Nixon-Ford was a disaster, but it was only minimally Nixon-Ford, except the Watergate mess. That was more a case of the dollar being bankrupted by the 1960's Viet Nam war and War on Poverty than anything else. Nixon should have stopped this crap, but he let it go on instead. Carter was a disaster and Reagan had a huge bull. Bush I was sideways and Clinton created a bubble with his henchmen Rubin and Greenspan. Bush inherited the biggest bubble in US history, at least a double of the 1929 market, so it was impossible to make a return. FDR got the market near its all time bottom and inflated, so he had the market set on a tee for him. Clearly Clinton had the best return, but he left a massive bubble that actually bore no relationship to the economy and was in fact the economy, the bubble economy that is finishing its collapse now.
So we had 2 Republicans walk into cyclical bear markets, Nixon and Bush II, Bush I walked into the Japan bust and the S&L refunding on the negative and Reagan and Eisnehour walking into new markets on the Republican side and Clinton and FDR walking into recoveries of some sort already under way. The comparisons are idiotic.
Now they think Obama has it set on the tee. I think he has an impossible task provided the market is above 7500 when he goes in. The 50% point is going to define the top of this market once it settles. The US bubble has broken and there isn't one to replace it. Keep chanting this, the US bubble has broken and there isn't one to replace it. The dividends, cash flows, PE's, consumption and capital spending was all financed by credit from the bottom and to the top. The bottom got subprime crap financing and the top borrowed money to leverage these subprime loans and expand their returns. The results on financial assets was great on the up and devastating on the way down, with the financing and the capital related to this financing wiped out. We are now seeing it liquidated and there isn't going to be any left to do the game over again. In the meantime, those in the middle ran their debts up or put their windfalls in the stock market depending on who they were, or they put it in their homes. The outliers were pumping the insides and now they are all suckikng each other dry.
I have often thought about how stock markets go down to levels that seem impossible to start. It is clear to me that once a credit bubble gets going, the bubble becomes the source of earnings and growth, which it stands to reason that cash disappears and so do earnings and growth. Thus a zero growth scenario needs a 5% dividend instead of maybe a 3% dividend in a normal market, or as we have seen, a 1.75% or lower dividend in a bubble market. Freely flowing cash disappears.
I still don't understand the Japanese market because I haven't seen the inside numbers of corporations. i would venture that Japan probably was valued in line with the Nasdaq at the peak and cash flow out of a real estate bubble stopped. Domestic demand dropped, profits dropped and fundementals adjusted from bubble levels to below trend. This has resulted in a steady decline, especially since export margins in Japan have been cut by cheap China labor. Capital assets have had to be scrapped and the result has been nearly 20 years below the half way point.
The Dow in the Depression market never made it past the halfway point. Halfway back then was actually a pretty healthy market, as the market had difficulty getting past the 100 point level for a long time. A rally to near 200 was a pretty good rebound, but the market really never put 100 in the rearview until around 1950. Relative, the current market had trouble with 1000 for a long time and that is the extreme view, that we would actually move that low. Since the entire move out of 1000 was created by a non-gold backed credit boom, it is entirely possible the unwinding of this bubble could take the market that low. We have already seen 7000 on 40000 in rough numbers in Japan, which would transpire to 2100 on 12,000 and 2450 on 14,000. Most people wouldn't believe below 3000 even though we have already seen it in a competitive major market in recent years.
My point is where does the market start and at what point in the cycle are we in? I believe the fact the Nasdaq failed to recover much past the 1/2 way point shows we are well into a bear market that has yet to break down totally. Remember the Nasdaq went down to interday 1000, an 80% decline. Dow 2800 isn't out of the question in light of this one item.
As I type, Seidman uses the term deleveraging as if the money is magically going to appear to effect that. what deleveraging is, for any of you that are confused is a $1 billion pile of assets that have $900 million borrowed against them are sold for cash and the loan is paid off. This is the optimistic delevraging, but the point is that $900 million in cash is destroyed unless the new borrower also leverages with a $900 million loan, which in effect is no deleveraging at all. The pessimistic side is the asset will only bring $800 million, the bank loses $100 mllion or the seller has to sell even more assets to make up the $100 million shortfall. If the first happens, then the bank loses the capacity to create $1 billion in credit and has to pull in more cash. Thus we are now talking about $1.8 billion being needed to fill the hole.
The credit bubble was just the reverse, the using of credit to replace what should have been done with capital. Thus we are actually transitioning from a credit economy to a capital economy and being the amount of capital in the system is an inverse multiple of the leverage, the supply of money becomes lacking and the flow of cash through the system slows as well.
No one can fix this, as the government can't create capital. I would venture they could leverage their public lands, but I would also venture they have already done this. Eventually the government is going to have its credit rating threatened and this game will end.
Debt has benefitted a lot of corporations in the US and in the world. It is the enemy of corporations and business as we go forward in this kind of economy. Over the past year there has been a lot of loans drawn to be sure the drawers had credit that is now going to weigh on these businesses. But, they are currently in better shape than those that failed to draw their credit lines before they lost them. Servicing these loans is going to not be easy.
This is a long unwind. If the Fed and government are successful in their recent ventures, then the banks will start lending and rescue the bubble. But, they will still have the bubble and it will need tons of new credit to keep intact. Thus it will continue to deflate at a slower pace or it will expand only to burst again in a few years. This is an epic bear market and it is just starting

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