pump - I'm curious about your long term views of the stock market and the economy? Do you believe we've seen a real bottom or that we are going to tank again after the Fed meeting. I believe we're going to see new lows but if you don't I'd like to know your reasons.
I also think we are going to see interest rate increases within after 12 months at the latest...
I wrote this - it is long - at the beginning of the year and still stick with it:
timingwallstreet.com
"We are now on the inevitable down phase of the cycle of Creative Destruction that Joseph Schumpeter described half a century ago. As such, policy makers must take great care not to interfere with the fundamental need to inject greater caution back into the system. A simple reflation of the bubble in financial assets which existed through the first half of this year would only involve greater dangers for the world economy in the period ahead."
Lawrence B. Lindsey at the Imperial Hotel, Tokyo, Japan, November 12, 1998
The Nasdaq gapped up 50 to 100 points on the first trading day of 2000. Apparently people were so relieved that there was no Y2K computer bug and that the four horseman of the apocalypse didn’t introduce themselves that they went on a drunken buying binge. A few days before that I gave a forecast for what we’d see in the year 2000 and argued that in the coming months we would find out if the technology stocks were for real or if we were looking at one of the worst speculative bubbles to appear on Wall Street. We all know what happened next.
The year 2000 has been one of the worst years I have ever seen as far as the news and the stock market goes. The things people really feared - the computer bug never happened. Instead the things that they believed in, the stock market bubble and the so called "new economy", turned out to be nothing but a hellish joke. It’s official the Nasdaq fell more in one year than it ever had before. The average investor lost his ass in the stock market, while the jackal pack of Wall Street insiders and manipulators made a killing. A recent study has shown that insider selling by executives, venture capitalists, and company insiders reached historic peaks in March before the market crashed and in the months of September through November. If you are holding stocks of technology companies at these levels now it is more than likely that their CEO’s have made out like bandits this year by dumping the stock while you and your technology mutual funds got left holding the bag.
Outside of the stock market, the news was dismal. Even the weather went completely nuts. 2000 has gone down in the history books as the worst year for natural disasters ever. More tornadoes broke loose than ever before. We had the flooding in Mozambique, fires in the midwest, and a drought in Europe.
And of course we went out of the year with the biggest freak show in American political history: the election that no one could win. The two candidates were so horrible that neither one could beat the other by any meaningful margin. Most people didn’t even bother to vote and just stayed home, turned off by the meaningless campaigns built upon polls and no principles. We now have a weak mediocorite President and a Federal Reserve Board that doesn’t know what to do. No one is flying the airplane while the economy is teetering on the edge of a recession.
Despite the stock market crash in April, people remained in denial of the coming economic slowdown about to come around the corner. Good times and happy vibes remained in the air. All this changed the day after the Presidential election. A feeling of horrible dread and anxiety could be felt everywhere. You could see it the mixed emotions of Chris Matthews, in the bars, and airport lounges across the country. Times were a changin’. This new spirit of anxiety had a temporarily lull during the Christmas week, but will grow stronger as the weeks of 2001 pass us by.
Don’t underestimate the impact of cultural images on the psyche of the nation and the individual investor. The history of telling tales through images is very old and goes back to before farming, writing, and warfare, the two pillars of civilization. Cave paintings were the first cultural artifacts created by man and pictures still drive our culture today. Now we just make them move in cartoons and movies.
The most popular cultural symbols tap into a civilizations’ collective unconsciousness. Unlike the personal unconsciousness the collective unconsciousness does not come from personal experience and development, but instead is purely hereditary. One could debate whether it comes from genetics or original sin, but it exists. You can see it in the reoccurrence of archetypical villains and heroes throughout the literature of various civilizations, from Ancient Greece, to China, and to the Aztec Indians. One of the more interesting facts is that every single civilization that developed on Earth created the same symbols for the Zodiac.
In 1940, children went mad over the movie the Mickey Mouse Hunt. Yesterday it was Mickey Mouse, today it's the Japanese Pokemon. Just like Looney Tunes, they provide a space for children and adults to engage in exploring their repressed primal urges. Myths and fame, like the beauty of an actor, are often the results of a particular era and represent the time in which they live; they are documentary, since they mirror the manias of the era and of the culture which surrounds them. Myths do change, but the archetypes never do. The passions remain the same.
The last few months of 2000 saw several important cultural icons disappear. Billy Graham stepped down. Rosie O’Donnell announced that she will end her talk show next year and Fred Rogers, of Mister Roger’s Neighborhood fame went into retirement. Over the years he filmed 1,000 episodes and demonstrated total mastery of puppetry as he led children to explore the nuances of the Neighborhood-of-Make Believe and brought characters such as Prince Tuesday and Henrietta Pussy Cat to life.
There is a certain irony that Prince Tuesday’s reign ended the same year that the bull market collapsed. Robert Prechter, who has been a leading promoter of Elliot Wave Theory through past decade, has done a study that compares the stock market to broader social trends. He has found that at bull market peaks euphoria, happiness, and contentment are heavily expressed in popular culture. When the market gets bad the culture of light becomes a culture of doom and darkness.
The bull market of the 1950s and early 1960s brought movies such as Peter Pan, Sleeping Beauty, and Mary Poppins. The 1970s era brought Night of the Living Dead, the Texas Chainsaw Massacre, and Halloween. And the great renaissance in horror came in the Depression era 30s with Frankenstein, Dracula, the Mummy, and King Kong. In the late 1990s the horror movie completely disappeared and got replaced by comedy horrors that made fun of the whole genre.
Music has followed a similar trend. The happy rock and roll of Surf Music, the Beatles, and Doo-Wop became replaced by Heavy Metal and Punk Rock weirdoes in the 1970s bear market. During the last recession we had the dark music of grunge and alternative Nirvana types that came and left as quickly as the recession did. Now we have happy teenage pop.
Just like the market our popular culture is at a turning point. Once Stuart loses money in his Ameritrade account he will become some bizarre angry rebel that will make the new wave punks of the early 1980’s look like normal people. The degenerates will stone Forrest Gump and Christina Aguilara. The Backstreet Boys will be beaten to a pulp. This happy teenage pop that has infected the airwaves will soon be mocked by a new group of angry musicians about to come around the corner and into the headsets of the young and innocent.
Most people don’t find economic slowdowns, rising unemployment, and stock market crashes too much fun. When their anger oozes into the popular culture it won’t be a pretty site. Like Hunter S. Thompson said after the election, we have seen weird times before but you better prepare for the super weird. "The only ones left with any confidence at all are the New Dumb. It is the beginning of the end of our world as we knew it. Doom is the operative ethic," he wrote.
How did we get to this point and how long will it last?
I’d like to give you a grand distillation of world and economic history from the dawn of man till today, because that is what is really required to understand what is going on, but I don’t have the time to do that. Instead I’d like to refer you to a chapter called Legally Pigilly from the book Critical Path by R. Buckminster Fuller for that. Fuller was one of the world’s top architects, scientists, and philosophers of the 20th century. In this chapter he lays out a speculative account of the evolution of man’s political and economic systems from it’s origins to the 1980’s. It is excellent reading which even today remains more right than wrong. Click here to check it out: geocities.com
For now, I’ll try to give you a quick summary of the state of the economy and where things appear to be headed. During the 20th century the United States saw three massive bull market booms - first during the 1920s, second in the 1950s and 1960s, and the last one that began in the 1980s and ended last year. The first two booms ended in an ugly manner. The end of the 1920s bull market brought the 1929 stock market crash and the Great Depression. The bust of the 1960s bull market brought stagflation, oil shocks, and a horrible bear market which lasted almost a decade. Contrary to the "new economy" fruit loops this past boom does not look any different. Each boom ended with a stock sector that formed a bubble in a speculative frenzy - the 1920s radio stocks, the 1960s "nifty-fifty", and the late 1990s technology bubble.
A rapid increase in the Gross Domestic Product of the United States came in the late 1990s on the backs of the stock market boom. As stock values soared, investors felt richer, saved less and spent more. At the same time, the high stock prices provided incentives for corporations to invest and expand more. Although this combination created high economic growth, it also encouraged the private sector to increase its indebtedness. International borrowing increased and the United States current account deficit - which includes the trade deficit and the balance of payments(a record of all transactions which take place between domestic individuals and corporations with foreign entities)- reached levels never before seen. By the end of 2000 the United States had become the biggest debtor nation in world history.
The Federal Reserve interest rate hikes finally began to reverberate throughout the US economy in the last 6 months of 2000 as the year ended with the beginnings of a rapid economic slowdown. Business investment dropped 50% from the 2nd to the 3rd quarter and consumer spending began to fall sharply in the 4th quarter of 2000. The domestic manufacturing base also shrank in the last several months of 2000, a sign which has been used as an accurate precursor to a recession in the past. At the same time the bottom fell out of the junk bond market. Morgan Stanley, Dean Witter, Deutsche Bank, and CSFB, were rumored to have lost over $1 billion dollars in corporate bonds gone sour. The financial markets put up a warning flag.
As the economy teeters on the verge of a recession it has some serious imbalances which could make an economic recovery very tenuous. The economic and stock market booms were built upon a massive increase of liquidity into the financial system thanks to the Federal Reserve and record debt levels. In other words: a credit and stock market bubble.
The origins of this indebted growth came in the October 1998 global financial crisis. People may have forgotten by now, but at the time knowledgeable people on the international scene believed at the time that the global capitalist system was about to implode. The currencies of Latin American and Asian nations and Russia collapsed as each country defaulted on loans made out to them by international bankers. The crisis spilled into the United States as an overleveredged multi-billion dollar hedge fund, Long Term Capital Management, threatened to blow up in a mass liquidation of US assets that would have sparked a stock market and financial collapse.
Faced with this firestorm, Alan Greenspan attempted to prop up global capitalism with several sharp interest rate cuts. As 1998 came to an end the money supply in the US economy went up dramatically. With lower interest rates and access to easy credit, corporations and individuals went on a spending and investing spree. Consumer demand jumped, private investment increased, and the stock market skyrocketed. The US economy grew at a faster rate than it ever had before. It all seemed to work.
The US economic boom also seemed to stabilize the global economy, as foreign countries exported more and more goods into the US market. However, instead of investing their profits in their own countries, much of this money ended up into the US stock market, US bonds or into purchases of the US dollar - hence the record current account deficit.
One side effect of this is that the value of the dollar increased. That made it cheaper for Americans to exchange dollars for foreign currency. A strong dollar meant it became more expensive for foreigners to buy American exports and cheaper for Americans to buy foreign goods, a process that helped keep inflation low in the United States and encouraged the current account deficit to once again grow even larger.
However, most foreign economies never recovered. This was a problem that had the side benefit of keeping the price of commodities low. Prices also remained low because US domestic wages remained flat throughout the economic boom. With the United States becoming more dependent on foreign goods, American workers had to compete more and more with foreign workers who made enough money to just barely survey. In this environment many US industries had to move overseas to remain competitive. At the same time repressive labor practices in the United States, such as the rise of temp workers(50% of US labor coming from temp agencies) and mandatory overtime, enabled corporations to get more out of their workforces without paying them more.
"New economy" proponents claimed that a technological revolution in the guise of the computer and the Internet had made it possible to have high growth without inflation, but they were mistaken on this. The combination of low commodity prices, a strong dollar, a massive trade deficit, and repressive labor practices in the United States helped to create an environment in which strong economic growth could occur for a time without any inflationary pressures.
It also created an economic boom in which most of the benefits were felt by a small minority of the population: mainly those who owned stocks. Although unemployment reached record lows, income inequality grew. The problem though is that no economy can sustain growth that is based upon monetary expansion and debt. In the summer of 1999, Alan Greenspan and the Federal Reserve Board began to fear that things could run out of control and create inflation. They didn’t think inflation was coming from the labor markets, but from the stock market itself. They decided to target the stock market and create a "soft landing" for the economy by raising interest rates, something they did until March of 2000.
Changes in interest rate policy usually aren’t felt in the economy for nine months. However, this series of interest rate increases were initially offset in the 4th quarter of 1999 by another massive dosage of liquidity into the banking system by an Alan Greenspan who feared that a Y2K computer crash might provoke a run on bank deposits. That liquidity spike helped spark a massive stock market rally that went from November of 1999 to March of 2000. In that time the Nasdaq went up almost 75% and the market capitalizations for worthless technology companies became worth billions of dollars. A monetary and credit bubble became a stock market bubble. The huge gains in the Nasdaq were not signs of economic vitality. When there are not enough solid investment opportunities for money to go into then it flows into the most speculative of ventures. Within weeks the stock market crashed and by the end of 2000 the Nasdaq had recorded its worst year ever.
Once the Federal Reserve’s interest rate hikes percolated throughout the economy in the last half of 2000, the economy began a sharp economic downturn, a process that is continuing into 2001. The Federal Reserve will most likely cut interest rates at its January and March meetings, however, these won’t have much effect on the broader economy for at least another 6 months and most likely 9 months. So the economy will continue to decelerate until the middle of the summer. Corporate earnings will continue to decline. Interest rate cuts won’t be fully felt until 2002. Any tax cuts by the Bush administration will even take longer to make any difference.
There are reasons to think that interest rate cuts will not be enough to prevent a recession in 2001. The record high current account deficit and enormous public debt levels are unraveling as the economy continues to slowdown. With such enormous debt levels and depressed stock prices corporations will be hesitant to resume large investment expenditures. Other economies, such as Japan and Europe, have recently suffered large declines in investment spending after major stock market downturns. There is no reason to think the United States economy will be immune to this.
As I mentioned at the beginning of this article, at the start of last year the question investors had to face was whether or not the Nasdaq had formed a speculative bubble. The question confronting 2001 is how sharp will current economic slowdown be and how long will it last? The consensus of economists and Wall Street analysts is that through interest rate cuts the Federal Reserve will create a "soft landing" and the financial markets will rebound sharply by the end of 2001. Just like last New Year, almost all Wall Street analysts are now forecasting gains for the stock market for the coming year. In my opinion the only soft landing that we will get will be the sound of Alan Greenspan’s head hitting the ground when he passes out in realization of the economic mess he has created. There are two main problems facing the United States economy that there analysts completely ignore: the current account deficit and a falling dollar.
As I mentioned before a lot of US economic growth and stock market gains have been fueled by foreign investment which has created a massive current account deficit which is simply unsustainable. If foreign money withdraws from the US in the face of a falling US stock market and economic slowdown then the stock market and the dollar will face enormous selling pressure. A falling dollar would drive the cost of imports up and create inflationary pressures for the US economy and put the Federal Reserve in a difficult position: managing an economy in a recession with inflation, something not seen since the 1970s.
There is no quick fix for this scenario. The Federal Reserve can’t just press a button and change things overnite. It would take over a year for the economy to recover from its hangover. The entire US culture would lose its confidence with aftershocks felt in the halls of Congress and in the White House.
In the next several weeks the stock market will tell us which direction the economy is going to take. The financial markets factor in the future and lead the economy. They crashed before the economic slowdown began and they will recover before the economy does. There are basically two scenarios to look for: a small rally in the Nasdaq in January and a basically flat year with low volatility until the 4th quarter of 2001 which brings the bulls back or another sharp market downturn in the 1st quarter of 2001 and the continuation of the bear market, interrupted periodically by explosive rallies, into the end of the year. Until proven wrong, I’d expect to see the latter.
January will be an important month for the stock market. Historically the market’s direction in January sets the stage for the rest of the year. In the history of the S&P 500 75% of the time that the market fell in January it had a bad year and vice versa. January has also been good to investors, being the second best month of the year for the stock market, following December as the best. There are reasons for this. People get their end of the bonuses in December, make New Year’s resolutions, and feel upbeat after Christmas. They put their extra cash into the hands of mutual fund managers who put it into stocks.
This year will probably be different. With the market slumping people have been taking money out of their mutual funds instead of putting more money into them. In fact investors took $19.1 billion out of them in the week that ended on December 20th - the worst outflow on record. On the positive side the Federal Reserve is likely to cut interest rates when it meets on January 31st, thereby providing hope to stock market bulls and giving people a reason to buy.
We’ll probably see a relatively flat January until that final week and then a rally into that Fed meeting. The question is how sharp will the downturn be after that. If no soft landing is in sight then the Nasdaq is facing the risk of another crash to new lows and the bear market will continue as people realize that the Federal Reserve will not save them.
I trade in and out of stocks for a living and try to take advantage of short term market swings. The average investor’s best place for his money right now is in savings bonds or money market funds. The coming year is going to be flat at best and a 5-8% return will most likely outperform the stock market and the vast majority of mutual funds. Stock sectors that look attractive are health care, tobacco, consumer staples, beverages, and drug manufacturers. These are "recession groups" which tend to due well during economic slowdowns because they do not depend upon a growing economy for their profits. I wouldn’t buy them at this time because they already had large runs in December and will probably pull back to digest their gains.
Eventually the Nasdaq and S&P will bottom out and return to a bull market phase. The best time to put money into the stock market is when a bull market first begins. You cannot pick out the exact bottom of the market, but there are signs to look for that point to the beginnings of a bull market. I will go through these in the coming months and we’ll look for them together. The patient investor will be rewarded.
One simple indicator which shows that this isn’t going to be an easy process is the 150 day moving average. We need to see the Nasdaq climb above this average for another bull market to appear. As you can see the composite is currently very far from this moving average and the average itself is in a steep decline. It will take months for the Nasdaq to break above this in any meaningful way. There is no hurry to make new investments in technology companies at this point. The good news is that this will give us plenty of time to pick out the stocks that will be the leaders of the next bull market. |
