The Score So Far
Mark M. Rostenko
Hard to believe that the bear market that "couldn't happen" just celebrated its third anniversary. Three years ago as of 24 March the S&P 500 topped out at 1553. Little did we suspect it'd mark any sort of top at the time. In fact most of us, judging from the irrational exuberance of years prior, figured it was just another number to surpass on the stock markets epic never-ending journey into the stratosphere. "Dow 36000" indeed.
Stocks weren't supposed to fall for three straight years and dagnabbit, they certainly aren't supposed to fall for four years. That has almost never happened before so by virtue of Newton's little known "5th corollary of my secret 8th law", ("if it didn't happen too much before and we hope and pray it doesn't happen again, maybe it won't"), we're in good shape for a rousing stock market rally and the end of the bear.
Or are we? While Wall Street statistamathemagicians dazzle us with sophisticated analyses like "it hasn't happened since the 30s so it can't happen now", the market doesn't determine its course based on history books.
It's funny how negative rarities "can't" happen, but "good" statistical anomalies are rarely doubted. We didn't seem to be bothered by the oddity of the stock market rising for twelve years in a row (if measured from its close in late March to the following late March, in honor of our solemn anniversary), something that never happens. But for stocks to fall for four straight years, well golly gee, that would be unacceptable. Can't happen.
(For those who enjoy dabbling in these kinds of statistical impracticalities, here's one to consider: prior to the most recent Fed rate campaign, never since the 30s have two successive rate cuts failed to generate higher stock prices twelve months later. I wonder how many times three, five, or ten successive rate cuts have failed to lead to higher stock prices? At least once, near as I can figure.)
The thing about the market is that it doesn't move based on probabilities, nor based on how many times something happened or didn't happen in the past. Every year in the market is an independent event that will be determined by current conditions and future expectations. Coins don't remember nor care how many times they ended up "heads" in the past. On the next toss, they'll end up wherever they do and statistics have nothing to do with it. The sun will rise tomorrow morning not because it has done so every morning in the past, but for entirely different reasons. So too Mr. Market doesn't peek over his shoulder in late December to determine whether it would be more polite to end the year higher or lower.
Now that we're clear on the fact that the past doesn't determine the future, let's move on to the reality of the marketplace, the factors happening now that will indeed have a major impact on how this fourth year of the bear, or perhaps first year of the bull (ha ha!) will turn out.
The Economy
Let's not bore ourselves with dry data and official statistics. We already know that much of that indicates weakness. Unemployment isn't looking so hot, GDP is nowhere near where we'd like it to be. In fact, just recently our brave new Treasury Secretary John Snow shared with us this brilliant revelation: "I think the economy has slowed somewhat and isn't performing where we'd want it to perform." You don't say! I wish I had access to the high-level propriety government data that led to that conclusion!
Apparently the folks at GM agree with Mr. Snow because they recently announced 0% financing for five years on nearly all of their vehicles. That's not exactly a vote of confidence for the future, folks.
Today's "auto" companies are nothing of the sort. Oh sure, they still make cars. But that's not where they make their big money. In fact, today's U.S. automakers are financing companies. They earn their big profits by selling big loans. "Would you like a car with that loan, sir?" But now GM is trying to sell cars minus the most profitable component of those cars. Sound like a vote of confidence for the economy? Or a desperate measure to roll out inventory at any cost and pull in whatever they can because who the heck knows what tomorrow is going to bring?
That's just another major sign that the underlying state of the economy isn't particularly strong. And now the financial pages are becoming riddled with talk of recession once again. Tech firms are issuing profit warnings again. GDP for the fourth quarter was estimated at an anemic 1.4%.
Now that the war has "ended" and economic reality is regaining the spotlight, economists are discussing the possibility that the Iraq war might not generate the economic boost it was supposed to. Well, "supposed to" according to them. Here at TSS we don't buy into outlooks that have no basis in reality. How is a multi-billion dollar war that generates profits for a few defense contractors supposed to boost the economy?
The short story on the economy is that it's obviously still weak and whatever legs it was still standing on appear to be wobbling, as we'll see later. What the Fed termed a "soft-patch" many many months ago, is still with us. What do you call a two year period that consists of a recession and then a long soft patch? I don't know what the proper term is, but I do know that it isn't "economic recovery."
Consumers Bankrupt, Costs of Living and Debt Rising
That GM 0% financing deal is going to come in quite handy for the nearly half of Americans who are apparently bankrupt these days. According to the Cambridge Consumer Credit Index, 40% of credit card holders are making only minimum payments on their credit card balances. Six percent have stopped paying entirely.
There are only two reasons why a consumer might pay the minimum balance on a credit card. The first is that the interest rate is so bloody low that it only makes sense to pay off as little as possible. But we don't live on Fantasy Island. So we conclude that the real reason is the second: it's all they can afford to pay.
If all you can afford to pay is your minimum balance, that means that you have less money than stuff, and a lot of that stuff belongs to someone else. In other words, you're in debt. Your net worth is negative. Said another way, you're bankrupt. Not officially bankrupt until you legally declare it so, but if you owe more money than you have, if your net worth is negative then you are, for all practical purposes bankrupt. The difference between practical bankruptcy and legal bankruptcy is that in the former, you're still keeping up with your payments. But you're still effectively bankrupt.
With almost half of credit-card holding Americans (i.e. most Americans) effectively bankrupt, do we have the basis for a traditional economic recovery, that is "pent-up demand"? I don't think so. Recoveries happen after a period of slowdown during which consumers tighten up, and limit their purchasing in order to pay down some debt and improve their bottom lines. That creates "pent-up demand" which uncoils like a spring as increasingly financially sound consumers hit the stores, eager to get back to shopping. But this time around, the "resilient consumer" has not curtailed his demand, has not improved his bottom line and has instead gone deeper into debt.
If you want to know why the old rules aren't working, why things aren't improving after twelve rate cuts, why the recovery isn't happening, consider that you won't get a traditional recovery if you don't have a traditional slowdown. These days consumers are acting in non-traditional ways by going deeper into debt, rather than paring down debt. During the 1991 recession consumers lopped $11 billion off their non-mortgage debt. Last year they tacked on $110 billion. Sound like a recipe for economic growth? Or a recipe for financial disaster?
The consumer is the lifeblood of the economy. The consumer is responsible for a big chunk of GDP. Alan Greenspan is relying on the "resilient consumer" to save the economy and his reputation. I don't know that the odds are so good. While the Fed tells us that inflation is tame, the consumer knows otherwise. Costs for heat, gasoline, utilities, water and insurance are rising. Big time.
But the official statistics for inflation are nonetheless low. Why? Because those stats always carry the inane disclaimer "excluding the volatile food and energy sectors" or the ridiculous "seasonally adjusted" statistical massage job. Seasonally adjusted, it never snows up here at 9000 feet elevation in the Rocky Mountains. But excluding the volatile seasonally adjusted sector, I got five feet of snow a few weeks ago!
We're talking about basic, necessary costs of living, non-discretionary expenditures that we have to pay. When gas rises, you don't start taking days off of work to save fuel. When health insurance rises, you pay it, assuming you can still afford it. Water and taxes: pretty much mostly non-discretionary expenditures for most folks, I gotta' believe.
And so the formerly "resilient consumer" is rapidly evolving into the "time-to-deal-with-reality consumer". Consumption has been down for two months in a row. And it wasn't because folks were busy watching the war on TV, contrary to the lame excuses and bogus claims of the intellectually-lazy financial media.
That's the score so far on the consumer front and from where I'm sitting, the consumer isn't winning.
Housing
Gas is up, the cost of heating is up. Even water costs more in many areas as municipalities in drought regions have raised prices in order to discourage consumption. Insurance never stops going up. We're told how wonderful it is that housing values continue to rise. But the officials don't discuss housing's ugly sister: property taxes.
Property taxes are based on home values. The more the local government thinks your house is worth, the more the value rises, the more taxes you have to pay. Meanwhile your wages are the same and nobody is handing you a check because the perceived value of your home is higher. A loan perhaps, but the last time I checked, loans are considered debt and do nothing to boost your bottom line. Anyway, most folks who loan money insist that you pay them back more than you borrowed.
With the "resilient consumer" having gone extinct sometime early this year, housing is the last and only leg this economy has to stand on. Single family housing foreclosures are at a 30-year high. Even while mortgage rates are at a 40-year low! Housing is more affordable than it has been in 40 years, but consumers are having the toughest time paying for it in 30 years! How can this be? Because household debt is at a record level. The average household owes more money than it pulls in during an entire year. Doesn't matter how "affordable" housing is, if you have no money, you can't pay for it.
Americans are in debt up to their ears, half of them are effectively bankrupt and most are likely living paycheck to paycheck in a time when unemployment is rising. And the folks at the Fed want us all to believe that lower interest and mortgage rates and increased borrowing will solve the problem! I'm not a thermodynamics professor nor an expert on volatile substances, but I think there's a reason why firefighters don't pour gasoline on burning houses. Somewhere in there is a lesson that the Fed would be very wise to heed.
The Fed's logic goes something like this: if housing continues to rise and interest rates remain low, consumers can keep borrowing against the imaginary value of their homes and spend that imaginary money (which is actually debt) and thereby prop up the economy. Of course the implicit assumptions are that housing can rise indefinitely and that consumers can afford to spend on toys. The latter, as we know, is rather suspect given the rapidly increasing prices of many necessities. The former is rather doubtful as well.
Housing starts have fallen. Home foreclosures were up 38% for the first quarter in the Denver area. The folks at Bridgewater recently stated that homebuilders' expectations for future 6-month sales dropped sharply in March after having dropped in February as well. From where I'm sitting, it looks as though the housing bubble might finally be popping.
Of course, the Fed will tell you there's no bubble. Just like they used to say there was no stock market bubble. But the IMF warns that housing might be on the verge of a slump following two years of record sales of homes and huge advances in prices. This while the economy is weak and the stock market is down 50%. That's not a bubble? Perhaps not. But logic dictates that home values can't keep rising forever when half of Americans are effectively bankrupt.
The score so far? Housing is still ahead, but is rapidly losing its lead.
War & Pestilence
Economies, markets and the folks who make up economies and markets aren't fond of uncertainty. Ahead of the war, nervous businesses froze hiring and cut their budgets. Business spending is down. All that amid expectations for a swift and decisive victory, mind you.
Yes, it looks like victory in Iraq has been established. But has this war ended or just begun? Will a U.S. presence in Iraq raise greater uncertainties for the future? Very likely.
Let's face it folks. Much of the Middle Eastern community isn't particularly fond of the U.S. While we were busy liberating Iraq from the clutches of an evil dictator, some folks from Egypt were signing up in Saddam's army to defend against U.S. invaders. As were others.
Reading the newspapers and keeping track of world news, it's hard to get a good grasp on who's telling the truth. Do the Iraqi people welcome our efforts? Or do they perceive us as greedy imperialists hell-bent on stealing Iraqi oil? I have no idea. Based on second-hand sources like news reports, I can only conclude that a case can be made for either viewpoint.
But one thing is indisputable: there are enough folks in the Muslim community who don't like us and view our efforts in Iraq in a very negative light. And some of these folks are well armed. Over here, we call them "terrorists". Over there, they're called "martyrs" and "heroes" (by some). There's no way to estimate in advance whether invading Iraq will ultimately have been a good idea or a bad idea. But one thing is certain: it introduces a whole host of new uncertainties into the market and the economy.
We don't know how long the repercussions of war will drag on. Terrorists deal in the currency of violence. Attack them with force, attack "their people" with violence, and if you don't fully stop them, you tend to inflame them, and seemingly "justify" their cause. If terrorists were upset with us before, you can rest assured that they're not real happy about the Iraq war. In fact, a good-sized portion of the Middle East community perceives Saddam Hussein as a hero for standing up against the U.S.
I don't know who's right, but I do know that this war will not end on the day when it's officially considered over. I suspect it will have only just begun. That spells uncertainty and it spells the potential for big disruptions in our economy and markets. What happened on 9/11 hurt us, anything else that might and probably will happen, is certainly not going to help us.
Meanwhile, we're dealing with another, perhaps even bigger uncertainty: severe acute respiratory syndrome, or SARS. Hong Kong is virtually in a panic about this outbreak. Analysts estimate that the costs to that economy will be very real. Cases of SARS have been found in various corners of the world. China, America, Canada, the UK, Singapore, Taiwan, and Germany have all reported cases and/or deaths.
So far folks here in the States aren't too worried about this threat. But it's a serious threat and could potentially be devastating. Tens of millions of people died of a particularly virulent strain of the flu after WW1. These things DO happen. World history has been shaped in part by disease. The Plague drastically reduced the world population.
Am I talking about a new plague? Shall we all hide out and panic? No. But it doesn't take much to push a teetering economy over the edge. Lots of folks have plenty to worry about these days: terrorism, unemployment, bankruptcy, etc. It doesn't necessarily require hundreds of millions of dead people to push the global economy over the brink. All it takes is enough fear of contamination to keep folks from shopping as much, flying as much, or traveling as much.
Folks in Hong Kong are taking the threat very seriously. You've probably seen the news photos of residents wearing surgical masks. The hospitals are full, in crisis. When you start talking "crisis", folks start staying home. The economic costs get very real, very fast.
Who knows how this thing will play out, but one thing is for sure: fear spreads faster than any germ or virus. Germs spread at a relatively predictable rate. Fear is irrational and completely unpredictable. SARS may end up having virtually no economic impact or it could have a huge impact. Only time will tell. But if it continues to spread, if there are any inklings that it's getting out of control, you can rest assured that neither the economy nor Mr. Market will be very happy about it. So far the market doesn't seem to care too much. But that could change on a dime.
The score so far? Uncertainties and highly volatile variables, 1 or 2, economy, 0.
Conclusion
Three years into the bear market and a couple years into economic weakness and the end doesn't seem any closer. The uncertainties have increased and the bulls haven't scored any points whatsoever.
Is a fourth year of market declines possible? Absolutely. Mr. Market responds to reality, to real conditions and expectations, not to statistical probabilities and improbabilities. If the economy slips deeper, if there's a terrorist backlash to a U.S. presence in Iraq, if the world gets sick with SARS, it won't matter much that "stocks rarely fall four years in a row."
Will it happen? I don't know. I never know. I just look at the available information and do my best to figure the score, to figure the odds. Right now the odds remain heavily weighted against an economic rebound and/or a major market recovery. That picture could change drastically in a month or two. But so far, the market isn't betting on it.
We remain mired in a 200-point trading range as we have been since last July. The market is voting on the side of uncertainty and following the admonition "when in doubt stay out." The market hasn't voted for recovery and it hasn't voted for economic disaster either. But if the collective wisdom of the marketplace has concluded "I don't know", I'm not going to argue with it. I won't pretend to know better. Combine that indecision with the score so far and it's not a stretch to conclude that we're not about to turn the corner.
Mark M. Rostenko
Editor
The Sovereign Strategist
14 April 2003
Mark M. Rostenko, a veteran of Chicago's commodity exchanges and editor of The Sovereign Strategist, spends far too much of his time enthralled by the never-ending procession of inane prattle emanating from Wall Street. Nonetheless, it hasn't stood in the way of accurately forecasting the dollar's top, the beginning of the gold bull market, and nearly every significant turning point in the stock market since the bear market began. Please visit www.sovereignstrategist.com for a free sample issue and more commentary. And while you're there, feel free to join our international family of well-informed and successful investors.
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