Opinion: New thinking needed - until at least 2015

Opinion: New thinking needed - until at least 2015

By Neville Bennett

I am perturbed that some commentators are asserting that equity markets have bottomed, and the long anticipated rally is underway. Their evidence is a good week: stimulated by the zombie Citibank claiming a couple of profitable months! There may be several good weeks to come for all I know, but there is no credible evidence that the bear market has passed. Caveat emptor! Indeed, I believe the bear will dominate for several years.

The present bear market rally, or "dead-cat bounce", will end in tears for those who gamble on this market which is still in panic (if you Google a VIX Chart).

Markets will suffer more set"“backs, and perhaps another bounce later this year as the Obama stimulus spending reaches its peak. That too will fade. Hedge funds may make money by riding the rally up and then shorting it on the way down, but ordinary investors could be pummeled.

 

 

This does not preclude buying in special situations.

I am personally buying oil, like the look of some techs like Cisco, and think some financials could be oversold. But I have also sold stocks in the last month.

The enormity of the present economic debacle or its historical significance is not understood. Expecting a rapid recovery, as some are doing, is wishful thinking. Times have changed, an era of excess has halted and it cannot be easily restored despite stimulus packages. There are raging, rampant economic forces which governments and central banks tremble before. Unwittingly, the world has caught Japan's deflationary virus.

A New Era

An "Age of Moderation" was struck down in July 2007. Confidence collapsed. The financial system became too saturated by debt to absorb the paper generated by the buy-outs of Boots in the UK and Chrysler in the US. The investment banks choked because they could not sell off the paper they normally flicked on. Their profitable pass-the-parcel game of collateralized subprime also choked in a massive spasm.

Within a year most investment banks had lost their autonomy and the credit instruments they had created, notably CDO (which are now worth 6c in the $) almost destroyed the great banks in the US, UK, France, Germany and Switzerland. The collapse of Lehman's was more than a death of an era: it may be the death of an age.

Strategy

If a recovery is not close, a different type of thinking is necessary to cope with a very unique situation. I believe that any investor will do well to keep their wealth intact over the next five years.

This calls for very clever portfolio selection and management.

The emphasis has to be less on yield. That was the previous era's obsession. The focus must now be more on risk and sustainability. The investor has to ask: "How can I preserve my wealth over the next five years?' It will not be by repeating the mistakes of the past era! Perhaps not by promoting infinite growth and accelerating consumption.

Rationale: cycles

Both bull and bear markets never produce straight increases or decreases. Both have their smaller cycles affecting days, weeks, months, years and so on. Sometimes there is a correction in a bull market, lasting on average about eleven months. Bear markets also have rallies.

Space does not permit a long discussion of major cycles, but the evidence is consistent with a Kondratieff cycle  beginning in the mid-1980's, peaking in 2000-2001 and commencing a long bear market. The length of the bear phase is unknown but my pick is about 2015.

The relevance of a Kondratieff is neither here nor there; it will take years of deflation to overcome current massively inflated asset prices. It will take time too to restore household balance sheets so that consumption can increase. There can be no sustainable growth until public and private debt is reduced to manageable levels.

Rationale: housing

Housing continued to decline in price in major markets. In the US the Case-Schiller Index is now back to 2005 price levels. Median value fell 11.6% over the year, the biggest drop in records going back to 1991, according to the Federal Housing Finance Agency.

US housing starts fell 16% last month to an annual rate of 550,000, the lowest since the government started compiling statistics in 1959. Foreclosures are at record levels of 2.6 million in 2008.  This is to be expected as one in six mortgage owners are "under the water". Over-supply will wreak prices for years to come. As the greatest falls came in the last quarter, so I believe the housing crisis is gaining momentum. In the UK, this annual change is -17.2%.

In the Americas, Europe and Australasia many households are burdened by housing debt, leaving little discretionary income for other consumption.

Rationale: global recession

Ben Bernanke, who has an excellent grasp of history, says the world is suffering its worst financial crisis since the 1930's. He is not talking about a recovery now, but says if there is to be one, there has to be financial stability.

Can anyone say we have financial stability now? Not when banks are being nationalised, and still hold so many toxic assets that the authorities may set up a "bad bank' to hold them.

The full horror of the banking story has not emerged. Many European banks have monstrous exposure to toxic undeclared CDO. These are undeclared because their accounting standards lack the mark-to-market regime which decimated American banks.  We also know that European banks are absurdly exposed to poor loans to Central and Eastern Europe for housing and current account deficits.

Rationale: production

Economic activity is collapsing in manufacturing. China is paying companies to produce without markets. Japan and Korea report devastating falls in production. Global manufacturing (like cars), and construction are deeply distressed.

The global economy is cooling at unprecedented speed. The world economy has wilted. Unemployment grows as consumption falls. There cannot be not be positive economic growth for a long time until inventory is cleared, productivity increases, business and household balance sheets restored, confidence returns, and capital investment renews.

Conclusion

Warren Buffett was bullish on shares. Not now. He shakes his head and says "the economy has fallen off a cliff". This is a suckers rally, like that of 1930.

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*Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.

 

 

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