Jun 2 2010
Is it safe to get back into the water?
Seems to me that many analysts, advisors, and media outlets that are bullish on domestic stocks, believe the market correction that we’ve experience over the last several weeks is over. Market pundits points that the markets are oversold – a technical analysis term describing a stock (or market) falling too far and/or is underpriced, i.e. the over-supply (and lack of demand) caused the price to drop rapidly to find equilibrium. Their anticipation is that prices will level and then rise.
Is the market decline over? Are stocks ready to rebound?
In my opinion, NO, not in the long-term. I do expect a short-term rebound over the next several weeks based on the following:
- European debt has received a trillion dollar rescue plan placing a backstop on the Euro. The silver lining is a lower Euro will boost the competitiveness of European exports and tourism. Further, the leverage tied to the sovereign debt is very different than the financial crisis. For example, Greece’s debt to GDP is 1 to 1, while at Bear Sterns and Lehman Brothers it was 40 to 1. Similar concerns of Dubai and Iceland debt emerged last year, however, no new issues of late have emerged.
- China’s growth remains on track and the weakness in Europe may keep Chinese officials from invoking further measures to slow their economy.
- The outlook for The Fed to raise rates have been pushed out to 2011.
However, the declines in May have been too broad and too across the board for a meaningful, long-term rebound. I’ve been talking (and writing) for over a year about the excess debt in the economic system and the fact that this debt will have to be dealt with sooner or later. I believe that the markets and investors are realizing that fact. Further, the more aware people become of the circumstances and consequences of excess debt the more likely the markets will continue to decline.
I have maintained that the stock market rally over the last year was a bear market rally. A few of my colleagues and a few clients believed I had become a perma-bear and “lost my marbles.” Most believed that economic rescue plans (Keynesian Theory) implemented by the government was/is turning things around and the next great bull market had begun and rising stock prices were here to stay. While it was tough to maintain and defend my position through the first several month of this year, there is growing evidence that I may be right.
While I believe there will be stock rallies along the way, I believe the market technicals and fundamentals point to a longer-term decline . While I don’t have a crystal ball, there are a number of drivers that are of concern:
- Financial reform legislation has weighed on the Financials sector.
- China’s measures to slow growth have been raising fear of slowing the world economy into a recession.
- In May there was a decline in the Index of Leading Indicators, the first decline in a year.
- The biggest issue currently affecting the markets has been the debt problems in Europe and fear of another global credit crisis.
- Potentially problems in the future are bank balance sheets. Due to the suspension of the mark to market rules accounting rules bank balance sheets are sheer fiction. Banks are holding bad debt on their books, uncollectable loans that are reported at the loan’s face value on the balance sheet. Eventually the day of reckoning will come.
A Dangerous End Game
The Fed and the Obama Administration are playing a dangerous game. Bernanke et al (The Fed) has printed trillions of dollars (and will continue to print trillions) in an attempt to forestall deflation and attempt to re-ignite the economy. Plan A – grow our way out of the recession, it worked before, but will it work again? What happens when the market begins to balk at high, unsustainable national deficits? What happens when inflation does return? What will happen to the dollar? How high will tax rates rise?
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