Monday, January 21, 2008

Stocks Tank Worldwide. Is This the Big One?

Are we setting up for The Big One?

While America was taking the day off in honor of Martin Luther King, Jr., one of our nation's greatest defenders of liberty, equality and justice, markets around the world were crashing from the after effects of the credit crisis and now the looming confidence crisis in the USA.

This article tells most of the story, but the reality won't hit the US shores for another 12 hours. By the time US equity markets open, the Asian markets will have gone through another day and Europe's will be well into their afternoon sessions.

Some of the drops on Monday were shocking:
Britain's FTSE-100 -5.5%
France's CAC-40 -6.8%
Germany's DAX 30 -7.2.
Hong Kong's Hang Seng -5.5%

The meaning in all of this for US stocks is disturbingly real, since all of the declines worldwide are keyed to the fear of a US recession. As the so-called buyer of last resort, the US bears the blame and also will likely suffer consequences equal or worse than those of our fellow capital-intensive countries. After all, the recession is going to happen here first.

Shades of the Great Depression

While the actual causes of the Great Depression are still the focus of argument among economists, what remains clear is that most of the world was plunged into an economic abyss after the market crash in 1929.

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The actual extent of the damage to capital markets is still unclear at this point, and while not wanting to be alarmist, I've remained steadfast that the subprime mortgage blow-up was more of a trigger than an isolated event. So far, with the Dow already off more than 14% since the October peak, I've been right. And now it appears that we are in the second phase of a bear market, where losses are the steepest.

Where this is all headed is in the wrong direction. Using Fibonacci calculations of 33, 50 and 67% declines from the previous gain (roughly 6800 points), the declines would be of the order of 2244, 3200 and 4690 points on the Dow.

With the Dow already close to that 2244-point decline, I had expected a bounce and the gains on Friday morning might have been all there was. That makes the next stop around 11,000, and if that breaks down, somewhere around 9500 may be the bottom.

It could get worse, however, if, as anyone paying attention might recall, the stock market began its tremendous bull run at the start of the Iraq War in March of 2003. Considering the massive fiasco that campaign has devolved into, might there be some coupling of the market gains to the war "effort" and if so, what have we wrought but death, destruction and about a trillion dollars in wasted spending?

The last 4 1/2 years of "prosperity" might have been an illusion. If that's the case, we're in for some hard times indeed.

If the Dow drops below 9500 and begins to head for the 7500-8000 area, it could portend catastrophe, not only for the stock market but for the US and possibly all other economies.

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Retracing the missteps of the Great Depression, government was found either powerless or ineffective in stopping natural economic forces from occurring. We may be seeing a similar scenario today. Despite three rate cuts by the Federal Reserve amounting to a total of 1%, stocks still lost considerable value.

Now, world reaction to the US government's plan has been met with skepticism if not outright disapproval. Since investors and economists are generally better-equipped than government bureaucrats and politicians to read the "tea leaves" correctly, the instinctive selling by the cognoscente may have already begun. As usual, the really smart money has gotten out of the way earliest.

We may be in the earliest stages of a cataclysmic economic event. Remember, during the Great Depression we had the relative security of the gold standard. Such a limiting mechanism no longer exists in the leveraged world of floating currencies.

If we are indeed going to hell in a handbasket, the signs should be easy to discern and some have already appeared: inept politicians, secrecy and distrust within the banking community, a continuing decline in stocks with only brief respites, falling prices, falling currencies, disruptions in trade and commerce, business failures, bankruptcies, municipal budget pressures, massive real estate foreclosures from delinquencies on mortgages or taxes or both.

Inflation may turn out to be the least of our worries. The temporary advance in prices may turn out to be chimeric as the real devastation of slack demand takes hold in coming months. Inflation can be beaten back. A cyclical deflationary spiral is a demon for which nobody is prepared to confront, but we're fortunately not there yet.

A couple of months ago, I mentioned that some people might consider cashing out their IRA or retirement funds, even if it meant losing 20% of the portfolio's value as a penalty. Today, that almost looks like sound advice, especially if you're invested in an indexed fund. Since August or October, you may already be down close to that 20%. Wouldn't you rather have whatever's left in your control, rather than that of a fund manager who is likely to be chasing profits where none exist?

I am not a pessimist. I am a realist and I only present the views as a cautionary tale. If the worst is yet to come and the economic reality is more severe than most of us wish to imagine, it's far better to be forewarned than caught in the snare of an economy biting the dust.

Is sure hope my father reads this. Despite my constant warnings, he continues to play the market long and loses. I fear for his economic fate, but more for the welfare of those under 18 who don't already have a place at the table, but will be picking up the scraps.

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