Monday, March 2, 2009

Deflation, Depression Drumbeat

Everybody Limbo! How low can she go?
  • On April 28, 1997, the Dow closed at 6783.02

  • November 1, 1996, the S&P closed at 703.77

  • The NYSE Composite closed at 4378.48 on February 11, 1997

  • The NASDAQ is still above its November 20, 2008 close at 1313, so, after that, the next closing low will be May 2, 1997, at 1305.33

Today's closing numbers, seen below, are close to those levels, so the financial news junkies will be saying the stocks fell to their lowest levels since 1997, or the worst in 12 years.

Dow 6,763.29, -299.64 (4.24%)
NASDAQ 1,322.85, -54.99 (3.99%)
S&P 500 700.82, -34.27 (4.66%)
NYSE Composite 4,360.99, -256.04 (5.55%)

These kinds of comparisons serve almost no useful purpose, except to jangle our memories to recall what life was like back then. Here's an idea. Tiger Woods was in his first year as a professional golfer. Since then, Tiger's done well by simply plying his craft and parlaying his popularity into lucrative endorsement deals.

The point is that investing - especially in times like these - is not for everyone, while working hard and seizing the financial opportunities that may present themselves is probably a more fundamentally sound plan. Saving 10% of your income doesn't hurt either.

What is more useful is looking at the relative price/earnings ratios and dividend yields during boom and bust periods. Conventional wisdom dictates that stocks are risky when p/e ratios are above the 12-15 range and good buys when they are 5-10. The bottom comes when these ratios reach a cumulative 5-7. They are currently around 8-10, so the bottom is close at hand, numbers-wise.

As for dividend yields, a 7% compounded return doubles your money in 10 years, but with interest rates running at or close to historic lows, anything over 7% should be viewed with some degree of skepticism. Either the underlying stock is still falling or the dividend may, at some point in the not-so-distant future, be cut.

Either case will dampen your overall return, so stocks which are paying a dividend yield around 3-5% are likely to be good bets. Their price may improve (or not fall much more) and their dividends are likely to remain intact.

While I think it is still too early to call a bottom of any sort or time period, I am on record for calling the bottom at Dow 5267 sometime later this year, probably between August and November. Noting that, I may be completely wrong. We may be only at the beginning of a period of prolonged economic distress, in other words, a Depression-like decline.

Some are calling for the Dow to fall to 4000, others, below that. Remember that during the Great Depression, which lasted anywhere from 8 to 10 years, from 1929 to 1938, stocks lost 90% of their value. The very worst years of the depression, from a day-to-day "life sucks" standpoint, was from 1931 to 1935, when unemployment peaked and remained high and death, disease and rampant poverty was the order of the day.

Back in the 30s, people starved, froze to death, and suffered from a wide assortment of maladies many of which today have been eradicated by modern medicine. Considering the dynamic economy in which we live and the incredible amount of government aid available, it seems unlikely that many today will stave or freeze, though many will die of heat stroke, especially the elderly who try to save on cooling costs by turning their air conditioning off during the summer.

While I continue daily to paint this "doom and gloom" scenario, be reminded that today's calamity was caused by just one more market event - AIG's announced $61 billion loss in the last quarter and the government throwing another $30 billion at the company. Somebody please tell me how any company can lose $61 billion in 3 months time. On one hand, it's ludicrous and without precedent. On the other hand, how much of these "losses" are merely papering over a bottomless pit of credit default swaps and other cross-party derivatives.

AIG was the king of insurance and the leader in CDS, which are essentially insurance against bond defaults. With defaults still at inordinately-high levels (and growing, according to some), AIG doesn't have to funds to cover their own bad paper. AIG is no sideshow to the banking crisis, it is at the heart of the crisis.

Until AIG's problems are solved, or until the government comes up with a better idea than to just continue pumping good money down a sinkhole, nothing will change. Wall Street banks and AIG blew up the world financial system and there needs to be a fundamental shift in how the system works. Investigations of the CEOs and other executives at the tops of the firms are necessary, and they should lead to prosecutions and jail for the perpetrators, many of them household names by now.

The point is that bad news continues, unabated, nearly every day. This week will be no different. Tuesday, auto and truck sales for February; Wednesday, private job loss numbers are released by ADP; Thursday, new unemployment claims; Friday, Labor Department's Non-Farm Payrolls. All of the figures are predicted to be dire, so any hope for a rally needs to be moved back a few weeks, or months, or years.

On the day, one of the most one-sided ever witnessed, declining issues beat advancers by a stunning 9-1 ratio, 6036-675. New lows danced on the graves of new highs, 1479-11. Volume was again very high, as investors scramble to get out of way of the rampaging avalanche of burning paper holdings.

NYSE Volume 1,967,912,000
NASDAQ Volume 2,336,813,000

Not a single Dow component registered a gain. The worst were Citigroup (C) 1.30, -0.20, -20.00%; General Electric (GE) 7.60, -0.91, -10.61%; Alcoa (AA) 5.49, -0.74, -11.88%; General Motors (GM) 2.01, -0.24 -10.67; American Express (AXP) 11.06, -1.00, -8.29; Caterpillar 22.17, -2.44, -9.91% and Bank of America (BAC) 3.63, -0.23, -8.10.

Commodities exhibited all the symptoms of a deflationary spiral. There was no one single commodity higher on the day. From natural gas to coffee to feeder cattle, everything was down. Oil got hammered on persistent demand concerns, down $4.61, to $40.15. The precious metals fared better than most, but still, gold lost $2.50, to $940.00. Silver lost just 2 cents, to $13.07.

Today was one of the most disheartening in a series of such. Nothing, not the government, nor Warren Buffett, nor Barack Obama, nor the Fed can stop the freight train of deflation, wealth destruction and decline.

We might as well accept the facts: We are already in a depression. We are beyond the state of denial. No investment is safe.

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