11/30/2011 6:15 PM ET|
Has the new bear market arrived?
Yes, stocks just had a big up day. But growing debts and tighter budgets here at home and in Europe are leading us toward a new recession and a prolonged downturn. In fact, we may already be there.
The bank bailouts and stimulus efforts of 2008 and 2009 gave us a shot at getting the global economy revved up before booming debt in Europe and the United States choked it off.
It was a race against time. We needed the economy to outgrow our rising burden to creditors, be it Chinese sovereign wealth managers or domestic pension funds and bank executives. And 2010 looked promising, with most of the economic numbers picking up.
But after the problems we've seen in 2011 -- including an energy price spike due largely to the Federal Reserve's stimulus efforts and the Arab Spring, economic head winds from the Japanese earthquake, political bickering in Congress and the European debt crisis -- I'm afraid we've missed our chance.
It didn't have to be this way. There were glimmers of hope in June and July, and again in October. Yet they faded like the winter sun as politicians shied away from tough choices and businesses remained cautious. A new recession and a new bear market for stocks now appear unavoidable.
Scarily, recent evidence suggests the downturn has already started. Although stocks are down only around 10% from their May highs -- below the 20% decline that commonly defines a bear market -- I believe the shift has already happened. Stocks have been locked in a downward pattern for the better part of the year. And, as I'll explain below, internal measures of market strength are flashing warning signals.
Yes, the Federal Reserve and the European Central Bank did act on Wednesday to try to ease dollar funding in Europe, and markets rallied. But this merely delays the inevitable and does nothing to fix the solvency problem in the eurozone. The West, including the United States, is on a path to debt destruction, plagued by tepid growth and the lack of political will to raises taxes, cut spending or do both.
There is simply too much debt to be serviced at rapidly rising borrowing costs. Helping banks with their day-to-day dollar funding merely treats a symptom, not the disease.
Mind you, I hate to sound so bleak; I've never been part of the run-and-hide crowd, in investing or in life. But without a course correction, this isn't going to be pretty. In fact, it's already getting ugly.
The new recession's epicenter
First, let's talk Europe.
In late October, under intense pressure, eurozone leaders huddled in Brussels to hatch a plan for a 1 trillion euro ($1.35 trillion) insurance fund to attract new capital from overseas and pay for possible bailouts for Italy and Spain. It was the latest in a long line of incremental moves that have likely doomed the euro.
The idea was convoluted from the start. With the Continent's bailout fund -- known as the European Financial Stability Fund -- down to just 250 billion euro, the plan was to leverage it up four times using loan guarantees and special investment vehicles to lure private capital. The money would then be used to go out and buy eurozone government debt.
Ostensibly, this additional rescue funding would give the governments of troubled European governments the time they need to enact painful tax hikes, spending cuts and economic reforms such as higher retirement ages and lower wages and benefits.
The trouble is that governments that inflict such pain on their people don't tend to stay in power. Leaders in Greece, Italy and Spain have all been replaced this month as voters rage against austerity that makes it harder to put food on the table. Ireland, under pressure from pensioners at home, is seeking to renegotiation its 85 billion euro bailout. And protesters have taken to the streets in Lisbon as Portugal warns its 78 billion euro bailout isn't enough; it may need 100 billion instead.
So the bond market has staged a revolt of its own: It is increasingly unwilling to fund Europe. Borrowing costs have surged across the eurozone, with Italian two-year bond yields jumping from around 3% back in August to nearly 8% this week. (Yields rise as companies have to pay more to attract creditors.)
For Italy, the world's third-largest issuer of government paper (behind Japan and the United States) with nearly $2.6 trillion in debt, these levels are crippling.
It gets worse. Italy's contribution constitutes 20% of the European bailout fund. If Italy is in trouble, private investors have to question the viability of the fund itself, and of any plans to leverage it.
France, another key contributor, is also coming under pressure. French financial newspaper La Tribune reported this week that Standard & Poor's is within days of revising France's credit outlook from stable to negative -- the first step in a possible debt downgrade.
The European Financial Stability Fund itself, as it was originally structured, is already having trouble raising private capital. Earlier this month it delayed a bond auction due to adverse "market conditions" before finally using its own money to buy its own bonds to complete the auction. Embarrassing.
As a result, eurozone leaders are acknowledging their expanded EFSF will be able to come up with only around 500 billion euro, and that only by becoming increasingly reliant short-term funding -- of the kind that sank Bear Sterns, Lehman Brothers and MF Global. Oh, and it won't be operational until January.
Too little, too late.
All the while, France and Germany continue to push for "more Europe" as a solution to the eurozone crisis. That means moving toward tighter fiscal integration that would require spendthrifts like Portugal, Greece and perhaps Italy and Spain to give up national control of their budgets.
With violent protests and fallen governments across Europe, driven by a powerful backlash against austerity driven by taskmasters in Brussels and at the IMF, it's hard to see how this plan would ever get off the ground. More likely, it would splinter the eurozone.
In the meantime, Europe is swan-diving into a deep new recession as its financial markets seize. Economic weakness will just make the debt problem worse.
Look at Italy. According the calculations by the Financial Times, a 4% borrowing rate on a 120% debt/gross-domestic-product ratio (an optimistic scenario) would require the Italian economy to grow 5% a year just to keep its debt stable. At current borrowing costs of around 7%, growth would need to be 8.4%.
Estimates by the Organisation for Economic Co-operation and Development put Italy's growth at just 0.7% this year and negative 0.5% in 2012. At this point, the math just isn't working anymore.
One final point here. Société Générale analysts estimate that it would cost Europe 1 trillion euros to bail out Italy and Spain over the next four years. In exchange, both countries would be on the hook to the rest of Europe for amounts greater than what Germany was forced to repay in reparations after World War I in today's money -- and would likely be forced to forfeit sovereign control of their budgets.
As you know, a popular backlash over the economic turmoil caused by the Treaty of Versailles, with similarly austere provisions, led to the rise of Adolf Hitler and the Third Reich. And yes, I know how that might sound, but this is a serious situation.
Shock waves at home
If Europe goes down, the United States won't be far behind. Bank of America/Merrill Lynch economist Michelle Meyer wrote in a note to clients recently that if Europe descends into a full-blown financial crisis, she expects the U.S. to fall back into recession. She puts the odds of recession at 40%.
We've got our own problems, too. The failure of the congressional supercommittee to agree on $1.2 trillion in budget cuts has further sullied the waters in Washington and makes any kind of meaningful policy compromise between now and the 2012 elections unlikely.
It also sets the stage for a fiscal tightening next year as tax cuts expire and government spending decreases -- putting the brakes on the economy at exactly the wrong time. J.P. Morgan Chase economists say we'll take a 3% hit to the GDP as the payroll tax credit disappears and unemployment benefits fall back to 26 weeks, from current, federally supported levels of up to 99 weeks.
With the economy growing at just 2% annually, a 3% hit would push us back into recession.
Canaries in a coal mine?
As all this plays out, stocks and other risky assets remain well off their May highs and increasingly appear to be in the grips of a new bear market.
I know this is a big shift from some of my past positions. But ahead of the supercommittee failure, I also asked "Will DC wreck the economy again?". I fear it already has, with plenty of help from Europe.
There is a lot of evidence to support the idea that the 2009 bull market ended when Seal Team 6 shot Osama Bin Laden on May 1 -- zinging the U.S. dollar higher and causing disruption as hedge-fund types scrambled to close their bets against the dollar.
Things have remained extremely volatile since. All the while, internal measures of market health look very similar to what happened early in the last big downturn. Take a look at these two charts for examples:
Economically sensitive stocks have been lagging less-sensitive stocks for the better part of the year -- a performance not seen since the 2007-2008 downturn. This kind of thing happens when investors grow increasingly worried about the economic future and move into companies like Kimberly-Clark (KMB, news) instead of Caterpillar (CAT, news). They prefer exposure to a necessity -- toilet paper -- instead of heavy construction equipment.
This is a hallmark of bear markets.
There's other evidence, too. Commodities, particularly industrial metals like lead and copper, keep moving down. Selling is heavy as people simply pull money out of stocks; the New York Stock Exchange Advance-Decline Volume measure, which tells us how much money is flowing into rising stocks, has been posting lower highs and lower lows. Even investment-grade corporate bonds are under pressure as investors weigh the risk of higher defaults in a new recessionary.
As for fundamentals, Credit Suisse equity strategist Andrew Garthwaite believes Standard & Poor's 500 Index ($INX) earnings-per-share growth will stall next year on weaker economic growth, rising costs and a stronger dollar.
What's really catching my eye is the way the S&P 500 has dropped more than 5% below its falling 200-day moving average. The last time this happened was in early 2008. Before that, it happened in late 2000. It also happened in the 1937 "double-dip" that made the Great Depression so bad. Each marked the beginning of a waterfall bear market collapse.
What should investors do?
I've been advising trade-minded subscribers to my newsletter and readers of my Top Stocks blog posts on ways to try to catch the market's ups and down for the last few months -- ups and downs that are set to continue, and require quick action to try to play. (Advice along these lines in this weekly column would likely be out of date by the time it's published.)
For average investors, it's much tougher, because stocks are moving based on macroeconomics and politics. Even good companies can get hammered. And there are few attractive alternatives. Treasury yields are in negative territory and are likely to underperform over the long haul.
So for now, hang on by holding off on new stock purchases and moving capital out of stocks and risky bonds and into cash.
At the time of publication, Anthony Mirhaydari did not own or control shares of any company mentioned in this article.
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American banks are fragile because they have billions in non performing mortgages and loans outstanding. Millions have homes that are underwater and many are simply walking away from their debts. Unemployment is at about 9% and isn't budging. Cities and States are in the hole for hundreds of billions in defined benefits plans for too many state and municipal employees. Recent college graduates are holding massive student loans and are back with their parents attempting to pay off loans for dubious degrees that may never help them obtain employment.
So, folks, the entitlement society is coming to an end because it's time to pay the fiddler. Except there isn't enough money to pay all the debts. Everyone could roll over their debts forever I suppose, but no one really believes that's a good solution. Thus, we muddle along.
This article, posted at 6:15 PM, got to thinking about what Friday will bring. It takes two days for our 401k transactions to post and I'm wondering whether people ran home from work and moved all their money into stock funds that will purchased tomorrow after the markets close...just in time for a 500 point drop on Friday's open. These 3-5 percent swings could be very profitable for someone who could time them correctly.
Lately I'm feeling like a plucked goose about to be popped into the oven for someone's Christmas dinner.
hmmm... W's tax cuts cost 120 Billion a year at the most. They were basically a 2% reduction across the board.
Over 10 years thats 1.2 Trillion. The 2 unesssary wars are estaimated to have cost 1.5 Trillion. (1.1 Trillion under W, .4 Trillion under Obama). That totals 2.7 Trillion. Mr. Obama's deficit SPENDING will total over 5 Trillion by years end. (10.2 Trillion when he too office, 15.1 Trillion today).
Yes, by all means LET the W tax cuts expire! Everyone will then contribute towards that 120 Billion extra revenue. This utter nonsense proposed by the Donkeys to future slash Social Security taxes is nonsense. We need to INCREASE SS and Medicare taxes.
But don't think for one minute letting the W tax cuts expire will even dent Obama's massive SPENDING increases.
We need to SLASH spending back to W's levels of 400 Billion.
Too little too late.
Unfortunately .. the statement might be correct .. given that the euro zone leaders have still not completed the necessary steps for the path to solvency. It is the fiscal policy that is in need of immediate attention .. both in Europe and here in America. Congress is in the power-room, and Europe hasn't woke up yet .. and Cinderella's witching hour is about to turn her stage coach into a pumpkin.
Imagine this analogy, you are the breadwinner in your family and your wife and kids are used to getting everything they want. You can no longer afford to give them everything they want and for years you have been going deeper into debt in order to give them everything they want. It begins to reach a point that the payments on your debts are getting to the point that you are having a hard time to pay the minimum payments.
You talk to your wife and kids to explain to them why you need to cut back on spending and they don't understand the problem because they never see the bills and don't understand such big numbers. They think you just no longer love them anymore and don't understand why you would want to make them unhappy. Your oldest kid tells you that you should spend less on his kid sister because she does not need all those dolls. The daughter says that you should cut your spending by taking the car away from the big brother. The wife says you should eat out less and cancel the home security system because it does not do anything anyways but make beeping noises. The wife and kids all agree that you need to make more money and then there would be no problem at all.
If you cut back on the spending as much as you need to your wife will dump you and the kids will disown you. You will be living on the street alone and your wife will get a new husband that will promise to continue spending the money on her and the kids. That guy will see the old husband warming his hands over a trash can fire in a parking lot and will not cut back the spending as long as money is still available. That man will steal, fight, and do whatever he can in order to keep spending until the money is no longer available. When the money is no longer available the poop has to hit the fan.
Too bad our leaders are more concerned with being re-elected than saving their country. Too bad we are so averse to pain that we would rather die. The pain would be now and since we can't see past the edge of our nose the imminent death is irrelevant and we will deal with it when it comes.
Overall education and basic home education will have to be addressed. Teaching the young people how to reduce child production when there is no roof or food on the table.
Our future outlook is meager. Birth control is still considered a sin by most politicians, while 20 kids per family is featured as glory to God. No talk about our future generation, their aspiration, and support to family education that will deliver high social skills. Religion has not faced the threat of the current population explosion in the unprivileged group of our society. Same can be said about sexual abuse.
Wake up America. We have our serious problems. Do not blend our problems with or into the European problems that are just as severe but based on different issues. ( For the most part).
We have the opportunity to attack and solve our issues without creating an other war somewhere else! Lets not get sucked into this by Middle Eastern issues or for religious based ideologies .
We will respect religions in our homes. We will respect freedom of speech in our country. But we should keep Congress responsible to manage our country without any special interest to religions.
Preserve the Venture Capital system, the backbone to innovation, progress to feed, nourish our people and ultimately to the energy of science.
Lets respect people in search for a just America and for the other part of the world.
Bush tax cuts increased income tax revenue by 40% in 4 1/2 yearsNice try but I'm not buying that! Two wars and socialized housing created economic expansion that increased tax revenues but did not pay for the cost of the wars or tax cuts. There's always statistics that support one more more points of view. Bush's strategies expanded US debt by $7-10 trillion that wasn't offset by tax revenue. It's fun to cherry pick your statistics.
as for you and your opinion tony, what are we going to do with you?
rewind a few weeks back and then what will you be posting if the S&P peeks through it's 200 DMA??? will you once again become an instant "technical" bull, throw out all of the fundamental analysis and tell everyone to jump on the bull bandwagon yet again??
are you also the policy adviser to mitt "they call me Flipper" romney??
I'm not sure what you mean about tying to income?
If you have currently paid in the maximum Social Security taxes during your lifetime your benefits are defined to be about $2000 a month. If your passive income, not wages, are over $25,000 then up to 85% your SSA benefits are taxed at normal progressive income tax rates. That's not the way ot used to be but it's reasonable Some states also follow that rule and some don't.. However, there are those who would like to actually take away your SSA benefits based on your income or wealth. Nothing should limit your benefits. Even Bill Gates should get his benefits he contributed to and earned. He's paid plenty of taxes.
Property tax (on housing) keeps middle income Americans from accumulating wealth
Watch out that's a double edged sword. Most property taxes go for schools. Why should childless and single property owners pay school taxes? You've basically got a socialized education system that', like many other socialized systems, isn't providing the quality that more spending keeps promising. Why should retired seniors pay school taxes. Many opt out by moving to local areas that have low property taxes or buy RVs. It's fun to have other people pay for your hobbies. Socialists thrive on that!
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