October 15, 2008
Some encouraging developments
Plenty of gloom out there if you're hungry for more. But I wanted to pass along a couple of developments this week that give me some hope.
First, via Rebecca Wilder and Arnold Kling, the Federal Reserve's H8 statistical release shows a big increase in real estate loans held by large commercial banks during the last week of September. There's likely a mechanical explanation in terms of some reallocation of security ownership during the recent turmoil. But if there has also been an increase of direct lending, that would be a promising development.
Whatever the meaning of those numbers, let me separately suggest that the recent dramatic drop in stock prices means that equities are more reasonably priced today than they have been at any time in the last decade. I am speaking from the perspective that the true value of a stock is the claim it represents on the discounted present value of future earnings. Stock prices have fallen much more than a reasonable projection of long-run earning potential, with many stocks offering a dividend yield today that is not far from the coupon yield on bonds. Once we get past the current economic challenges-- and we will-- those dividends are going to grow with inflation and real GDP, whereas coupons remain stagnant.
Capital Chronicle notes that Yale Professor Robert Shiller tries to capture the long-run value of stocks by taking the ratio of the current stock price to a ten-year average of recent earnings. On the basis of that long-run price-earnings ratio for the S&P500, you'd say that stocks today are a better buy than they've been at any time since 1995.
Granted, the economic picture is going to get worse-- perhaps much worse-- before it gets better. But the best time to buy stocks is 3 to 6 months before the recession is over. The last two recessions each lasted for 8 months. The current recession I believe began in December, which makes it 11 months old already. The longest postwar recessions on record lasted 16 months. This one could well go longer than that, but even if it does, this might not be a bad time to start buying.
Posted by James Hamilton at October 15, 2008 09:59 AMdigg this | reddit
Whatever the meaning of those numbers, let me separately suggest that the recent dramatic drop in stock prices means that equities are more reasonably priced today than they have been at any time in the last decade.
This is only true if you ignore the actions of government. Fundamentals of the market are acutally great, but government intrusion is worse than anytime since the Great Depression.
I don't think we can compare this downturn to any since the Great Depression. Never have we had so much attention focused on inflating our way out of the problem and holding up falling prices.
Stock market prices are reasonable considering the prospects of future taxes, or inflation, to pay for the bailout.
Posted by: DickF at October 15, 2008 11:26 AM
What do you guys see as the fundamental aspect of the financial sector that needs to be changed once the USA endures this recession?
I think plans to fix this issue (though they are necessary) will only repeat the problem. That is, the fundamental issue was the exorbitant credit market. Individuals in the USA consume so much more than they earn because there is a plethora of credit that can be obtained. Then many of these individuals spend their lives paying off debts. The solution now is to free up the credit market so that consumers can start borrowing again. But isn't that going to eventually recreate the issue that is being encountered now? The sub-prime mess and the housing bust may have accelerated the crisis being faced now but wasn't it bound to happen. In the USA it seems that it is not income that flows in the microeconomic model (from firms to households and back to firms through consumer spending) but rather it is debt (or credit) that flows. However, the USA may be at the point where there may not be a resolution to this issue (after all, there are so many huge companies whose main revenue is consumer debt-which is why there is this financial debacle to begin with).
Posted by: bert at October 15, 2008 12:22 PM
Professor Hamilton, by chance do you know what was the longest lag between the beginning of a recession and the NBER committee declaring the recession? For example, according to your post, if the NBER would call it a recession this month, it took them 11 months (Dec07-Oct08). Just curious.
Posted by: Daniel at October 15, 2008 12:26 PM
Sure. As always. Whether the public saves or dis-saves, chooses to hold their savings in the commercial banks or to transfer them to intermediary institutions will not, per se, alter the total assets or liabilities of the commercial banks; nor alter the forms of these assets or liabilities.
The lending capacity of the CBs is dependent upon monetary policy, not the savings practices of the public.
Collectively, only the non-banks suffer dis-intermediation. The last period of dis-intermediation for the CBs was during the Great Depression.
Posted by: flow5 at October 15, 2008 12:33 PM
“Banks have long contended that the costs of reserve requirements (i.e., forgone earnings) put them at a competitive disadvantage relative to non-bank competitors that are not subject to reserve requirements – Testimony of Treasury
“These measures should help the banking sector attract liquid funds in competition with non-bank institutions and direct market investments by businesses” Testimony of Treasury
A commercial bank only becomes a financial intermediary when there is a 100% reserve ratio applied to all its deposit liabilities. Reserve ratios were at 84% in 1942.
Any institution whose liabilities can be transferred on demand, without notice, and without income penalty, by data networks, checks, or similar types of negotiable credit instruments, and whose deposits are regarded by the public as money, can create new money, provided that the institution is not encountering a negative cash flow.
From a systems viewpoint, commercial banks as contrasted to financial intermediaries: , never loan out, and can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits (TRs), or time deposits (TDs) or the owner’s equity or any liability item.
When CBs grant loans to, or purchase securities from, the non-bank public (which includes every institution, the U.S. Treasury, the U.S. Government, state, and other governmental jurisdictions) and every person, except the commercial and the Reserve Banks), they acquire title to earning assets by initially, the creation of an equal volume of new money- (TRs).
The lending capacity of the member CBs of the Federal Reserve System is limited by the volume of free gratis legal reserves put at their disposal by the Federal Reserve Banks in conjunction with the reserve ratios applicable to their deposit liabilities (transaction accounts), as fixed by the Board of Governors of the Federal Reserve System.
Since 1942, money creation is a system process.
No bank, or minority group of banks (from an asset standpoint), can expand credit (create money), significantly faster than the majority banks expand. If the member banks hold 80 percent of all bank assets, an expansion of credit by the nonmember banks and no expansion by member banks will result, on the average, of a loss in clearing balances equal to 80 percent of the amount being checked out of the nonmember banks.
From the standpoint of the individual commercial banker, his institution is an intermediary. An inflow of deposits increases his bank’s clearing balances, and probably its free/gratis legal reserves, not a tax [sic] – and thereby it’s lending capacity. But all such inflows involve a decrease in the lending capacity of other commercial banks (outflow of cash and due from bank items), unless the inflow results from a return flow of currency held by the non-bank public, or is a consequence of an expansion of Reserve Bank credit. Hence, all CB liabilities are derivative.
That is, CB time/savings deposits, unlike savings accounts in the “thrifts”, bear a direct, one-to-one, unvarying relationship, to transactions accounts. As TDs grow, TRs shrink pari passu, and vice versa. The fact that currency may supply an intermediary step (i.e., TRs to currency to TDs, and vice versa) does not invalidate the above statement.
Monetary savings are never transferred to the intermediaries; rather monetary savings are always transferred through the intermediaries. Indeed, as evidenced by the existence of “float”, reserve credits tend, on the average, to precede reserve debits. Therefore, it is a delusion to assume that savings can be “attracted” from the intermediaries, for the funds never leave the commercial banking system.
Consequently, the effect of allowing CBs to “compete” with financial intermediaries (non-banks) has been, and will be, to reduce the size of the intermediaries (as deregulation did in the 80’s) – reduce the supply of loan-funds (available savings), increase the proportion, and the total costs of CB TDs.
Contrary to the DIDMCA underpinnings, member commercial bank disintermediation is not, and has not been, predicted on interest rate ceilings. Disintermediation for the CBs can only exist in a situation in which there is both a massive loss of faith in the credit of the banks and an inability on the part of the Federal Reserve to prevent bank credit contraction, as a consequence of currency withdrawals. The last period of disintermediation for the CBs occurred during the Great Depression, which had its most force in March 1933. Ever since 1933, the Federal Reserve has had the capacity to take unified action, through its "open market power", to prevent any outflow of currency from the banking system.
However, disintermediation for financial intermediaries- (non-banks), is predicated on their loan inventory (and thus can be induced by the rates paid by the commercial banks); earning assets with historically lower fixed rate and longer term structures.
In other words, competition among commercial banks for TDs has: 1) increased the costs and diminished the profits of commercial banks; 2) induced disintermediation among the "thrifts" with devastating effects on housing and other areas of the economy; and 3) forced individual bankers to pay higher and higher rates to acquire, or hold, funds.
Savers (contrary to the premise underlying the DIDMCA in which CBs are assumed to be intermediaries and in competition with thrifts) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through intermediaries. Shifts from TDs to TRs within the CBs and the transfer of the ownership of these TRs to the thrifts involves a shift in the form of bank liabilities (from TD to TR) and a shift in the ownership of (existing) TRs (from savers to thrifts, et al). The utilization of these TRs by the thrifts has no effect on the volume of TRs held by the CBs or the volume of their earnings assets.
In the context of their lending operations it is only possible to reduce bank assets and TRs by retiring bank-held loans, e.g., the only way to reduce the volume of demand deposits is for the saver-holder to use his funds for the payment of a bank loan, interest on a bank loan for the payment of a bank service, or for the purchase from their banks of any type of commercial bank security obligation, e.g., banks stocks, debentures, etc.
The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can make loans (if monetary policy permits and the opportunity is present) which amount to server times the initial excess reserves held.
Financial intermediaries (non-banks) lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the CBs lend no existing deposits or savings; they always, as noted, create new money in the lending process. Saved TRs that are transferred to the S&Ls, etc., are not transferred out of the CBs; only their ownership is transferred. The reverse process, which is called “disintermediation”, has the opposite effect: the intermediaries shrink in size, but the size of the CBs remains the same.
Professional economists have no excuse for misinterpreting the savings investment process. They are paid to understand and interpret what is happening in the whole economy at any one time. For the commercial banking system, this requires constructing a balance sheet for the System, an income and expense statement for the System, and a simultaneous analysis of the flow of funds in the entire economy.
From a System standpoint, time deposits represent savings have a velocity of zero. As long as savings are held in the commercial banking system, they are lost to investment. The savings held in the commercial banks, whether in the form of time or demand deposits, can only be spent by their owners; they are not, and cannot, be spent by the banks.
From a system standpoint, TDs constitute an alteration of bank liabilities, their growth does not per se add to the “footings” of the consolidated balance sheet for the system. They obviously therefore are not a source of loan-funds for the banking system as a whole, and indeed their growth has no effect on the size or gross earnings of the banking system, except as their growth affects are transmitted through monetary policy.
Lending by intermediaries is not accompanied by an increase in the volume, but is associated with an increase in the velocity or turnover of existing money. Here investment equals savings (and velocity is evidence of the investment process), whereas in the case of the CB credit, investment does not equal savings but is associated with an enlargement and turnover of new money (money supply).
The difference is the volume of savings held in the commercial banking system is idle, and lost to investment as long as it is held within the commercial banking system. Such a cessation of the circuit income and transactions velocity of funds, funds which constitute a prior cost of production, cannot but have recessionary effects in our highly interdependent pecuniary economy. Thus, the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on GDP and the level of employment.
It began with the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”
In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary in order to make the statement correct. Perhaps this is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, Reg Q, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, etc.
How does the FED follow a "tight" money policy and still advance economic growth.? What should be done? The commercial banks should get out of the savings business -- gradually (REG Q in reverse-but leave the non-banks unrestricted). What would this do? The commercial banks would be more profitable - if that is desirable. Why? Because the source of all time deposits within the commercial banking system, are demand/transaction deposits - directly or indirectly through currency or their undivided profits accounts. Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know. The growth of the intermediaries/non-banks cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.
Dr. Leland James Pritchard (MS, statistics - Syracuse, Ph.D, Economics - Chicago, 1933) described stagflation 1958 Money & Banking Houghton Mifflin,
“The Economics of the Commercial Bank Savings-Investment Process in the United States” -- “Estratto dalla Rivista Internazionale di Scienze Econbomiche & Commerciali “ Anno XVI – 1969 – n. 7
“Profit or Loss from Time Deposit Banking” -- Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386.
Posted by: flow5 at October 15, 2008 12:36 PM
Daniel, the longest lag since I have a record of the NBER announcement dates (goes back to 1980) was a lag of 9 months, with the July 1990 peak announced April 25, 1991.
Posted by: JDH at October 15, 2008 12:44 PM
Thanks. I guess that if current recession would take longer than 9 months (as you suggested) we shouldn't be surprised, after all current times are reminding us of the importance of the tails in probability distributions, right?
Posted by: Daniel at October 15, 2008 12:52 PM
"... this might not be a bad time to start buying."
Umm, with what?
(Gallows humor for the day ...)
Posted by: pianoguy at October 15, 2008 01:29 PM
Bert asked "What do you guys see as the fundamental aspect of the financial sector that needs to be changed once the USA endures this recession?"
That's easy: US oil & gas imports. Right now they're the primary cause of the excessive national and household borrowing which caused this mess in the first place. The links between the housing bubble and O&G imports may seem indirect, but they're very strong - in the longterm they're the biggest cause of US economic weakness.
We need very high priority efficiency, conservation and (as a lower priority) production measures to reduce those imports. That's not easy, because Carter's cardigan speech (in which he pushed for this kind of thing) is still a potent (though inaccurate) symbol of political failure.
Posted by: Nick G at October 15, 2008 02:09 PM
I am going to guess that the spike in RE loans held by commercial banks is a result of JP Morgan taking the WAMU portfolio onto their balance sheet (WAMU was a thrift, not a commercial bank).
Posted by: TheCaptain at October 15, 2008 02:36 PM
If the market reflects the "aggregate of available public and private information"--I don't recall your exact words but think that is the gist of it--why would you think now the market is not pricing in future earnings correctly? Is it your view that under conditions of panic, the first sentence is no longer valid?
Posted by: TedK at October 15, 2008 02:45 PM
Good luck on bottom calling, James. There are three reasons why your statement that stocks are more reasonably priced is wrong: (1) interest rates are at low levels. That means that if they need to be raised, pressure will be for dollars to flow out of the market to, (2) the deficit is at dangerous levels, meaning that serious tax rises are probably inevitable, and (3) consumer debt is so high that they won't be buying for a long time; many companies are going to fail in the meanwhile. Owning stock in a bankrupt company is not profitable, no matter how low the P/E was.
There is opportunity, but it's a very, very dangerous year to be buying. And, by the way, I made that prediction on my blog in December, 2007.
Posted by: Charles at October 15, 2008 03:58 PM
I'm not calling the bottom, Charles. I'm just claiming that stocks are a much better buy now than they have been in the recent past. After today, they're an even better buy. Doesn't mean that tomorrow they won't be better yet. If you think you can call the bottom, you'll wait for your moment. If you don't think you can call the bottom, you might start reinvesting the cash you wisely took out in 2007.
Posted by: JDH at October 15, 2008 04:48 PM
I'll go on record as suggesting the 2008 low was made intra-day last Friday when the S&P 500 touched 839.80, though I'll be honest and admit no one can say with certainty. Good details here:
One aspect of the stock market crisis not being too well reported on currently are the massive redemptions being dealt with by hedge funds and mutual fund managers which are causing FORCED selling in widely-held names (especially around 2:00 pm when many mutual fund managers receive notice of redemption flows), compounded by deleveraging forced on overlevered hedge funds by their prime brokers (though this was much more of an issue in August and September than October).
Look at what happened today to a lot of already-depressed stocks in the energy and metals sectors, where stocks that were down 50% year to-date through Monday night's close were trading down another 10% around 2:00 pm or so and then more selling cascades knocked them down a total of 20% ON THE DAY! And these aren't lightweight penny-stocks either - Schlumberger was down -18.4% on the day, for example.
So. More volatility is assured, but I'm highly confident that if the Thursday intra-day lows don't hold the ultimate low won't be too far below that - the panic is the wildest in the markets in living memory and the time to buy is when blood is in the streets, as they say.
Posted by: Anarchus at October 15, 2008 05:29 PM
My call - the DOW will bottom at about 6,000. I second Charle's points. Federal deficits are going to become even more dangerous than they are now.
From your graph, there is no clear trend in the PE ratio, but it looks still to be above average, just as home prices have further to fall. If there is arbitrage among asset prices, this would imply a further drop in stocks. Real interest rates appear unsustainably low. Oil exporter savings are drying up, and Asian savings will too, when their income comes down. It seems to me the downturn in the real economy is just starting to pick up steam, and will get worse when foreign economies slow and U.S. exports drop.
The NIKEI was at 30,000 in 1990. Look where it is today.
Posted by: don at October 15, 2008 07:44 PM
If you have cash then put a fraction into equities now. There is a chance that ~900 S&P500 is the bottom. We will test that bottom this week or next. If it holds, then put another fraction into equities. If it fails then wait for the selling to subside. If 900 does not hold then you will probably have several months to average back into the market before the S&P gets makes a meaningful move beyond 900.
Also, keep in mind that the Federal Gov't will be announcing massive stimulus packages for homeowners and taxpayers. Look for huge bounces on the news with retracements like we saw this week.
A key signal of a bottom will be when we get a news release containing bad economic data but the market moves sideways or higher. That event signals the market has fully priced the economic downturn and is ready to move higher.
Posted by: tj at October 15, 2008 08:49 PM
My hunch is that the S&P 500 P/E ratio declines to levels seen in 1982/83. As (trailing) earnings will continue to shrink, that means equity prices will continue to decline, substantively.
There is no traditional inventory overhang, just too many houses and too many automobiles cluttering up the landscape. Dead bear bounces aside, the market bottom is still ahead.
Posted by: GNP at October 15, 2008 08:57 PM
Commercial Bank Mortgage Holdings -
As I recall, many of the mortgage securitization contracts issued in the last few years contained clauses allowing for mortgages that involved fraud or other legal deficiencies, to be unbundled and returned to the originator of the loan.
I know that monoline insurers have been working overtime to investigate mortgage insurance claims... I believe that the 9% spike in Large Commercial Bank mortgage holdings in the last year reflects take-backs caused by failure of securitized instruments.
P/E Ratios - Only a fool would buy stocks at a P/E of 20 just as the economy was entering a protracted and severe recession. Earnings can easily erode 30-50% as consumer credit dries up and business credit costs escallate. In addition, the long-term average P/E for equities on the NYSE is about 16... Stock prices have a long way to go down in order for the last 13 years of high stock prices to be averaged-out relative to a P/E of 16, while earnings are simultaneously in decline.
Posted by: MarkS at October 15, 2008 09:28 PM
What James neglects to mention is that by the same chart, if you'd follwed his advice in 1929, you'd lose roughly 75% of your money as the P/E fell from roughly 20 to roughly 5.
Also, see the following trendline analysis at naked capitalism.
It shows we're still 23% above trendline, while going into a bad recession, with massive credit deflation and fear levels unknown by most anyone alive today.
I'm just sayin'....
Posted by: R-N at October 15, 2008 09:33 PM
R-N, Shiller's graph just goes through August 2008. If you update it with yesterday's close of 908 for the S&P500, you'd calculate a current value for the long-term P/E of 14.82. You would have waited until July 1931 to buy after the October 1929 crash before you passed that trigger to buy back in. If you'd bought the S&P at 14.33 in July 1931, you're right that you would have lost 2/3 of your money if you then sold at the trough of 4.77 in June 1932, though it was back to 10.92 by April 1934.
I do grant your point that if we're about to enter another Great Depression, the time is not yet ripe to buy. I do not believe we're going to see another Great Depression. For one thing, Bernanke is certain to avoid the deflation between 1931 and 1933, and as I point out above, inflation means those nominal dividends will rise.
Posted by: JDH at October 16, 2008 06:09 AM
"Shiller's graph just goes through August 2008. "
Ah, gotcha. That's impossible (for my old eyes) to see on the graph, but as you say, extremely relevant.
No, I don't think Bernanke has any intention of allowing another Great Depression either. I think large stimulus of all kinds from food stamps to checks in the mail will be forthcoming, particularly if Obama wins.
However, I don't think that can happen anytime soon given that the taxpayer has been put on the hook for incomprehensibly large sums already, seemingly day after day after day. So I just don't think there's the political will for it just now.
But after a couple more months of the very worrying real economy data points we've been seeing lately, I'd expect the coffers to open wide. The discussion is already very much in the air, and I believe, is probably even consensus now.
But a lot can happen between now and then, such stimuli have a lag, the flows can't be directed, so even then it'll be problematic.
Further, the underlying conditions behind the real economy are terrible: very low savings rate, strong consumer habits built-in of living on credit, enormous debt burdens, a service-based economy that serves largely each other and won't do much to help the trade deficit.
All of which to say that almost every breeze in this storm is blowing against us, unlike in 1929 when we still had some strong international advantages.
In this case we have a strong student of history at the helm, with the power and will to do all he can. So I agree, no repeat of the Great Depression can possibly come.
But many other bad things can. Money flows are so fast today between global markets. It's very hard to see what can be done that will push us to cure some of the underlying problems (raise interest rates, say) and not just blow bubbles somewhere.
This is about more than frozen credit or defauting mortages. This is about the US economy adjusting to fit more properly into a more balanced global economy.
A very long-winded way of saying you may be right, stock values might simply go back up again. But I have a hunch it's more complicated than that.
Posted by: R-N at October 16, 2008 06:34 AM
JDH, do you think that deflation is something that Bernanke has to avoid? It seems to me that before the events of the fall, we were seeing a number of inflationary pressures through the summer. In your opinion, have they abated?
Posted by: sjp at October 16, 2008 06:56 AM
yes, sjp, I am much less concerned about inflation today than I was 3 months ago.
Posted by: JDH at October 16, 2008 07:05 AM
I believe Bert and R-N are on to something. I have long suspected and truly come to believe that the so called "service economy" is a failed experiment. It was made possible by the enormous and uncontrolled amount of credit that was made possible by the dollar as reserve currency which, in turn, was made possible by Nixon's actions in 1971 re gold. On a positive note, I am beginning to hear even in mainstream media that the country needs to get back to "productive" activity i.e. no more financial engineering but actual work making stuff that we can sell to the rest of the world. We might actually see median incomes increase for the first time in 30 years. Oh, were that it is true!
Posted by: Footwedge at October 16, 2008 07:53 AM
P/E - Another logical reason for P/E to decline during a recession is competition from the bond market. Its only a matter of time before money exiting the equity market can no longer support the Treasury securities market. When that occurs, yields on Treasury securities will rise forcing prices on equities to fall....
In the event that the Treasury and FED push credit on to the market without auction support, the resulting inflation will again force equity prices lower in response.
Don't forget that from 2004-2006 Mortgage Equity Withdrawel (MEW) amounted to $700 Billion/year, and sent S&P 500 P/Es from 14 to 24. MEW has almost totally disappeared... Want to guess what will happen to corporate earning when this cash flow disappears?
There is no free lunch.
Posted by: MarkS at October 16, 2008 11:31 AM
Worth noting that corporate interest rates are much higher than the government rates show in the graph, putting more pressure on stock multiples.
Spreads matter and they are very wide today. Might be interesting to see that chart with corporate A rates rather than government rates.
Posted by: GuySmilie at October 16, 2008 11:45 AM
I do grant your point that if we're about to enter another Great Depression, the time is not yet ripe to buy. I do not believe we're going to see another Great Depression. For one thing, Bernanke is certain to avoid the deflation between 1931 and 1933...
This could be an interesting test. You and I do agree that there was deflation between 1931 and 1933 but where you believe as a monetarist that this was cause, I believe that it was a reaction to the fiscal mistakes. This current crisis is a good test. If Bernanke engineers a recovery by massive injections of liquidity without fiscal changes then perhaps you are right. But if there is no change, or a continued fall in the economy after the Bernanke injections then I believe you may need some serious rethinking of the theoretical foundation of your economic philosophy.
That means that if there is no turnaround in the next 6 months this theory will fail.
Posted by: Anonymous at October 16, 2008 12:12 PM
Here is a question :
Everyone knows that the Nikkei was at 30,000 in 1990 but 18 years later, is just 8000.
What prevents the same from happening in the US stock market?
The Nasdaq is already mirroring the Nikkei. But what about the broader S&P500?
Posted by: GK at October 16, 2008 12:17 PM
Anonymous, no, I don't believe the theoretical foundations of my economic philosophy would be challenged in any way by a downturn that extends longer than the next 6 months. I have made no prediction that this downturn will have ended within six months. I instead made the narrow claim that it is possible for the Federal Reserve to create enough money so as to prevent the price level from falling by 30%, and I certainly expect Bernanke to prevent the price level from falling by 30%. I have further claimed that a fall in the price level is one important factor that contributed to the decline in nominal stock prices between 1931 and 1932.
Posted by: JDH at October 16, 2008 12:31 PM
I think we can agree on the following :
1) The S&P500 at 900 or less is the cheapest valuation since 1983.
2) But it would have to go to 700-750 to match the 1974 or 1982 bottoms.
3) It would have to go to 600 to match the 1932 bottom within the GDep.
So, yes, it is a 'great time to buy' but there is every chance that even greater times to buy could arrive soon. No one knows for sure.
Posted by: GK at October 16, 2008 01:13 PM
JDH may not be calling the bottom. But I am. For followers of technical analysis, the bottom was likely in as of Friday.
If you take the long view, we are in a secular bear market that began with the top in 2000. If it behaves like previous secular bear markets, it should be expected to run for about 17 years, during which the market will bounce roughly between the previous highs, and the lows set in 2002. Those lows were 794.10 on the S&P 500 and 7428.32 on the DOW, on October 4, 2002.
On Friday, October 10, 2008, we hit levels of 839.80 on the S&P 500, and 7882.51 on the DOW. In both cases, about 6% above the previous low. There is simply uncommonly little downside risk here, given the combination of extremely attractive fundamental valuations and strong technical support at those levels.
We may be testing those lows again over the next couple of months, but ultimately, there is over 50% upside to the previous highs, and we are likely to be there in the next few years. And it is unlikely we'll see prices break below those 2002 levels for any length of time.
Posted by: acerimusdux at October 16, 2008 07:32 PM
We are going through a period of deep cleanzing right now. Using the metrics of the graph presented, we will not turn around until we reach a P/E ratio of 5-7. We will see the P as well as the E contract over the next 6-12 months.
Even if we have an Obama rally after Nov. 4, it is not a good idea to start buying until Sept. 2009. At least that is my 2 cents.
Posted by: tyaresun at October 16, 2008 09:43 PM
Posted by: JDH at October 17, 2008 05:53 AM
JDH says, " I'm just claiming that stocks are a much better buy now than they have been in the recent past."
This is like telling a man who has fallen out of a ten story building at the third floor that he is almost through his crisis. It's technically true, but it fails to capture some essential element of the situation.
Stocks can easily stay at depressed levels for five years. It has happened before, even after lesser crises. GK points to the example of the Nikkei.
Warren Buffett is a very, very rich man. If stocks went to 10% of their current value and stayed there, he would be able to care for all his needs and the needs of his descendants to the seventh generation.
How many of us could do the same?
Posted by: Charles at October 17, 2008 08:05 AM
I instead made the narrow claim that it is possible for the Federal Reserve to create enough money so as to prevent the price level from falling by 30%, and I certainly expect Bernanke to prevent the price level from falling by 30%. I have further claimed that a fall in the price level is one important factor that contributed to the decline in nominal stock prices between 1931 and 1932.
Your theory reminds me of a special I saw on Zimbabwe a couple of nights ago. The narrator said that the grocery store was open every day. As the camera panned the shelves he continues, "Of course there is nothing on the shelves." Bernanke may keep prices high, Hoover did and Roosevelt did, but will that prevent the unemployment and bread lines?
Posted by: DickF at October 17, 2008 08:29 AM
I have to take issue with James' sentence :
"But the best time to buy stocks is 3 to 6 months before the recession is over. "
NO. The last recession was from March '01 to Nov'01. Thus, anyone following this advice would have bought in mid-2001. But the bottom was not until October 2002, 1 year after the recession ended. It tested those lows again in early 2003. The person buying '3-6 months before the recession ended' would have been down another 25%, 12 and again 18 months later.
Thus, stocks can go down another 25% after the recession has ended.
I think the better corelation is that stocks bottom around the time when unemployment peaks (which is also after a recession has since ended). When does unemployment peak? When productivity stats jump, more or less....
Posted by: GK at October 17, 2008 11:55 AM