Here's why stock markets will fall
13 AUGUST 2010
Another week gone by. Nothing has been learned. Nothing has been proven. Nothing has been decided.
In the markets, we mean. It looks like the stock market is finally rolling over. After a big drop on Wednesday, the Dow followed up with a modest drop yesterday - down another 58 points.
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Is the market really headed down? We've been wrong about it before. About the timing, that is. But we still have little doubt that this market is headed down. Why? That's just the way it works. After hitting extraordinary highs, we must have extraordinary lows in the forecast. Winter follows summer, no?
You can imagine as many reasons why stocks might want to go down as we can. Households are de-leveraging. People are getting older and shopping less. Savings rates are going up. Housing is underwater and sinking. Unemployment is nearly 10% officially...much higher than that in reality. The US is broke. The empire is probably rolling over too. Emerging markets are leaner, faster, more solvent and more competitive. We now have to compete on both ends - sales and raw materials - with 3 billion people who do not have to carry the burdens of success on their backs.
Do we have to go on?
Of course, Mr. Market can do what he wants. He won't get any argument from us. But we're pretty sure he's ready to take a long walk down a long, lonely road.
Want to see the roadside attractions? Just look out the window. The New York Times:
"During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back.
"The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.
"Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.
"The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up."
For two years, we've been talking about US household de-leveraging. Some of the debt is paid off. But much of it just disappears. Here's how; the TIMES continues:
"When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats," said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. "Their chances are pretty good of walking away and not having the bank collect."
"Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages , government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter.
"Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. "People got 90 cents for free," Mr. Combs said. "It rewards immorality, to some extent."
"The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say. Most of the debt is still on the books of the lenders, which include Bank of America, Citigroup and JPMorgan Chase.
Yes, dear reader, we are on a long, lonely road. Want to know where that road leads? To Japan! Here's Bloomberg:
"The U.S. is no longer an engine for the global economy and may suffer deflation sometime in the next three years, said Genji Tsukatani, head of fixed income at the Japanese unit of Schroder Investment Management Ltd.
"Ten-year Treasury yields slid to a 16-month low after the Federal Reserve said yesterday the U.S. economic recovery will be "more modest" than previously anticipated. The spread between yields on U.S. and Japanese 10-year debt is at the narrowest since May 2009.
"The aftereffects of the credit bubble along with the aging population mean it's possible that the U.S. will slip into deflation" in the next three years, said Tsukatani, whose company manages about $211 billion in assets globally. "If real interest rates fall in the U.S., it's likely to drag down those in Japan."
"Tsukatani said he derives real interest rates by subtracting inflation rates from 10-year bond yields. Deflation increases the value of the fixed payment from bonds.
"Scott Mather, head of global portfolio management at Pacific Investment Management Co., wrote in an article this week that "the risk is rising" that the U.S. will follow a similar path to Japan's. St. Louis Fed President James Bullard wrote in a report released last month that the U.S. is "closer to a Japanese-style outcome than any time in recent history."
"The U.S. hasn't been an engine for the world's economy since around 2005 but it's being driven by countries like China and India whose economies grow 8, 9 percent," Tsukatani said. "With slowing population growth and more emphasis on debt reduction, the U.S. economy probably won't grow that much."
"A total of 12.8 percent of the U.S. population was 65 years or older at the end of 2009, up from 11.3 percent in 1980, Bloomberg show. That compared with 22.2 percent in Japan. "
*** Meanwhile, the price of gold took off yesterday. Up $17 to $1,216. It didn't make much sense. The rest of the news is recessionary, deflationary and dreary. Why does gold still glitter?
We don't know. Maybe investors are thinking what we're thinking: that the feds will get desperate, sooner or later. They won't be able to resist the allure of free money. Then, even in the midst of a de-leveraging cycle, the price of gold will soar .
The Rise, Fall, and Rise of Disaster
The US Department of Agriculture may have some usefulness. Projecting future prices isn't one of them. In 2005, it looked five years ahead and saw a bushel of wheat selling for $3.50. Last week, the price rose to more than twice that much.
Why? God himself is to blame. Not since 1880 has Russia been so dry. And not since Napoleon's invasion has Moscow suffered so much soot. The government banned wheat exports and prices shot up to their highest point in 51 years. In the curious way that one thing lead to another, Napoleon's Russian Campaign grew out of the French Revolution like a forest fire out of a careless barbecue. The revolution stirred up enemies on all France's frontiers. When Napoleon had finished with them all, he had to reach farther - all the way to the banks of the Moskva River - to get his fingers burnt.
But the Revolution may never have happened without the summer of 1789. That was God's work too. That summer was the opposite of the Russian summer of 2010. Europe was cold and rain-soaked, believed to be the result of the explosion of the volcano Laki in Iceland. The price of bread in Paris rose 67% in 1789. The average laborer only made about 20 sous a day, barely enough to buy a loaf of bread. The intellectuals may have been stirred by the Enlightenment. But it was high bread prices that gave the mob an appetite for revolution.
One of the awake observers of this period was a young Anglican clergyman named Thomas Malthus. While the rest of the intelligentsia imagined a world of industrial and social progress, Mr. Malthus peered down to the bottom of a dark well. Ten years after the French Revolution, he published his "Essay on the Principle of Population." His point was simple, obvious and modest: populations can grow faster than food production. This led to the idea of a "surplus" of humanity, which was practically a Christian heresy. It presumes that God is a jackass, something that occurs to the average man about once a day, but which is a rare thought for a member of the clergy. Everything in nature is bounded by limits and hounded by failure. Trees don't grow to the sky. Bull markets don't last forever. And every step people take in life brings them closer to the grave. God told man to be fruitful and multiply. Was he just setting him up for catastrophe?
But the Malthusian limits keep getting pushed back. Even after nearly two centuries and 6 billion more people added to the human population, most people can still multiply without worrying about mass starvation.
Paul Ehrlich published his "Population Bomb," in 1968. But his prediction was as big a bomb as Malthus's. Populations didn't outrun food supplies. Instead, output per acre doubled in the 'green revolution' that followed - rising faster than the number of people. If people starved, it wasn't God's fault. And now, Le Monde reports that obesity may be a bigger health threat to the poor than starvation.
Forty years ago, experts said the world was running out of oil, too, with only 40 years' worth of reserves. They predicted disaster. But huge new discoveries of deep reserves have been made since then. Four decades later and the world still has 40 years' of reserves. The only a disaster was for those who were counting on buying it at $10 a barrel.
And now, the alarmists are on to other worries. Water, for example. Not that there isn't plenty. The seas and rivers are full of it. But getting the right kind of water to the right place is going to be expensive.
Peak water...peak oil...peak food...peak this, peak that. After so many alarms with so few fires, many people think they can put away the fire extinguishers. Higher prices draw forth more supply...and substitutes. The limits seem to recede forever.
But the threat of disaster hasn't disappeared; it is just retreating in good order like the Tsar's troops...waiting for the worst possible moment to strike. There is only so much arable land. There is only so much water. There is only so much energy to move food and water. Man has been growing food for 12,000 years. Surely, he's reached capacity, no? Experts see disaster coming again. The undeveloped world is still multiplying -- and with much larger numbers. The population of the earth is expected to add nearly 3 billion people by the middle of this century. On that basis alone we'd need another 'green revolution' to keep up with it. But since the mid-90s there's been little improvement in farm output. In fact, people have eaten more than they've produced for most of the last decade. And as people get richer, they change their eating habits. Grain is fed to the cows and pigs; people want meat. China's consumption of pork, for example, increased 45% between '93 and 2005. The need for grain multiplies 5 times faster than the people they are meant to support; a calorie from grains takes only about 20% of the inputs needed to produce a calorie from meat.
Is the world running out of wheat? No. There will be plenty of wheat available. But probably not at $3.50 a bushel.
But every half-empty glass is also half-full. The summer of 1789 was a disaster for plants in Europe. But with so much volcanic ash in the air, the sunsets were uncommonly pretty.
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