Let us keep looking through our binoculars…
We are trying to see the big picture, trying to understand what is really going on. We can imagine ourselves like Caesar – watching the action at Alesia from a nearby hill – or like Lee looking at Cemetery Ridge as the Confederates tried to push back the Yankees. Which way is the battle going? Who’s going to sweep the field…who’s going to carry the day? Caesar won at Alesia with a combination of strategy, planning, and discipline. But Lee lost at Gettysburg for lack of resources…bad luck…and bad tactics. And now…General Bernanke is losing too.
Yesterday’s news described another day of deflation. The Dow lost 42 points. Oil fell almost $4, to $121. The commodity index, the CRB, dropped 18 points. And gold lost nearly $10, ending the day at $907.
What to make of it?
Banking has always been a boom and bust business. Bankers tend to act like retail investors who just happen to have a lot of money. They lend to whatever is fashionable…then, when the go-go businesses go bust, the bankers look for the next opportunity to lose money.
The retail investor doesn’t know anything about investing or economics either. Instead, he watches television or reads the papers. Gradually, he forms the opinions that turn him into a chump for Wall Street – ready to buy financial products because he’s heard someone say they make good “investments.”
From 1997 to 2007, the retail lumpenhouseholder developed an extraordinary hallucination; he came to believe that he could make money simply by buying a house and living in it. Of course, the little guys are always susceptible to delusions – especially those that flatter them or offer them something-for-nothing; that’s how democracy works. But what was really remarkable, in the ’97-’07 period, was that sophisticated bankers and brokers came to believe the same thing – that they could get rich by buying and trading the mortgage contracts of people who thought they’d never have to pay back their mortgages.
Of course, the whole thing blew up last year. The marginal homeowner is in trouble – with more mortgage than house. And the marginal banker is in trouble too – he owns the mortgage! So far, houses have fallen about 20%, with another 10% to 30% left to go. And the banks have written off about $476 billion worth of bad credits – according to the Int’l Institute of Finance – with maybe another half a trillion in mortgage-related losses.
So far, the subprime mortgages have been the focus of losses. But now the Alt-A and Prime mortgages are getting into trouble too – with delinquency rates in both categories on the rise.
Nothing astonishing about this picture. A correction is always equal and opposite to the claptrap that preceded it. The housing hallucination was a whopper. So is the correction. The housing bubble caused big increases in nominal GDP, retail spending, and corporate profits (from the financial sector). Now, the GDP is flattening out, retail spending is softening and corporate profits have been crushed.
Taken altogether, guess how much money the Dow stocks are making? These are the companies that form the backbone of American commerce and industry. Guess again. Because if you put them all together, says Barron’s, you’d have a loss of more than $80 billion. The last time there was such a loss in the Dow was 75 years ago – in the Great Depression.
This is an encouraging word to many observers. They note that the last time Dow earnings went negative proved to be a very good time to buy stocks. After ’32, stocks in the United States went up 373%.
But wait, they went up AFTER having lost about 85%. The Dow in ’32 rose from a low of 41…with stocks trading at only 5 to 8 times trailing earnings (in terms of current negative earnings, the P/Es were meaningless). In other words, the stock-market had been crushed before it rose again.
Today’s stock-market has not yet been crushed. In fact, the Dow itself is only a bit lower than its all-time high.
The correction has taken the wind out of Wall Street’s sales. But, so far, it has done very limited damage to U.S. stocks. Most likely, more pain lies ahead…before another upswing.
Hey, don’t take our word for it. No less an authority than Alan Greenspan himself says there is more suffering ahead…and there is no less an authority than Alan Greenspan.
The auto business is being corrected – severely. One of the biggest losers on the Dow was – no surprise – General Motors. It lost $11 a share in the second quarter– which is almost unbelievable, for a share that sells for $10. And Chrysler’s latest attempt to raise money fell $6 billion short. The auto industry will probably go broke – and be nationalized, like housing.
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