“What’s that smell?”
We were on an airplane when Edward, 15, noticed an odor that seemed out of place.
“Dad…you should have at least cleaned your boots!”
The manure began accumulating when we rode up to the high pasture on Tuesday. More about that below…
In the meantime, the Dow rallied a bit yesterday – up 127 points…barely half of what it lost on Monday.
Is the bounce still bouncing? We don’t know. But we don’t trust it. They say the stock market ‘looks ahead.’ So, it is possible for it to see things we can’t see. On the other hand, what was it looking at two years ago? Didn’t it see the economy going over a cliff? Apparently not.
But investors tend to believe what they want to believe. And what they want to believe is that the stock market has had its vision corrected and now sees a recovery.
Our guess is that they are wrong on both scores. The stock market is just as blind now as it was in early 2007…and there is no recovery coming any time soon. As to the first point, we have no further evidence to present…but as to the second; at least we have a theory.
By our reckoning, this is not a recession…this is a depression. In a recession, the bull market formula still works. It just needs a little time to rest…catch its breath…work off inventories…and rebuild cash accounts. But in a depression, the formula stops working.
The basic formula that drove the U.S. economy for the last 60 years has been the expansion of consumer spending. At first, that spending was healthy spending. People had built up savings during the war. In the Eisenhower years, they were ready to get back to work in the consumer economy, get married, have children, and spend money. America was the world’s leading lender…leading exporter…leading manufacturer…and leading everything. Gradually though, having so many advantages caught up to the United States of America. By the ’70s, the Nixon administration thought it could do away with the gold backing for the currency. By the ’80s, the United States slipped from being a net creditor to being a net debtor to the rest of the world. By the ’90s, American consumers were spending more than they made…and by the ’00s they had given up saving all together – depending on the savings of poor people in China and elsewhere in order to continue living beyond their means.
Each time this system was faced with a recessionary correction, at least in the last 25 years, the feds tried to stimulate consumer spending with easier credit. And each time, consumers took the bait and got hooked on more debt. That’s why the financial industry expanded so much…it sold more and more debt in more and more grotesque and amazing ways.
This time is different. This time the feds have responded with zero interest rates…and $13 trillion worth of bailouts and boondoggles. But the old magic doesn’t seem to work anymore. This time, the formula no longer works. Consumers already have too much stuff – and no way to pay for it all. They have no choice; they have to cut back. This is not a pause in the long cycle of increasing consumption, debt and speculation. It is a reversal of the cycle – with less consumption and less debt (more savings). This is a depression.
If left alone, this cycle will see falling asset prices, falling bond prices and rising savings for many years. Stocks should sell down to levels where they are attractive again – at average P/Es below 8…7…or even 6. And with dividend yields above 5%.
Of course, when that happens people will have lost interest in stocks. The financial magazines will have pronounced the stock market “dead” and Jim Cramer will have been booted off the air.
By that time, the economy will have been restructured too. There will be less retail space. Many malls will have gone broke. Living standards in America and Britain will have gone down. And many of the people in the financial industry will be doing what they ought to have been doing all along – taking lunch counter orders.
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