The Dow went nowhere yesterday. Gold dropped $5. Oil held at just under $115.
There is also a growing realization that the U.S. economy is sinking into recession.
Yesterday, we organized our thoughts on the economy into a series of 4 points:
1. There’s a whole lot of ‘flation’ going on.
2. The de-flation takes the air out of housing and the financial industry; the in-flation gasses up commodities, gold and oil.
3. Together, they are re-adjusting the U.S. economy (and, to a lesser extent, the United Kingdom and other Anglo-Saxon economies) downward… reducing the value of assets and labor (more about that too… keep reading), but also reducing the value of their debts.
4. This is fine with us… it’s just capitalism at work.
Last night, leaving the office, we walked by a TV studio. The wind was blowing; it was a spring day in London but it could have passed for January in New York. Still, there was a long line of people waiting to get into the studio.
Further down the street was another line – this one a line of bums and down-on-their-luck street people – waiting for a food truck. One was wrapped up in a sleeping bag on the sidewalk… another was shaking his head at no one in particular.
But here at Markets and Money headquarters, we’ve never seen the line we wanted to join. We’d rather go hungry than wait behind others for a sandwich. And as for wanting to see a TV show… we’d have to be crazy.
We only bring it up to remind ourselves that people love lines. In Russia, before they abandoned communism, if people saw a line forming, they’d get in it… figuring that there must be bread or cucumbers, or maybe a list where they could sign up to buy a car, at the other end. In Paris and London, people wait in line to get into nightclubs. And in America, the line of young people trying to get into Harvard, MIT or Johns Hopkins is unbelievably long.
No, dear reader, count us out. But most people do not like being alone. They don’t trust themselves to figure out what they should do. Instead, they look around and see what others are doing…
That is why financial markets tend to move in such broad patterns. People get in line… share the same sentiments… believe the same things – even when those beliefs are far-fetched or absurd. One day they believe that the world is coming to an end… the next, they believe it will never end. In 1999, we recall that President Clinton remarked, “things could be better.” Now, if you read the papers, you might think they couldn’t be worse.
Sometimes it is hard to know what people are really thinking. Pollsters have found that they often say one thing – often what they think they should say – while they actually believe the contrary. And poets have figured out that they often don’t know what they think.
This subject matters to us because crowd behavior affects prices. When people think the sky is falling, they don’t want to lend money; why bother, they think they won’t get it back… or won’t be around to enjoy it. Interest rates go up fast. Asset values plummet.
But there’s the paradox: the sky is said to be falling… but investors aren’t running for cover. The S&P is still selling at nearly 20 times earnings. In other words, a person who buys a share is willing to wait 20 years to get paid back out of earnings – if all remains the same. Twenty years is a long time in the stock market. Like dog years, companies measure time in quarters, not years. Only one of the original Dow companies – General Electric – is still on the list. So, a 20-year outlook is fairly optimistic.
Historically, the range of price/earnings ratios varies from about 10 on the low side to 25 on the high side. Anything below 10 is usually a great buying opportunity. Anything above 25 is usually a great selling opportunity. At 20, the market is expensive… but not outrageously so.
What makes us wonder is how stocks could remain so expensive in the face of what appears to be such bad news?
Yesterday, for example, brought more depressing headlines.
“US Economy: Worse than Believed,” begins the Washington Post, citing the Fed’s Beige Book report.
“Offering a picture of [the] US economy being squeezed from all directions, the Beige Book, a compilation of anecdotal reports of US business conditions prepared by the US Federal Reserve, showed economic conditions in the US have weakened almost nationwide in the past six weeks.”
Manufacturing output is down. Construction is down. Demand is down. Business Week points out that statisticians made it look like consumers were spending more than they actually were – by jiggling health care costs. Handled properly, says BW , consumer spending figures would show a drop since last November.
Out in California, house prices have fallen 26%, adds another piece from Business Week.
Rice hit another record high – amid more grumbles from the sweaty mobs.
Australia is ‘drying up,’ adds the International Herald Tribune .
The art market is “bracing for a bust,” says this morning’s news.
Our own MoneyWeek cover story tells us, “Why the credit carnage is far from over.”
And even Harley Davidson has had to announce cutbacks.
What is this world coming too?
Nothing bad, apparently.
Because people are still buying stocks at 20 times earnings. And they are buying Treasury bonds with yields that are scarcely above the level of consumer price inflation. In short, they don’t think the sky is falling at all.
Markets and Money