MARKET DECLINE IS BASED ON MORE THAN FEAR
Today marked a new phase in investors’ understanding of the EU crisis. Although the Euro itself recovered a bit, investors realized that Europe’s problems could spread to the U.S. and impede or stop its economic recovery. This would possibly mean that the 14-month market rebound in U.S. stocks may not have been justified. The possibility is more than just a fear, but a realistic assessment of a dire situation. Even if the EU and the Euro survive, all of the member governments, including the relatively stronger ones, would have to undertake severe spending cuts and pay down debt to rectify their budgets. These actions would lead to a long and serious economic slump that would most likely spread across the globe.
The crisis is also reminding investors that we have undergone two 50% plus market declines in the same decade and that the S&P 500 today closed at same level it first reached over 12 years ago in mid-March 1998. The two major declines are a reminder to traders of the benefits of getting out relatively early, while the lack of progress over 12 years make long-term investors wonder what they doing in the market. For those who didn’t get out on time at the tops in early 2000 and late 2007, the bell is ringing for a third time.
The potential impact of the European crisis on the American economy and markets is not just Comstock’s opinion. In testimony before a Congressional committee yesterday, Fed Governor Daniel Tarullo stated that sovereign debt problems in “peripheral” Europe could spill over and cause problems throughout Europe that, in turn, could be transmitted to global financial markets. This, he said, could cause banks and other financial institutions to pull back on lending as they did following the Lehman bankruptcy. “The result could be another source of risk to the U.S. recovery in an environment of still-fragile balance sheets and considerable slack”.
The Fed’s minutes of its last meeting, released this week, indicated that the economy was not doing quite as well as advertised, even before the impact of Europe’s problems. Attributing the recent increases in consumer spending to temporary factors and a lowered savings rate, they concluded that it was unlikely that consumer spending would be the major factor in driving economic growth. They added that the housing market appeared to have flattened despite major government support and that both sales and starts had stalled at depressed levels. They also saw the possibility of increased foreclosures adding to already bloated inventories of vacant homes, threatening a downside risk to prices. The minutes mentioned that commercial real estate continued to fall as a result of deteriorating fundamentals, while bank lending was declining and credit remained tight.
Other recent economic releases were also not encouraging. The Mortgage Bankers Association (MBA) reported a record 4.63% of mortgages in foreclosure in the first quarter with combined foreclosures and delinquencies amounting to 14% of all mortgages. We note that this is before an expected surge of new defaults and foreclosures as a result of foreclosures being delayed due to attempted workouts and the pending increase of adjustable-rate mortgages due for reset in coming months. In addition applications for new mortgages for home purchases plunged in the week following the expiration of the latest home buyers’ tax credit. It was also reported today that initial weekly claims for unemployment insurance unexpectedly jumped to 470,000. While one week doesn’t necessarily mean anything, we note that claims have now been flat since year-end, indicating that the labor market still remains weak.
We would be remiss if we didn’t mention increasing concern about China as a negative market factor. The Chinese housing market has been booming, and the authorities have been slowly tightening monetary policy. In the first quarter the nation reported its first trade deficit since 2004. If the Chinese economy slows down at the same time that Europe is dealing with its crisis the U.S. and global economy will stall. This is already being reflected in a sudden decline in commodity prices on anticipation of a drop in Chinese purchases. We’ll have more on this topic in subsequent comments.
In our view the 14-month rally since March 2009 is over and a major decline is underway. The recent decline has been extreme in the short-term, and some sharp rallies are likely. However, we believe that none of these rallies will hold and that the eventual market bottom will be far lower than today’s level.
I think you are way too dire in your predictions. When you make a good point you follow it’s repercussions to the extreme, as if they would develop in a vacuum. The Euro became overpriced when people got skeptical about US spending. Now it’s moving toward fair value. Equity valuations got too rich, too quickly, and now are coming in line. Granted, both adjustments have been far too abrupt, but it’s because markets are suffering from post-traumatic stress disorder, they have visions of 2008…. The world is not such a scary place. Nevertheless, discussing seriously a break-up of the Euro is ridiculous. Can you imagine if Greece had the Drachma? they would still have to borrow in dollars, with a depreciating currency, they would be insolvent by now, and doomed to poverty later.
Same goes for US equities. Valuations are getting quite attractive and buyers will step in. Everybody knew the market was overextended and are waiting on the sidelines. Of course, contagion is possible, there are multiple pockets of weakness, etc. but it’s worth emphasizing that these are still remote possibilities, IMHO.
“you” as in Comstock….
“… investors realized that Europe’s problems could spread to the U.S …”
I’m still wondering how people could believe that a problem could be ‘contained’ if this is indeed a globalized world with globalized markets. Even if a problem doesn’t directly backfire from one market into the other, it certainly will do indirectly, like in the simplest terms, even if U.S. banks are not owning Greek bods, Euro banks do and when an Euro bank goes bust, there will sure be U.S. banks for funds who own equity or bonds from those banks.
I guess the FED sees this more clearly, being willing to partially fund the EU bailout, wasting U.S. taxpayer’s money on Ouzo as some people put it.
Subprime crisis, EU crisis: same actor, different masks.
i know of 3 people still in their houses after 28 months without making a payment, haven’t heard from the bank in months-hey,they’re mowing the grass!….cleaning the pool!
1 is in viginia-not exactly pheonix or ft. myers.
even after all the foreclosures of the last 2 years, 8% are behind or making NO payments.
the big banks making money on FED 0% money buying 2-3% treasuries.
small banks–more of them than last year will go BK’d
its going to take years not months to delever all this.
I agree that the crisis is not over, but I am not sure the bell is wringing yet. Based on T&A, there are three prevelant scenarios:
a) EWave/presidential cycle, which I think is too mainstream, we crash in 2010 to DJ 5-6K then have huge rally 3rd year Pres cycle
b) 1937-41 scenario, ie LYamata tech crash=1929 crash, we have 20% correction, retrace then 2 year bear market probably starting in Oct
c) scariest of all, 15-year H/S pattern in Dow, we stay between DJ 10k-11.5k +-, to Oct then face bottomless pit. This would probably occur with rising rates with mtg rates approaching 8-10% over time.
One thing that puzzles me about guys like Comstock and Hussman… big bears usually… and they certainly like to write about it… is that as money managers… they have made any real money to speak of!
DRCVX 3yr ann. 4.54% 5yr ann. (1.69%) 10yr ann. 0.29%
HSGFX 3yr ann. 0.47% 5yr ann. 1.85%
If I am not mistaken the S&P is down almost 27% over that same 10 year period. I have had a few glasses of scotch but even by my clouded calculations that’s not to bad considering if you had put your money in most any other mutual fund you would have lost your ass(ets).
S&P May 29 2000 1477……………..S&P May 21 2010 1087
No need to panic as long as SP500 holds 1050-1000 area.
If only I had a dime for every time I came to pragcap.com… Incredible read.