http://www.dailyreckoning.com/Issues/2008/DR123108.htmlWell, here we are. The last day of the worst year in stock market history.
At least, in a few hours it will be over. Let us bow our heads in prayer: please Lord, don’t give us another year like 2008.
What’s ahead for 2009 is the subject of today’s end-of-the-year reflection. Not that we know anything. In fact, Daily Reckoning readers often chide us gently after we make remarks about politics, fashion, art or other subjects: “stick to what you know,” they say.
Trouble is, we don’t know anything. Beyond what we see and hear directly, it is all hypothesis, inference and conjecture. We’re even a little suspicious about things that take place right under our own noses. “Did we see what we think we saw?” we ask ourselves.
As for the markets – nobody knows nuthin’. Even the greatest economists of the 20th century were mostly wrong. But even as to that we are uncertain. Being wrong in economics is a matter of opinion. It’s not science. You can’t test economic theories. Because you can’t do a controlled experiment. The conditions are always different...and there’s always more to the story. So you can never definitively prove whether they are right or wrong. All you can do is argue about them.
As for the analysts, practically all their projections, forecasts, models and formulae have proven worse than useless. We remember, in March, we went looking for a money manager. The pros gave us neat diagrams showing their forecasts for how much we would make from different asset classes...along with probability figures showing how much we could count on the money. For example, we might expect to make 8.2% per year from emerging markets over the next 10 years...with a probability of 68% to 85% that this would turn out to be correct. Thus could we choose an investment strategy suited to our needs.
The numbers were impressively detailed. But they were just numbers. In the event, it turned out that the analysts had no idea. Nowhere in their projections...or even in their dreams...was the possibility of losing half our money in emerging markets before the end of the year.
But the analysts put on a good show. And they misled an entire generation of investors into making the dumbest speculations of all time. Now, those mistakes are being corrected – which is why we are ending a year with the greatest losses of all time.
Yes, dear reader, fair warning: it’s all guesswork.
We hope and suspect that our guesses are better than those of most economists. Not because we are smarter or better informed, but because we dumber and more ignorant. We were never smart enough to understand how the theories that guide most economists could possibly be true. As to how you could get rich by borrowing money...or how you could help a deadbeat debtor by lending him more money – we never got the hang of it. And put the Black-Scholes Option Pricing Model in front of us...and we go blank. Maybe those numbers mean something...and maybe they don’t.
Let us put it this way, we are unburdened by the illusion of knowledge. In other words, we are aware of the profundity of our ignorance...giving us a little edge over most investment forecasters.
Besides, our operating metaphor is more in line with the facts. Economies are not machines. Instead, they are organic, natural phenomenon in which the principal actor – man – is subject to fits of brutal sanity, interspersed by long periods of hallucination in which he is trying to get something for nothing. Fundamentally, it is a ‘moral’ system, not a mechanical system. When people make mistakes they have to pay for them.
“Find the premise that is false and invest against it,” says George Soros. At the end of the last century people believed that stocks would go up forever while gold went down. We bet against it, with happy results. Then, in 2007/early 2008 there were so many false premises around that a contrarian investor was spoiled for choice. Housing, stocks, shipping, oil, copper...debt, equity, commodities...he could point blindfolded at the Financial Times and find a good short sale opportunity.
But what now?
What is the premise that is wrong today? Perhaps it is revealed in the following two news items:
“Consumer confidence at all-time low,” reports Bloomberg .
Meanwhile, yesterday, the 10-year Treasury note was at an all-time high, with a yield of only 2.09%.
Consumers think the world is ending tomorrow. But investors imagine that U.S. government debt, and the currency in which it is denominated, will be good forever. At the present nominal rate of return on T-notes, an investor would have to wait 50 years to earn back his investment. At the real rate – adjusted for the current rate of consumer price inflation – people will ice skate in Hell first. The real rate of return on T-notes is negative.
The supply of U.S. government debt is soaring; surely, you might imagine that it would go down in price. Sometime in the future, interest rates are bound to go up. When they do, investors in Treasury bonds are going to be disappointed. But when that disappointment will come, we don’t know. Maybe by the end of 2009...maybe not until 2010 or beyond.
As for 2009, there are few signs on this highway. In all history, there have not been many crack-ups like this one. Still, judging by those few, we can see a pattern. In psychological terms, there’s the shock of the initial crash. Then, the denial. Then, the pile-up...in which the crisis affects the entire economy. Gradually, people come to realize how bad the situation really is.
Normally, that’s the end of it. But this time it IS different. We think there will another stage...one that didn’t happen either following the Crash of ’29 or after Japan’s crash of ’89. We call it the Omega stage...the last stage of a financial crisis...which we’ll turn to in a moment.
In market terms, what we’ve seen so far is the crash. What normally follows is a rebound. If this crisis follows the pattern of ’29-’32, for example, we’ll see a rebound of 30% to 50% in the first 6 months of ’09.
Richard Russell comments:
“Following a true crash, stocks and stock averages have a habit of recovering roughly 50% of the action lost in the crash. Robert Rhea wrote that the surest action in the market was the recovery, usually halfway back from the points lost in a crash.”
Then, again if the pattern of ’29-’32 holds, the market will crash again...with the Dow going down below 7,000...perhaps to about 5,000. Finally, investors will begin to realize that this crisis is no temporary setback, but a fundamental change. The bull market – and the mentality that go with it – will be dead. Typically, assets will reach their lowest level – with losses of 75% to 95%. And then, a new bull market can begin...slowly, cautiously and reluctantly.
That’s when you can get great deals – solid stocks paying 10% dividends and selling at only 4-6 times earnings.
But then...there’s the Omega Stage...the last stage of this crisis...the climax of the world’s biggest bust. In the crash of ’29...and all previous crashes in modern history... money was connected to gold. Stocks may have been suspect. Bonds may have been dubious. Assets of all sorts may have been called into question. But at least money itself was solid. You could depend on it. Cash was king.
Not now. Since ’71, cash has been just another asset – one without fixed value...one with no earnings...one with no guarantees. A dollar might you a cup of coffee one day....a few weeks later, you might need two or three dollars to buy a cup of coffee.
Or, if you were in Zimbabwe in 2008, you might find the cup of coffee that you paid $2 Zim for in May would cost you $2 million Zim dollars by September. No kidding. Consumer price inflation in Zimbabwe was running at 230 million percent by the end of the year – so fast, statisticians couldn’t keep up with it. And by December, that cup of coffee was almost unavailable, no matter how many pieces of paper you had. Hyperinflation destroyed the economy completely. And the money was completely worthless.
Why do we bring up Zimbabwe? Because the final stage of this crisis...the Omega Stage...is likely to resemble Zimbabwe.
And here is Zimbabwe’s central banker, Gideon Gono, explaining why:
“Banks, including those in USA and Britain are not now just talking of, but actually implements flexible and pragmatic central bank programs where these are deemed necessary in their national interests.
“That is precisely the path that we began only 4 years ago in pursuit of our national interest and have not wavered from that critical path despite the untold misunderstandings, vilification and demonization we have endured from across the political divide.”
Yes, dear reader. Central bankers have their own stages too. First they turn to the monetary stimulus of Milton Friedman. Then, when interest rates get to zero, they turn to the fiscal stimulus of John Maynard Keynes. You’ll see plenty of that in ’09...and President Obama unfurls his flag. But as it becomes clear that that will not work either – sometime in late ’09 or 2010, we imagine – they will turn to the printing press stimulus of Gideon Gono.
Happy New Year!
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