Friday 3 June 2011

Why the stockmarket could fall by 70% in real terms

(The following article was published yesterday on Seeking Alpha.)

My Feb. 11 SA estimate that the Dow could drop to 4,500 is echoed in a May 16 video interview with Russell Napier, who is predicting an equities bottom at around S&P 400. Actually, this is even lower than my guess, in proportion to the index chosen, but Napier says his figure is an average of what he expects valuations to be.

I've had a little abuse for this view, some rather personal, and it seems I'm too dumb to notice that the market has just had its biggest, fastest rise in history. Actually, the latter fact has not escaped me, and I take my hat off to those who have got on and off the Enron-like ride at the perfect moments -- so far.

What we've really seen in the last decade is two economic heart attacks and liberal use of the defibrillator: First a slash in interest rates that (given the venality and criminality of some in the financial world) led indirectly to the busting of the housing market and some major banks, and then a pouring of resources into the banking system that is now busting the credit of whole governments.

In a way, conventional market analysis is now hardly relevant, because the system is so grossly interfered with by government that everything hangs on what the Fed decides to do ... and how long it can get away with it. I pointed out several months ago that China (among others) is becoming very antsy about the export of America's inflation to the developing world.

In a May 10 interview with MoneyWeek's editor Merryn Somerset Webb, Napier says he expects the "reset" to come in two stages: First deflation, and then sharp inflation. I've pondered the in/de question for a long time, and his analysis seems plausible to me. We're so interconnected these days that a bust wouldn't just wipe out profligate banks, but also would crater the pensions and investments on which we have come to depend ... not to mention the taxman, who (particularly here in the UK) has found it very convenient to harvest money from the swollen financial sector. So inflation will be seen as the way to steal wealth to spackle up the cracks in the system. (Can you make a whole house out of spackle and duct tape, though?)

What's unusual about the current situation is that bonds are not on the other end of the seesaw to equities. Napier foresees a swift move up in interest rates that will undermine both. They say you shouldn't give an estimate and a timeframe at the same time, but he does, for the bear "pit": 2014. We shall see.

Meantime, Mike Shedlock today gives an alternative view, pointing out that corporations are holding a lot of cash. Maybe so, though I'd like to know more about who has the cash and who has the debt; whether some have both; and what the latter may do if interest rates spike. Not to mention what will happen to the demand side when ordinary Americans finally run out of money, as indeed many are doing already.

I have suggested that cash is not a bad place to be, unless you are one of the SA-reading gunslingers who has a sharp eye and sharper reflexes. Given the growing vulnerability of the US dollar (and various moves to weaken its position as the world's reserve currency), Napier has said (in the May 16 interview linked above) we might consider the currencies of emerging markets.

And I hedge my bet on the destination of the market by saying it may not be Dow 4,500 or S&P 400 in nominal terms -- but the market could well be there after adjusting for inflation.

Finally, there is a bright gleam in the dark: As Napier says, the bottom won't be in for long, and those who have the cash then and get in fast can "go to the beach" for years afterward. Like, as the FT interviewer said, in 1982.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.


Jazzbumpa said...

I followed the Napier link and find his inflation scenario very unconvincing. The deflation part seems inevitable. But inflation? You can't have that unless wages are rising. I see no prospect for that in even the medium term - perhaps ever, the way things are going.

I see a decline into oblivion. The question is -- will it be a steep plunge or a slow, agonizing stumble into a lost century?


Sackerson said...

I just find it hard to believe that the powers-that-be will allow us to be safe if we hold cash.

What if Ron Paul's investigation finally tips the game against the Federak Reserve, the government takes over the tight to issue money and then does so with a vengeance?

This is a great time for what-ifs and conspiracy theories - personally I'd rather not have to be thinking this way and just get on with life as per my 1950s happy normative expectations.

What jazz do you like? I like the originals - Stable Yard Rag - plus Charlie Parker and some experimental stuff, not that I'm any expert. You Dixieland?