Welcome to the New Bear Market

What little good QE2 accomplished has now vaporized.

Shortly after the open this morning, the S&P 500 dipped to 1,087 — 20% lower than the April 29 high of 1,363, thus meeting the formal definition of a “bear market.” That much you’ve likely already heard if you were unfortunate enough to turn on your radio or TV.

Here’s what you likely haven’t heard: 1,087 is only spitting distance from 1,049 — the level of the S&P on Aug. 26, 2010. That was the day Fed chief Ben Bernanke delivered his annual speech in Jackson Hole, Wyo., and signaled that a second round of “quantitative easing” was in the bag.

The market’s performance since then has been Bernanke’s benchmark. Something to brag on. A point of pride…

  • Nov. 4, 2010: “Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action,” he wrote in The Washington Post the day after QE2 was made formal policy
  • Jan. 13, 2011: “Our policies,” he said at an FDIC forum on small business, “have contributed to a stronger stock market, just as they did in March of 2009, when we did the last iteration [of quantitative easing]. The S&P 500 is up about 20% plus and the Russell 2000 is up 30% plus.”

Indeed it was. It is no more.

The S&P 500 and Russell 2000 Since Bernanke's 2010 Jackson Hole Speech

The Federal Reserve “will continue to closely monitor economic developments,” said chairman Ben Bernanke during snoozer testimony to Congress this morning, “and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability.”

Funny, he didn’t say squat about the stock market.

In any event, the suggestion that the Fed is still standing at the ready to mainline more QE heroin was enough to ease traders’ withdrawal pangs. The major indexes have bounced off their early-day lows.

“Banks are still undercapitalized, overleveraged and still burdened by far too many derivatives,” said GoldMoney’s James Turk to King World News today.

“The only uncertain thing is: On which side of the Atlantic will a major bank collapse? Because there are so many insolvent and fragile institutions around, it is hard to say which domino will topple first. I don’t think investors fully understand at this point the potential ramifications.

“When the first domino toppled in 2008, central banks stopped the contagion at Lehman, but they didn’t solve the problem, which has now become larger and much more severe than it was three years ago.

“What this means is that once the first domino topples, this event may be beyond the control of any one government or even central banks.”

What Mr. Turk is describing would be 2011’s version of Creditanstalt, the private Austrian bank that collapsed in May 1931, intensifying the Great Depression.

The contagion began in Austria, whose government responded with draconian measures. “The introduction of exchange controls in Austria,” recalls Russell Napier in his book Anatomy of the Bear, “had created concern among depositors in German banks that the balance sheet of their institutions may be undermined.

“As more than half of all German bank deposits were owned by non-Germans, a loss of confidence by these investors had very serious international consequences. There was a full-scale banking crisis in Germany by July, and exchange controls followed. As U.S. bank deposits in Austria, Hungary and Germany were frozen, the stability of U.S. bank balance sheets was further undermined.”

That encouraged Americans to pull their money out of U.S. banks. Total deposits shrank from $58.1 billion in December 1930 to $49.5 billion a year later.

Between April-August 1931, 573 banks failed. In the following two months, the number accelerated to 827.

Which brings us to the question: Who is a possible candidate for 2011’s version of Creditanstalt?

Dave Gonigam
for The Daily Reckoning