One Way To Get A Really Big Slowdown

The question is asked: “How much worse can it get?”

“Well, probably a lot…” comes the reply.

Sure the Dow closed down 188 Friday… at 7528, its lowest finish since Nov. 13, 1997 – just shy of a five-year low. Sure the S&P 500 shed another 3.3% for the week, closing at 800. And…yes, it’s true, the Nasdaq did decline another 4.9% this week, slipping down to 1139.

But if you look at the market through the simple lens of price to earnings, we’ve probably got a long way to go before this bear market reaches its nadir. At the current level of 800, roughly 30 times earnings, the S&P 500 will have to fall under 500 – an additional drop of about 37.5% – just to reach an “overvalued” P/E of 20.

In fact, if you want to follow this line of thinking closely, I recommend looking at some charts posted and interpreted by Joseph Miller on the Alternatives For Financial Freedom website . Miller’s analysis shows that the S&P has been exceeding the “overvalued” 20 times earnings mark since 1996 – round about the time Greenspan claimed that not only did he know what an irrationally exuberant investment bubble was but that he knew how to stop one, too. Which means the Dow’s approach of a five-year low this week… is only getting somewhere near the “overvalued” mark.

To return to “fair value”… a P/E of about 15 on the S&P… would require another 430 points to be sheered of the broad index. That’s a drop of about 54% from here.

Trouble is, that’s not even the half of it. Let me put it to you this way: do you think we’ve even begun to see the despair and anguish you’d expect to accompany the bursting of the largest investment bubble in history? “Before this bear market ends many years from now,” writes Miller, “P/E ratios will drop back to…a P/E of 8 to 10.”

That means an additional drop from the current level of 800 to somewhere near 250… or an additional drop of about 69%.

We’ve long speculated that resistance to the idea we’ve entered the “big daddy” of all bear markets is derived from the rising level of home prices. According to the Wall Street Journal, in more than 100 US cities, home prices have climbed at least twice as fast as personal incomes since 1998.

“Though the problem is most common in the Northeast and on the West Coast,” says the Journal, “the list of localities with out-of-proportion prices includes large cities around the country such as Atlanta, Las Vegas, Denver, Houston, Tucson and Charleston, S.C. In Miami, home prices have shot up 58% since the beginning of 1998, while incomes have risen only 16%. In New York’s Long Island suburbs, an 81% increase in home prices compares with a 14% rise in incomes. In Boston, home prices have jumped 89%, compared with income gains of only 22%.”

But, notes the article, cracks are beginning to appear in the foundation of the bubble. Mortgage delinquencies have skyrocketed to their highest level in a decade, forcing lenders to begin tightening credit… and job losses are beginning to take their toll. More than 85,000 people have lost their jobs in Boston, for example. “At some point, [lenders are going to pull back even further],” the Journal quotes a mortgage analyst from UBS Warburg. “That would be one of the ways you could really get the big slowdown.”

With the market momentum weighted heavily in the down direction… how much longer will unsightly low rates keep consumers lining up on weekends filling out mortgage applications? Aided by the lowest mortgage rates since the 60s, “speculative money that once went into the stock market,” writes the WSJ, has increasingly been flowing into the housing market and artificially pushing up prices. Such speculation is usually temporary and tends to presage a peak.”

Can you say…Tokyo, 1991?

Bon weekend,

Addison Wiggin,
The Daily Reckoning
October 5, 2002

P.S. Evan Pickworth, a colleague of mine who mans the South African bureau of Agora Publishing, sent me a tally of the world markets over the last 12 months. It doesn’t look pretty… but I discovered he had an ulterior motive.

The world markets… that is, Dow Jones Global Indexes valued in US dollars… were down an average of 18% over the last 12 months. Notably, Brazil down nearly 50%… Sweden, Finland and Venezuela about 40%… and about 10 more countries, including the US, approaching 30% down. Of 35 countries listed, only 6 had a positive year. Indonesia, up a whopping 23% took the cake, but right there in second was South Africa… up 16.5% over the past 12 months.

I guess the world’s desire for gold is having a positive affect in at least one country’s market, eh?

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THIS WEEK in THE DAILY RECKONING

10/04/02 BLACK AND BLUE
by Bill Bonner

“…During the first 3 decades following WWII the ratio of debt-to-GDP growth was fairly constant. For every extra dollar of GDP, debt went up by $1.40. Recently, the ratio has gone out of whack – with nearly $5 in debt for every extra dollar in GDP. There is a hint of desperation about these figures, we think. People are borrowing not to invest in new and better industries, but to keep up appearances…”

10/03/02 THE CURRENT ACCOUNT GUESSING GAME
by Andrew Kashdan

“…Post-bubble, all those foreign investors who generously financed the U.S. spending spree have little to show for it. So, it’s not that the rest of the world is unwilling to carry the burden of importing (as if consumption were an act of altruism), but rather that they are unable…”

10/02/02 GRAYER MATTERS
by Bill Bonner

“…Savings require discipline, forbearance and sacrifice. They are the ‘something’ without which you don’t get but ‘nothing’. But the word was forgotten by the last generation of American economists…and replaced in the dictionary of central bankers by the word ‘credit’, which promised to do the same work at much less cost…”

10/01/02 BETTER VALUE FOR THE MONEY
by Bruce McWilliams

“…The truth is, all those toiling away in Wall Street and City boardrooms wish they could affect the market, but it is you and me, dear reader, with our investments, who drive the market higher. Study after study has shown that big market advances take place unpredictably. It would be good if we could nip in and duck out right before advances and falls were to take place…but how can one foretell the future?…”

09/30/02 GRAY MATTERS
by Bill Bonner

“…The problem with theory, outside of mathematics and the ‘hard’ sciences, is that nature is very much alive. She won’t stand still. Trying to force a theory upon her is like trying to argue with a smart woman…she squirms, feints, and distracts you from your point so thoroughly that, after a few minutes, you have forgotten what you were talking about…”

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HEADLINE, NEWS And INSIGHT : When A Private Virtue Becomes A Public Vice… Saber Rattling And The Price Of Oil… Will Foreigner Investors Remain Confident In The Dollar?

Dollar Devaluation Party
by John Mauldin

“…If every consumer in America decided it was in his best interest to start saving an extra 5%, the US economy would tilt into recession quite quickly. What would be a good policy for each individual would have negative collective consequences for the economy…”

When Bush Comes to Shove
by James Dale Davidson

“…the impact of continued saber rattling on the economy is so negative, just in terms of higher oil prices, that it raises the possibility that what appear to be ham-handed comments by Bush administration officials may actually reflect a subtle effort at coalition-building. By talking up oil prices, Bush may be paying off the Saudis, Russians and other oil producers to mitigate opposition to a regime change in Baghdad…”

Keys to the Printing Press
by John Myers

“…If foreigners lose confidence in the dollar en masse, interest rates will soar. (Washington would be forced to pay more to attract and keep its creditors.) That would set off a chain reaction of a vicious cycle that dampens consumer spending, which causes corporate profits to fall, which knocks the legs out from under the stock market. In quick fashion fear would replace uncertainty…”