How Much Juice is Left in this Bear Market Rally?
Since it peaked in 2007, the UK stock market lost 60% of its value. As of yesterday, it had recovered half of what it had lost.
All over the world, the story is about the same. Markets have recovered half or more of what they gave up.
The US is a laggard. While the S&P is up 60%, the Dow isn’t yet at the halfway point. Some foreign markets, meanwhile, have 100% + gains.
Fund managers who missed the rally are kicking themselves. They’ve failed to keep up with the benchmarks.
Even before the market headed up in March we echoed Richard Russell’s words: “One of the surest phenomena in the financial world is the bear market bounce,” he said. We also guessed that the bounce would go to about half the previous losses. We based that on what had happened after the Crash of ’29.
Well, we’re still not there. But an analyst from Morgan Stanley tells us that markets tend to do better than that. The typical bounce is about 70%, says he.
Whew! That’s a pretty serious bounce. If we’d known it was going to be that big we would have encouraged dear readers to bet on it. Instead, we judged it a dangerous countercurrent…like a back eddy or rip tide. Yes, it can take you places…but not necessarily where you want to go!
Our outlook here at The Daily Reckoning is very long term. We don’t like betting on countercurrents…even important ones. Instead, we like to go with the flow…and keep going with it until it arrives at its end.
That’s not as easy as it sounds.
In 1999, it looked like the bull market had come to an end. We thought so. We told readers to get out of stocks…and stay out. Gold was a better place to be.
Investors made nothing in stocks for the next 10 years. In real terms, the stock market decline began in January 2000. Prices went down. They bounced…such a big bounce that it looked like a genuine new bull market. But after inflation, there wasn’t much left. Adjust for purchasing power and investors were worse off every year. Even now, after a 7-month bounce and a 45% gain, Dow investors are still down 30% to 40% from the highs set in 1999.
“The only thing we really learned in this extremely flashy, seven-month, 60%, nine-point multiple expansion-led rally, is that momentum investing never did become extinguished this cycle. It is really a fascinating commentary on human behavior that so many ‘investors’ are lamenting about how ‘the train has left the station’ without them. Please, give us a giant break! The train has left the station countless of times in the last 10 years but obviously none of these trips lasted very long because the reality is that equities have failed to generate any positive return over this time interval.
“As for the here and now, there is another reality. Price gains in the stock market have generally occurred with low volume. There are limited buyers – hedge funds and flash traders – but no sellers (not yet, anyway). And, we saw in yesterday’s decline that volume climbed across the board, and the number of high-volume selloffs is a major red flag that should not be ignored.”
The typical major bear market lasts 15-20 years. The last one began in 1966. It wasn’t until 1982 – 16 years later – that the next major bull trend began.
This bear market is already 10 years old. Perhaps it will end in 2015. Maybe in 2020. We don’t know when. We only know how it will end – in misery.
Now, despite 10 years of stinkin’ returns, investors still believe in stocks. They still hope to find the ‘next Google.’ They still punish fund managers who hold back. They still read the financial press. They still watch CNBC. They still want to know what stock to buy.
Yesterday, they bid up the Dow 131 points. The price of stocks to gold is about 10 to 1. When this trend began ten years ago, we predicted that the Dow and gold would go all the way to 1 for 1. We guessed it would happen at the 3,000 to 5,000 level. We’ll stick with that prediction until it proves correct…or it makes us look like a fool.
Government debt? No problem. The net interest paid by the US government is actually about the same – as a percentage of GDP – as it was 40 years ago. It’s only 1.3% of output – nothing to worry about.
But wait…what’s this? The average maturity of that debt has come down from more than 5 years to only 4. And according to the Office of management and Budget, if the US continues on its present course, net interest will rise to 5% of GDP in 2019 and 10% in 2034.
And that assumes there is no big increase in interest rates…and that the economy recovers as planned. If either of those things fails to happen, the situation will degrade fast.
Imagine if the government were forced to refinance debt at double-digit interest rates – as it was in the late ’70s. Net interest could go to 5% of GDP within months.
We’re in a depression, not a recession. Depressions take longer to sort out. But they are also far more treacherous. Because there are always periods when things seem to be going “back to normal,” only to go back down again as soon as investors turn bullish.
Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan’s long, dark passage:
“We had these false starts… The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”
Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they’re going to have a “lost decade,” just like the Japanese.
You have to keep the stimulus money flowing “until the private sector de-leveraging is over,” he says.
By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can’t finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger…along with the entire global financial system.
Koo may be right – as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too – a default…and hyperinflation. Worse than a depression.