Is the Bounce Still Bouncing?

“What’s that smell?”

We were on an airplane when Edward, 15, noticed an odor that seemed out of place.

“Dad…you should have at least cleaned your boots!”

The manure began accumulating when we rode up to the high pasture on Tuesday. More about that below…

In the meantime, the Dow rallied a bit yesterday – up 127 points…barely half of what it lost on Monday.
Is the bounce still bouncing? We don’t know. But we don’t trust it. They say the stock market ‘looks ahead.’ So, it is possible for it to see things we can’t see. On the other hand, what was it looking at two years ago? Didn’t it see the economy going over a cliff? Apparently not.

But investors tend to believe what they want to believe. And what they want to believe is that the stock market has had its vision corrected and now sees a recovery.

Our guess is that they are wrong on both scores. The stock market is just as blind now as it was in early 2007…and there is no recovery coming any time soon. As to the first point, we have no further evidence to present…but as to the second; at least we have a theory.

By our reckoning, this is not a recession…this is a depression. In a recession, the bull market formula still works. It just needs a little time to rest…catch its breath…work off inventories…and rebuild cash accounts. But in a depression, the formula stops working.

The basic formula that drove the U.S. economy for the last 60 years has been the expansion of consumer spending. At first, that spending was healthy spending. People had built up savings during the war. In the Eisenhower years, they were ready to get back to work in the consumer economy, get married, have children, and spend money. America was the world’s leading lender…leading exporter…leading manufacturer…and leading everything. Gradually though, having so many advantages caught up to the United States of America. By the ’70s, the Nixon administration thought it could do away with the gold backing for the currency. By the ’80s, the United States slipped from being a net creditor to being a net debtor to the rest of the world. By the ’90s, American consumers were spending more than they made…and by the ’00s they had given up saving all together – depending on the savings of poor people in China and elsewhere in order to continue living beyond their means.

Each time this system was faced with a recessionary correction, at least in the last 25 years, the feds tried to stimulate consumer spending with easier credit. And each time, consumers took the bait and got hooked on more debt. That’s why the financial industry expanded so much…it sold more and more debt in more and more grotesque and amazing ways.

This time is different. This time the feds have responded with zero interest rates…and $13 trillion worth of bailouts and boondoggles. But the old magic doesn’t seem to work anymore. This time, the formula no longer works. Consumers already have too much stuff – and no way to pay for it all. They have no choice; they have to cut back. This is not a pause in the long cycle of increasing consumption, debt and speculation. It is a reversal of the cycle – with less consumption and less debt (more savings). This is a depression.

If left alone, this cycle will see falling asset prices, falling bond prices and rising savings for many years. Stocks should sell down to levels where they are attractive again – at average P/Es below 8…7…or even 6. And with dividend yields above 5%.

Of course, when that happens people will have lost interest in stocks. The financial magazines will have pronounced the stock market “dead” and Jim Cramer will have been booted off the air.

By that time, the economy will have been restructured too. There will be less retail space. Many malls will have gone broke. Living standards in America and Britain will have gone down. And many of the people in the financial industry will be doing what they ought to have been doing all along – taking lunch counter orders.

Now, we turn to Addison for news on the global financial losses:

“Banks, brokerages, fund managers…you name the financial firm…they’ve now seen nearly $4.1 trillion in digits evaporate since the beginning of the credit crunch, says the International Monetary Fund (IMF) this morning.”

“More than half the losses – $2.7 trillion – were sustained by U.S. firms,” explains Addison in today’s issue of The 5 Min. Forecast.

“So far, global financial losses in this bust are almost equal to the entire market cap crunch of the tech bust early in the century:


“In an effort to paper over the losses abroad, the IMF has already funded over $55 billion in emergency loans to European nations including Hungary, Serbia, Romania, Iceland, Ukraine, Belarus and Latvia.

“Last week, Mexico became the first Latin American country to put up the white flag, asking for a $47 billion line of credit. Just yesterday, Columbia followed suit, seeking $10.4 billion. We’ll go out on a limb here… they won’t be the last.”

Each weekday, Addison brings readers the The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments – in five minutes or less.

And back to Bill, with more thoughts:

Compuel is a huge valley…probably about 10,000 acres…above 3,000 meters in altitude. There are no trees. And a cold wind blows through the sage even in summer. This time of year, at least it is green.

The summer rains came late this year. A river runs through the center of the valley, wide and shallow…you can splash through it on horseback. For a few months of the year, it turns the center of the valley into wetlands. Later, in the winter months, it will be dry as Death Valley and as cold as a tax collector’s heart. But last week it was wet and marshy…with ducks flapping up suddenly wherever you go.

You can get to Compuel in a 4×4…but it is an almost impossible drive…not to mention dangerous. There are sections of the road that are hardly as wide as the wheelbase…with a 1,000 ft drop off the edge.

“It was probably an old Inca or pre-Inca trail,” explained Veronica. She was one of three archeologists who showed up at the house on Saturday. They asked if they could camp out and do some digging in the Indian ruins on the ranch.

“We won’t take anything. Besides, the law requires that anything we find belongs to the state,” she anticipated our questions.

“This area is very rich in archeological evidence,” Veronica continued. She was from Buenos Aires, a cheerful, talkative woman with a librarian’s air about her. With her was Paola…another archeologist from Buenos Aires …and Hector…an archeologist from Salta. They were trying to figure out dates.

“We don’t really know much about the Indians who were here before the Inca,” Veronica went on. “All we know is that they were brave and independent. This tribe resisted the Inca…and the Spanish. The Incas tried to subjugate them…forcing them to pay tribute. But they fought them off. I guess they figured that if they could beat the Incas they could also beat the Spanish. In fact, they were the last Indians in all of Argentina to surrender. And the story is that women took their babies up into what they call the ‘fortress’ – a natural stone formation – and threw them onto the rocks down below rather than see them enslaved by the conquistadors.

“But we don’t know much more than that. So we dig down to try to find bits of pottery…and seeds…and soil samples that will tell us what they ate and which groups of other tribes they were related to. Then, we put the pieces together and gradually develop a better picture of who they were and how they lived.

“That’s why we need to go to the ruins at Compuel.”

“How are you going to get there?” asked Jorge, the farm manager.

“We’re going to hike. What do you think…can we get there in 4 hours or so?”

“Ha…ha… it will take you at least 7 hours… depending on how strong you are. And of course, you will need a pack mule to carry your equipment.”

On horseback, you can get to Compuel from the ranch house in 4 hours. The trail is rugged…with the horses stepping from stone to stone in some areas. By the time we got there we were already tired and saddle-sore. When we arrived, the roundup had already begun. The vaqueros – our local cowboys – had already rounded up the cattle from the whole valley and driven them into a big stone corral. They were roping the calves and separating the bulls from the cows. Occasionally, a bull would charge…but the cowboys were fast, they dashed to the side and jumped up onto the stonewall. Their dogs stood on top of the stonewall watching attentively. This was a once-a-year spectacle they didn’t want to miss.

To be continued…

Bill Bonner
The Daily Reckoning