Not Your Grandfather's Recession: Why Stocks are Headed Down

The present volatility will be resolved by a decisive move to the downside.

Yesterday, the Dow moved 225 points into negative territory. Was that decisive? No. Not in itself. But it looks like the top is in. If so, stocks should be going down…down…down…

Maybe for a year…maybe for 5 years…maybe for another 10 years…

Yes, dear reader…the stock market is now free to complete its rendezvous with destiny.

Just where, exactly, will that rendezvous take place? Who knows? About 3,000 on the Dow is our guess. But it’s just a guess.

Stocks trade around 20 times earnings now…and the Dow is about 10 times the price of gold. Sometime in the future, you’ll probably be able to buy Dow stocks at 5 times earnings and maybe only 1 times the price of gold.

Three thousand seems like a likely target, because that would move stock prices down into the right range from a P/E standpoint…and we can easily imagine a gold price of $3,000.

Why would stocks move down?

First, because the bear market that began in January 2000 never fully expressed itself. It was distracted, first by the big flood of stimulus during and after the micro-recession of 2001…and then by the huge flood of stimulus following the crisis of ’07-’09.

Second, because the economy is in a Great Correction – a difficult time, with lagging earnings, slow growth, and high unemployment.

Paul Volcker is the only financial authority associated with the government who has any credibility left. Here’s what he says:

“What we need is more saving, more industrial investment, and a stronger trade position. Our expansive and expensive program of entitlements simply must be brought under control. Our mortgage market must be rebuilt from the ground up.”

Volcker is talking about a Great Correction, which he describes in the same way we do: “a long period of economic adjustment:”

“Not much of that can be done this year, or even next,” Volcker said. “It is a challenge not just for this Congress and this administration, but for years ahead.”

Neither Tim Geithner nor Ben Bernanke seem to understand this. But the man on the street feels it. This from Charles Delvalle, who runs the research team for our family office:

Floyd Norris points out that the Conference Board’s economic survey, which dates back 4 decades, shows a curious change in future expectations. Since 1967, Americans have for the most part, remained more optimistic than pessimistic about their own futures. This was true even when their expectations for the overall economy were negative.

But that optimism disappeared during the 2007-9 downturn. A majority of folks began to expect their own financial situation would get worse – versus those expecting better personal times ahead:

“In April, the Conference Board reported this week, about one person in 10 expected his or her family’s income to improve, while about one in six expected family income to go down.

“…good times in recent years have produced less net optimism than in previous cycles, while bad times have brought more pessimism.

“On its face, such a result would seem to indicate Americans are losing their optimism, but it may not be as simple as that. In this cycle, unlike earlier ones, many workers were forced to take pay cuts, at least on a temporary basis. So it became reasonable to expect lower income, even for some who did not expect to lose their jobs.

“Still, the decline in expectations regarding their own incomes is another indication of how much this recession scared people – and that some of the fright remains.”

As we keep saying, this is not a typical post-war recession. So, it is no surprise that consumers and investors aren’t acting like they usually do.

This time it’s different – really. This time people are beginning to doubt that old formula works. They know they can’t continue to run up debt in their own accounts. And they doubt that the government can do it either.

That’s why gold is moving the way it is. Only a few months ago gold and the dollar were headed in opposite directions. Now they’re moving together. When investors get worried, they move into gold AND the dollar.

The next trend will be to move into gold and reject the dollar. But that trend may be far in the future.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning