By Jon Markman of MSN Money:
Stocks scorched the sky in impressive fashion last week, starting with a 379-point Dow rocket Tuesday and proceeding with the sort of jubilant, eat-my-shorts swagger that has characterized the start of many new bull markets of the past.
Bravo, well done, and quite a relief. But enough to signal an end to the 17-month capital attack that has blown up $50 trillion in market value and blistered many investors' professional reputations? Not a chance, as well-armed bears in police uniforms are just itching to give out tickets to investors trying to break the laws of financial gravity.
The roots of the advance were suspect, and undeniable earnings and credit disasters still lie ahead. The previous 23 times that 5%-plus up days for the market have followed massive one-year declines all came in the ever-hopeful but share-bleeding Depression years of 1931 and 1932. The market may well rally 12% more to the February highs, but bulls shouldn't send out party invitations just yet. Expect the rally to fizzle out by the end of this week or next, or, in a stretch, by the start of April.
Why so glum? Bad news that hasn't hit stock markets is like a case of embezzlement; in both cases the victim can believe he has access to funds for a long time even though they are actually gone. Bear markets are thus like a long forensic investigation of what economist John Kenneth Galbraith called the "bezzle," the plundered funds.
Bears take a break, sharpen claws
Catalysts for the rally were patently absurd. The kickoff event last Tuesday, March 10, was an announcement by Citigroup (C, news, msgs) that it had earned a profit in the first two months of the year -- as long as you don't count loan write-offs or other losses. That's like saying Death Valley is temperate except for the heat.There was also word out of Congress that legislators wanted to suspend much-hated mark-to-market accounting rules -- but then acknowledged it's really the call of the Securities and Exchange Commission, which quickly said it would do no such thing. And then Treasury Secretary Tim Geithner told reporters that the Obama administration planned to do what was necessary to fix the economy -- yet unfortunately plans from his understaffed department are still all they've got.
A week earlier, the market would have fallen apart on this bland news. So why the big rally March 10? The smug answer revolves around supply-and-demand nuances. But the sassy answer is that the bears are sort of like a thug who has been pounding a victim for hours and needs to take a break to ice his knuckles. This is just a timeout. The beatings will continue until morale improves.
Let's get the facts straight: The bear market has not been about panic or psychology; it's been about plunging demand and the death of credit securitization. Neither shows any signs of improving in the next six months. Retail sales for 2008 were off 10.4%, a plunge equaled in the past 60 years only by July 1951, according to analyst Philippa Dunne. In February, just 6% of respondents in Dunne's monthly survey of state officials hit their targets for sales-tax collections, down from 21% in January. Said one official: "I have been doing this 25 years, and I never thought I would see broadly and consistently declining sales-tax receipts."
Home prices are now declining at their fastest pace ever, according to ISI Group analysts. Since those declines are coming at the same time stock prices have plunged, credit has re-tightened, and unemployment is accelerating. Among smart independent economists, gross domestic product growth forecasts for 2009 are going negative, down from prior expectations of flat to 1% growth. And next year is looking much worse: An analysis by ISI, which has been right on the money so far, shows the country likely to lose 4 million more jobs by the end of 2010 to reach an 11% unemployment rate. In the past two recessions, 2001 and 1990-91, employment didn't start to grow until one to two years after the first quarter of GDP growth.
Making the housing problem more acute are forecasts that the next leg down will slam areas such as New York and Seattle, where prices are down only 15% from their peaks so far. In areas like California, where prices are down 50%, sales are actually surging from very low levels, but part of the reason is that foreclosure dumping has created stunning bargains that also cut marginal pricing further.
Some good news: If home prices fall 10% more nationwide and mortgage rates stay on track to hit 4.75%, housing affordability, already at a record high in January, will rise an additional 20%, setting the stage for a robust recovery in a couple of years.
Commercial property vacancies are on track to hit 18% by the end of the year.
Too much Obama drama
Meanwhile, there's been a backlash against anyone who has proposed that the 20% decline in stocks since Jan. 20 can be laid to the inauguration of President Barack Obama, but it's pretty hard to deny that his administration's policy blitzkrieg has thrown some elbows and blackened some eyes. You can argue whether his initiatives are smart or wrongheaded, but you can't deny that they have freaked out investors who were already at DEFCON 1. The short list includes:- Proposals for higher income taxes on the highest earners.
- Higher taxes on capital gains and dividends.
- A new tax on all securities trades.
- "Cram-down" legislation forcing banks to accept lower profits on mortgages.
- The Employee Free Choice Act, which would give unions an advantage over management.
- The carbon tax.
- Limits on oil drillers' tax breaks.
- Limits on agricultural subsidies.
- Smaller deductions on mortgage payments.
- Cuts in subsidies to independent student loan providers.
- Limits on drug pricing and Medicare rates.
The Obama administration has further poisoned its relationship with global investors by failing to staff the Treasury Department to a level consistent with the emergency, leaving the job of creating a new plan for banks, credit and the currency to a single inexperienced, overworked secretary and a handful of bureaucrats.
British financial authorities have complained to the Financial Times that when they have called Treasury for help with organization of the upcoming G-20 summit, no one answered the phone. Understaffing may be partly to blame for growth assumptions in the 2010 budget that are wildly out of whack with reality in a way that will undermine policy, assuming, for instance, that unemployment will peak at 8.8% this year and that GDP growth will be back to 3%.
Overseas, German machinery orders in January were down 45% year over year, and commercial-real-estate prices were down 30%. From Tokyo comes reports that most Japanese don't see the stock market as an investment option anymore after the Nikkei has fallen from 37,500 to 7,000 over the past 19 years. (If U.S. prices track the same path, the S&P 500 Index ($INX) would be at 400 in 2020.) And emerging markets from Hungary to Mexico and South Korea are seeing currency collapses that are playing havoc with savings accounts and foreign buying power.
Bulls contend that all of this is known and discounted, and yet bad news does still have the capacity to shock. One area of further concern is the impact on the rising U.S. savings rate, which I discussed in a recent column, and on credit cards. ISI calculates that if American families push savings to 7% of income by the year's end, as expected, consumer installment debt will fall 20% to $540 billion. That may be good for consumer balance sheets, but it will further crush revenue and margins at credit card issuers such as Capital One (COF, news, msgs) and JPMorgan Chase (JPM, news, msgs), because their sales volumes will decline at the same time unemployment-spurred delinquency rates are at 5.6% and climbing -- a bad combination.
CNBC dragged Warren Buffett on the air the other day to give a reprise of his "buy American" speech from October, when the market was 30% higher. But his company and the rest of the market are just as vulnerable as ever, as exposures to housing, insurance, banks, transportation, retail and machine tools are cracked open to reveal the bezzle. Enjoy the respite and the short-term gains, but recognize that bears are not sleeping -- they're reloading.
