It Really Is That Simple
Kit Webster
March 7, 2009
When flying at 30,000 feet, the world looks like a simple, orderly place. You cannot see the people or the cars.
When you get closer to the ground, it gets much, much messier.
When contemplating the current economic crisis at 30,000 feet, it is actually fairly simple.
- The Fed provided a lot of liquidity
- That liquidity allowed the refinancing of mortgages, withdrawing huge amounts of equity to apply to consumption
- That liquidity turned into a gargantuan amount of debt, allowing increased consumption
- All of that debt drove up asset prices
- The debt, which, simplistically, is consuming today borrowing consumption from tomorrow when the debt has to be repaid, led to an unsustainable lifestyle – put another way, it crammed 15 years of consuming into 5 years (5 and 15 are representative times and have no precision)
- The game came to an end, as all games must
- We have to get debt down to normal levels to have a stable economy, through repayment and bankruptcy
- Normal levels are far below the frenzy levels
- Therefore wealth and the level of “normal” economic activity will be far below frenzy levels
- Government policies will make all of this easier or harder, but stimulus packages, etc. are thumbs in the dike. The government is the only sector able to incur debt to keep things going while the remainder of the economy is rationalizing.
- The good bank/bad bank thing is the first major step to making debt go away and to repricing assets
- Sooner or later, the public sector of the economy will also have to be rationalized. At the moment we are trading ill-advised consumption by the private sector with ill-advised consumption by the public sector. The danger to our wealth in the long term is extreme.
The bottom line:
- Normal and sustainable economic activity (and debt levels) is significantly below the peak economic activity, so that the economy will have to go through a wrenching transformation, exemplified by the end of the investment banking industry and the bankruptcy of the domestic automobile industry.
- Government can make things better or worse, and will likely do both, with an emphasis on worse. The emphasis will be on worse because the government will tend to politically popular and ideologically consistent approaches rather than actually having economic recovery as a priority.
- There are continuing, significant issues that remain to be addressed, such as energy security, Social Security, Medicare, and global warming – we have borrowed from the future in more ways than simply incurring debt. Each of these will hinder economic recovery and exacerbate the economic transformation.
Let’s look at some graphs that describe the debt orgy.
Trillions of dollars were taken out of home values and primarily used for consumption.
These charts speak for themselves and indicate the debt orgy we have been through.
They also make it difficult to determine what a “normal” level of debt is. Debt increased during the entire supercycle, essentially from its beginnings in 1947. The rate of increase has been greater during the mania, but we began leveraging at a slow rate in the 50s, 60s and 70s, at an accelerating rate in the 80s, some slowdown in the early 90s and then another steep rise in the late 90s and 00s.
For argument’s sake, let’s assume the increase from roughly 1950 – 1980 is a good, sustainable increase. So, I drew a line extrapolating that growth to today. Normal would then be about 200% of GDP today as opposed to around 350% actual. (Since GDP is contracting and debt is increasing, the current number is higher. The average on the chart is a completely meaningless number, the equivalent of averaging mice and elephants, except that it neatly intersects with my meaningless extrapolation.)
By a similarly invalid argument, I demonstrate in another forum that the current “normal” price of the Dow Jones Industrial Average is around 3000.
The point is not the accuracy of my analyses, which have no chance of being correct, given all of the assumptions and the complexity of the problem, but that the gulf is large, that normal economic activity is far below peak economic activity, that normal, economically reasonable times will feel bad because of the large, required adjustments from the peak, and that it will take many years of normal growth to get back to the frenzy level. Recall that the Dow first exceeded its 1929 level in 1955, and that the Dow first exceeded its 1966 peak in 1991, after inflation. About 25 years in each case.
Nationalization
As a dyed in the wool free trade capitalist who is scared to death of Nancy Pelosi and Barney Frank, not to mention Barak Obama, I reluctantly conclude that the only solution to the bank problem is bankruptcy, just as with GM. Since politically we cannot call it bankruptcy, what we do is the same thing and call it nationalization. The bad stuff has to be dealt with. So far we have not dealt with any of it. I wonder why not. What are Geithner and Obama waiting on?
(I am simplifying my economic position here to make a point. My actual position is complicated to the point that it would take hours and pages to explain, and is not that interesting. Suffice it to say that I strongly believe that capitalism brings the greatest wealth and opportunity to the greatest number of people, but that the Earth cannot withstand the triumph of capitalism. As all trends contain the seeds of their end, capitalism enables the overpopulation of the Earth and the depletion of Earth’s resources on a massive scale. With the turning of China and India to quasi-capitalistic economies, a tipping point has been reached at which, essentially, too many people will become too wealthy and consume too much. Things were getting a little dicey just with 1 billion of us privileged Westerners enjoying ourselves; the addition of billions of others moves the game into an entirely different level. The world’s current economic repositioning will slow down that dynamic, but 6.6 billion people, growing to around 9 billion by the end of this century, are simply too many people, living too long and consuming too much. We will be significantly challenged by our success. While I am not a tree hugger, it is clear to me that there will be severe disruptions and reorganizations, particularly during the second half of this century. It is ironically likely that capitalism will be a necessary part of the great restructuring since it is the least bad way to transmit price signals.Like I said, more than you wanted to know.)
Gold
This picture from The Economist shows gold in constant dollar terms. We are a long way from the mania of the late 70s.
Philosophy
About once a year I subject you to ruminations about determinism and free will. But I am fascinated by the subject.
The thesis goes like this: to the extent I (or anyone) can predict the markets’ futures, the future is in some sense determined.
If, ‘way before the presidential election, I can say that the stock market is going to 10600 and that we will be lucky if it stays above 7000, and then when it gets below 10600 I say that it is going to around 6600, and it does, then in some sense it did not matter who was going to be elected president. The market was going to 6600 in some deterministic sense. On the other hand, the shape and length of the ultimate bottom may be dependent on the president and his policies.
There seems to be an intriguing interplay between periods of strong determinism and then periods in witch it appears that multiple futures are possible until one is chosen and there is another period of determinism. In the middle of all of that, random events (pandemics, asteroids, etc) disrupt and reset the system entirely.
The stock market is rapidly approaching the end of a highly deterministic period and the beginning of a sorting out of future possible realities. The market “wants” to go to 3800 or 1000, and that is the way to bet. However, we may be entering into one of those reality-sorting-out periods in which taking the “right” action can interrupt what would otherwise be the normal course.
Some time ago, following similar thoughts, one of you responded that individual behavior is subject to free will (a proposition unlikely to be proven one way or the other until the physical basis of consciousness is identified) but that mass behavior is more determined.
I liked that, except that mass behavior depends on individual behavior. In some ways it is like the weird, probabilistic quantum mechanics underlying the neat, mechanical Newtonian world (and before you get to Einsteinian weirdness near the speed of light). It could be that human behavioral reality has phases.
Enough of that – for another year or so, anyway.
The US Stock Market
The world continues to unfold as it should. We reached my target of 6600 and the (likely) completion of a major Elliott wave pattern. I sent out a quick update on Thursday indicating where I thought the market is and would go:
And I said:
6600 it is.
Now what?
Two possibilities:
The less likely possibility is that it is all over and time for the rebound (40/60)
One of the biggest bears on Wall Street, who runs a bear mutual fund, has advised people not to buy his fund, that a rally is coming, and it is likely the bear market is over.
The more likely possibility is that wave iii is over and we will get a pretty sharp upward movement in wave iv (for you Elliott types keeping score at home, since ii was a flat, iv will likely be a sharp) (60/40)
As always, it will be difficult to tell in its early stages whether the full bear market rally is under way or just a nice move up in a wave iv. As we get more evidence, I will let you know.
The new target is around 6300.
I am becoming more and more worried that there are flaws in my longer term forecast. This market is just extremely bearish. (Cycles indicate that) we are running out of time for a meaningful bear market rally. Again, more information as I figure it out.
Anyway, one way or the other, Obama’s “tracking poll” should provide him some short term relief. (If you missed it, the Pres said that he was not worried about the “short term fluctuations” in the stock market, that they were like a political tracking poll, that the “profit to earnings ratio” is getting to the point that buying might be a reasonable idea. Obama said on the campaign trail that he did not follow or understand the markets.)
Next week I will go into some detail about my growing unease about my longer term forecast.
US Treasury Bonds
In the short term, interest rates should be going down (bond prices should be going up). There is an argument that the bull market in bonds is over, and the current run up in bonds should go a long way toward telling us whether it is or is not.
US Dollar
In the short term, the dollar should be going down.
In the longer term, the dollar should remain bullish for a while. All hell will break loose at the end of the current pattern up.
Gold
Gold has been acting strangely – going up when the dollar is going up.
I am stubborn, in denial, or both, but I think that gold will be heading back to the 700s before the next bull leg.
With the dollar going down in the short term, the way to bet is that gold will be going up.
Oil
I have no strong opinion on oil, either. Supply and demand are trying to come into synch. This is my best guess (although the consolidation could lengthen into a triangle). Ultimately, I would look for new lows, but I am not yet ready to make that prediction.
About Kit Webster
Mr. Webster is a management consultant, based in Austin, Texas. His practice focuses on assisting companies in crisis, including revising business plans, revising operational practices and processes, strategic partnering, mergers and acquisitions, and turn arounds. Mr. Webster has previously been chief executive officer, president, and chief financial officer of privately- and publicly- held companies in areas including health care, marketing and high tech hardware and software, and has a broad expertise in strategic and operational management, as well as technology and finance. Mr. Webster earned a Masters of Electrical Engineering from Rice University in Houston, Texas, and is a Certified Public (Chartered) Accountant. Mr. Webster is a Lecturer at the University of Texas, teaching an undergraduate course on business process strategy, improvement, implementation and integration. He has also taught finance, with emphasis on mergers and acquisitions, within the MBA school.
© Copyright 2001-2009 Kit Webster and MarketTimingCycles.com All rights Reserved
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Market Timing Cycles
It Really Is That Simple, Kit Webster
March 15, 2009It Really Is That Simple
Kit Webster
March 7, 2009
When flying at 30,000 feet, the world looks like a simple, orderly place. You cannot see the people or the cars.
When you get closer to the ground, it gets much, much messier.
When contemplating the current economic crisis at 30,000 feet, it is actually fairly simple.
The bottom line:
Let’s look at some graphs that describe the debt orgy.
Trillions of dollars were taken out of home values and primarily used for consumption.
These charts speak for themselves and indicate the debt orgy we have been through.
They also make it difficult to determine what a “normal” level of debt is. Debt increased during the entire supercycle, essentially from its beginnings in 1947. The rate of increase has been greater during the mania, but we began leveraging at a slow rate in the 50s, 60s and 70s, at an accelerating rate in the 80s, some slowdown in the early 90s and then another steep rise in the late 90s and 00s.
For argument’s sake, let’s assume the increase from roughly 1950 – 1980 is a good, sustainable increase. So, I drew a line extrapolating that growth to today. Normal would then be about 200% of GDP today as opposed to around 350% actual. (Since GDP is contracting and debt is increasing, the current number is higher. The average on the chart is a completely meaningless number, the equivalent of averaging mice and elephants, except that it neatly intersects with my meaningless extrapolation.)
By a similarly invalid argument, I demonstrate in another forum that the current “normal” price of the Dow Jones Industrial Average is around 3000.
The point is not the accuracy of my analyses, which have no chance of being correct, given all of the assumptions and the complexity of the problem, but that the gulf is large, that normal economic activity is far below peak economic activity, that normal, economically reasonable times will feel bad because of the large, required adjustments from the peak, and that it will take many years of normal growth to get back to the frenzy level. Recall that the Dow first exceeded its 1929 level in 1955, and that the Dow first exceeded its 1966 peak in 1991, after inflation. About 25 years in each case.
Nationalization
As a dyed in the wool free trade capitalist who is scared to death of Nancy Pelosi and Barney Frank, not to mention Barak Obama, I reluctantly conclude that the only solution to the bank problem is bankruptcy, just as with GM. Since politically we cannot call it bankruptcy, what we do is the same thing and call it nationalization. The bad stuff has to be dealt with. So far we have not dealt with any of it. I wonder why not. What are Geithner and Obama waiting on?
(I am simplifying my economic position here to make a point. My actual position is complicated to the point that it would take hours and pages to explain, and is not that interesting. Suffice it to say that I strongly believe that capitalism brings the greatest wealth and opportunity to the greatest number of people, but that the Earth cannot withstand the triumph of capitalism. As all trends contain the seeds of their end, capitalism enables the overpopulation of the Earth and the depletion of Earth’s resources on a massive scale. With the turning of China and India to quasi-capitalistic economies, a tipping point has been reached at which, essentially, too many people will become too wealthy and consume too much. Things were getting a little dicey just with 1 billion of us privileged Westerners enjoying ourselves; the addition of billions of others moves the game into an entirely different level. The world’s current economic repositioning will slow down that dynamic, but 6.6 billion people, growing to around 9 billion by the end of this century, are simply too many people, living too long and consuming too much. We will be significantly challenged by our success. While I am not a tree hugger, it is clear to me that there will be severe disruptions and reorganizations, particularly during the second half of this century. It is ironically likely that capitalism will be a necessary part of the great restructuring since it is the least bad way to transmit price signals.Like I said, more than you wanted to know.)
Gold
This picture from The Economist shows gold in constant dollar terms. We are a long way from the mania of the late 70s.
Philosophy
About once a year I subject you to ruminations about determinism and free will. But I am fascinated by the subject.
The thesis goes like this: to the extent I (or anyone) can predict the markets’ futures, the future is in some sense determined.
If, ‘way before the presidential election, I can say that the stock market is going to 10600 and that we will be lucky if it stays above 7000, and then when it gets below 10600 I say that it is going to around 6600, and it does, then in some sense it did not matter who was going to be elected president. The market was going to 6600 in some deterministic sense. On the other hand, the shape and length of the ultimate bottom may be dependent on the president and his policies.
There seems to be an intriguing interplay between periods of strong determinism and then periods in witch it appears that multiple futures are possible until one is chosen and there is another period of determinism. In the middle of all of that, random events (pandemics, asteroids, etc) disrupt and reset the system entirely.
The stock market is rapidly approaching the end of a highly deterministic period and the beginning of a sorting out of future possible realities. The market “wants” to go to 3800 or 1000, and that is the way to bet. However, we may be entering into one of those reality-sorting-out periods in which taking the “right” action can interrupt what would otherwise be the normal course.
Some time ago, following similar thoughts, one of you responded that individual behavior is subject to free will (a proposition unlikely to be proven one way or the other until the physical basis of consciousness is identified) but that mass behavior is more determined.
I liked that, except that mass behavior depends on individual behavior. In some ways it is like the weird, probabilistic quantum mechanics underlying the neat, mechanical Newtonian world (and before you get to Einsteinian weirdness near the speed of light). It could be that human behavioral reality has phases.
Enough of that – for another year or so, anyway.
The US Stock Market
The world continues to unfold as it should. We reached my target of 6600 and the (likely) completion of a major Elliott wave pattern. I sent out a quick update on Thursday indicating where I thought the market is and would go:
And I said:
The less likely possibility is that it is all over and time for the rebound (40/60)
One of the biggest bears on Wall Street, who runs a bear mutual fund, has advised people not to buy his fund, that a rally is coming, and it is likely the bear market is over.
The more likely possibility is that wave iii is over and we will get a pretty sharp upward movement in wave iv (for you Elliott types keeping score at home, since ii was a flat, iv will likely be a sharp) (60/40)
As always, it will be difficult to tell in its early stages whether the full bear market rally is under way or just a nice move up in a wave iv. As we get more evidence, I will let you know.
The new target is around 6300.
I am becoming more and more worried that there are flaws in my longer term forecast. This market is just extremely bearish. (Cycles indicate that) we are running out of time for a meaningful bear market rally. Again, more information as I figure it out.
Anyway, one way or the other, Obama’s “tracking poll” should provide him some short term relief. (If you missed it, the Pres said that he was not worried about the “short term fluctuations” in the stock market, that they were like a political tracking poll, that the “profit to earnings ratio” is getting to the point that buying might be a reasonable idea. Obama said on the campaign trail that he did not follow or understand the markets.)
Next week I will go into some detail about my growing unease about my longer term forecast.
US Treasury Bonds
In the short term, interest rates should be going down (bond prices should be going up). There is an argument that the bull market in bonds is over, and the current run up in bonds should go a long way toward telling us whether it is or is not.
US Dollar
In the short term, the dollar should be going down.
In the longer term, the dollar should remain bullish for a while. All hell will break loose at the end of the current pattern up.
Gold
Gold has been acting strangely – going up when the dollar is going up.
I am stubborn, in denial, or both, but I think that gold will be heading back to the 700s before the next bull leg.
With the dollar going down in the short term, the way to bet is that gold will be going up.
Oil
I have no strong opinion on oil, either. Supply and demand are trying to come into synch. This is my best guess (although the consolidation could lengthen into a triangle). Ultimately, I would look for new lows, but I am not yet ready to make that prediction.
About Kit Webster
Mr. Webster is a management consultant, based in Austin, Texas. His practice focuses on assisting companies in crisis, including revising business plans, revising operational practices and processes, strategic partnering, mergers and acquisitions, and turn arounds. Mr. Webster has previously been chief executive officer, president, and chief financial officer of privately- and publicly- held companies in areas including health care, marketing and high tech hardware and software, and has a broad expertise in strategic and operational management, as well as technology and finance. Mr. Webster earned a Masters of Electrical Engineering from Rice University in Houston, Texas, and is a Certified Public (Chartered) Accountant. Mr. Webster is a Lecturer at the University of Texas, teaching an undergraduate course on business process strategy, improvement, implementation and integration. He has also taught finance, with emphasis on mergers and acquisitions, within the MBA school.
© Copyright 2001-2009 Kit Webster and MarketTimingCycles.com All rights Reserved
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Tags:Dow Jones Industrial Average, Gold, Interest Rates, Kit Webster, Liquidity, Nationalization, Oil, US Dollar, US Stock Market, US Treasury Bonds
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