Fear and Loathing in the Markets
We were somewhere around 14,000 on the Dow when the delusions began to take hold. The economics babe was talking about how she hadn’t had so much fun since ‘99 and the bear visions had diminished to the point where I was loathe to mention them lest someone accuse me of seeing ghosts. The sub-prime crisis was contained and the commodity bull was just getting really interesting. Why spoil the party talking about bears that only existed in the fevered imaginations of the masters of gloom who always seem to find the dark lining in every silver cloud?
Nine months ago the average investor wasn’t worried about bank failures, Fannie and Freddie bailouts, oil prices, war with Iran or the credit crunch. There were still problems, but they seemed contained as we high fived the arrival of another new high in the Dow last October. The Fed had once again ridden to the rescue with interest rate cuts and new, innovative lending facilities. Why worry about bank stocks when you’ve got commodity stocks to take up the slack? What difference did it make that the housing bubble had popped? The commodity bubble would take its place just as the housing bubble took the place of the tech bubble, right? No problem.
Now, the prophets of doom enjoy their well deserved media attention. They were right; the sub- prime crisis wasn’t contained, Bear Stearns is a distant memory and the commodity bull turned out to be what it has always been - an indicator of inflation. The Fed rescue hasn’t worked and the losses at the banks and brokers turned out to be a lot worse than initially thought. According to the Nouriel Roubini crowd, there’s much more to come too. This won’t be over until we are mired in a deep recession or maybe even the Great Depression Part II. And by the way, there’s not a damn thing we can do about it.
And so, a mere nine months after the rejoicing of a new high in the stock market, we find ourselves mired in the depths of a bear market. Our worst fears seem to be well on their way to being realized. All the news is interpreted in negative fashion. Oil drops 25% and it is cited as only as confirmation of weak demand from a reeling world economy. The dollar rallies from the depths and it is seen as threatening our booming exports. The savings rate rises (finally!) and this is seen as reinforcing the recession because Americans will stop consuming. House prices drop and it is seen through the prism of the negative wealth effect where people feel poorer and thus spend less, prolonging the recession.
At the top of the market there was a delusion that all was well and the credit problem was being solved by the Fed. This delusion worked because in most investors’ lifetimes, the Fed has always ridden to the rescue with another dose of credit. Now that the myth of Fed power over the market has been revealed as a fraud, investors are moving to the other extreme of pessimistic delusion. Most of the economic news today could be interpreted in a positive light: Falling oil prices and a rising dollar are two sides of the same coin and the result is an increase in purchasing power for consumers; more savings should be welcomed as it is necessary for future growth; falling home prices will allow more people the opportunity to own a home; the credit crunch ensures that only those who are deserving and have acted responsibly with credit in the past will get a loan.
The optimistic view of the economy is a decidedly minority one. Googling “no recession” returns 728,000 results. Google “new depression” and you get 13,000,000 results. In other words, if you think the economy is bad right now and getting worse, you are the crowd. Think about how that worked out during the Internet bubble or the housing bubble. Considering that most of the newly prescient pundits have been bears for as long as anyone can remember, what are the chances they’ll be able to recognize good news when it really arrives? Will you?
Accepting the majority view of American economic decline is easy at this point. The press pushes the story every day. Prominent economists with gloomy outlooks get profiled in the New York Times. Pandering politicians promise economic nirvana if and only if they are elected and their recovery plans are put into action. Those who offer an optimistic outlook are ridiculed and dismissed. But good investing decisions are not made by hewing to the consensus view.
The seeds of a better economic future lay in the destruction of the last boom. Tighter credit in an economy recovering from a credit overdose is not a bad thing. Homes becoming more affordable is not a bad thing. Falling oil prices are not bad news. The dollar moving higher, not only against the euro but also gold, is not a bad thing. People saving more is not to be lamented. Markets are self correcting mechanisms. We may not like the adjustment process but it is necessary to ensure future growth. Nothing lasts forever, not even Presidential campaigns, and this period of economic malaise is no different. It is time to think, and act, like an optimist.