"Back to the Great Depression?"

A story in the UK’s Times give a recap of the gloomy forecasts for the US and world economy, including a particularly cheery prediction by a SocGen strategies that foresees that the Dow will drop to 4500 and the S&P 500 to 500. Not included in this forecast is a grim warning from Barclays and a forecast of a US financial meltdown in the next few weeks from Fortis.

Now readers probably know that I am of a bearish, or perhaps more accurately, contrarian temperament. I am firmly of the view that the economy and the markets will get considerably worse before they get better.

Normally, I’d take so many downbeat sightings as a perversely good sign. Remember than the 1987 crash, the Great Depression, and the dotcom bust were not widely anticipated. This outbreak of gloom might indicate that the trajectory downward will be a grinding down of the remaining optimists rather than a rush for the exits. Indeed, if we were to have an unexpected bout of good news we might even see a little rally

The countervailing factor is that signs of stress in the credit markets are rising. The TED spread and credit default swap spreads have risen, evoking concerns that we may be on the verge of another liquidity crunch, which will send equity prices downward. The ugly realization is sinking in that banks big and small have a lot more writedowns in their future.

So as much as such a pronounced outbreak of downer sentiment might portend an intermediate upturn, it would seem to require some particularly good news, such as a break in oil prices.

Update: In a rich bit of synchronicity, the next post I saw, at Some Assembly Required, quoted Albert Edwards, the same SocGen analyst, saying “Investing on the basis of forecasts is a waste of time.” So you have all officially been given permission to ignore him and everything that follows.

From the Times:

When Wall Street slumped on Thursday, in response to the oil price surging above $140 a barrel and renewed fears about the banking system, the alarm bells rang more loudly than usual.

Barring a miraculous recovery tomorrow, the Dow Jones industrial average is heading for its worst June since 1930, when it plunged by almost 18%.

That month is ingrained in the Wall Street psyche. After the crash of October 1929, the stock market continued to slide through the winter. By the spring the worst seemed to be over. Then shares lurched low in June 1930, signalling deep problems for the economy and the stock market.

America entered depression and the stock market went into a deep freeze that lasted a quarter of a century, taking until 1954 to get back to its precrash high. Are there any parallels with today?

Although it is eight months since the Dow peaked at 14,164, its performance since then has defied gloomy predictions. Despite most economists declaring the economy to be in recession, the index was above 13,000 as recently as last month.

This month, however, reality has hit home. “Some of it is clearly to do with the oil price but essentially what we are seeing is a slow-motion car crash,” said George Magnus, senior economic adviser at UBS.

“The first act was the housing market, the second act was the credit crunch, and what we are now seeing in this third act is the bigger picture of a downturn that has a long way to run.”

Few are gloomier about that prospect than Albert Edwards, strategist at Société Générale in London. “America is leading the way, diving into deep recession as a collapse in consumer confidence induces the great unwind,” he said. Edwards compares the economy with a pyramid scheme that is poised to crash to earth and interest-rate changes can do nothing to avert it.

He thinks Wall Street and the other main markets have a lot further to drop, and will end up 70% below the peaks of last year. That would imply a level of just 500 for the S&P 500, which was at 1,280 on Friday, and 4,500 for the Dow, compared with Friday’s closing level of 11,346.

The FTSE 100, which closed at 5,530 on Friday, will plunge to 3,000, he predicts. The good news is that he expects the oil price, which was above $142 on Friday, to slump to $60 a barrel. The bad news is that he sees this occurring as a result of “deep” recession in the advanced economies and a sharp slowdown in emerging markets.

The gloom on Wall Street, where the stock market dropped again on Friday, is almost all-pervading. Veteran banking analyst Richard Bove of Ladenburg Thalmann said there was “an absolute unwillingness among clients to talk about anything other than how bad things are”. Investors wanted to know which bank would be the next to blow up or be forced to raise capital. Even though there were hopeful signs of recovery in the sector, albeit from a low base, many in the market had “lost perspective”, he said.

“The last time loan losses were at these levels was 1934,” he added. “I don’t believe we are going back to a 1930s environment with people living in tents.” Bove predicts bank losses will at least stabilise in the coming months.

However, Scott Anderson, senior economist at Wells Fargo, summed up why the markets are so gloomy. The economy is caught between the twin problems of near-recession and sharply rising inflation. “Consumer confidence levels are at their worst since the early 1980s, we have record oil prices and the Fed will have to react to that and start raising rates by the end of the year if they don’t recapitulate soon,” he said. “That would certainly drag out the housing correction and be a further drag on consumers.”

He has scaled back his forecasts for the end of this year and into 2009. “One half [of Wall Street] is worried about growth, and they are scared,” he said. “The other half are worried about inflation, and they are scared too. Sell in May and go away may have been the best strategy this year.”

A drop in the oil price would be the best remedy for jittery markets and a shaky economy, though it could also cause problems. One fear is that a sharp fall in oil and other commodity prices would bring a new wave of troubles for investment banks and hedge funds. As it is, most have been revising up their forecasts for the oil price.

A survey by Reuters shows that analysts expect the price of American crude to average $113 a barrel this year, remaining around that level next year, before increasing to $115 in 2010. Last year the average was $72.

Some analysts, though, are much more aggressive in their forecasts. Fortis, the Belgian-Dutch financial group, sees crude averaging $125.70 this year, $171.50 next year and $224.90 in 2010. In contrast, Royal Bank of Scotland sees a price average of $86 next year.

It matters a lot who is right. Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania, said the stock market should begin to recover before the end of the year, as long as the oil shock starts to fade. “It’s all predicated on the assumption that oil prices are at least peaking,” he said. “If fundamentals mean anything then it’s hard to argue they can go higher.”

The descent into gloom on Wall Street has come even as the latest news about the American economy has offered a few glimmers of light. Growth for the first quarter was revised up to an annualised 1%, meaning the economy has yet to meet the strict technical definition of recession.

Figures on Friday showed a 1.9% jump in personal incomes and a 0.8% rise in spending last month as consumers received their tax rebates. There was even a modest rise in home sales, breaking a long downturn…

We are not in for a rerun of the Great Depression of the 1930s, but we will be having a pretty rough ride.

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11 comments

  1. Anonymous

    “The last time loan losses were at these levels was 1934,” he added. “I don’t believe we are going back to a 1930s environment with people living in tents.” Bove predicts bank losses will at least stabilise in the coming months.

    This says more about Bove than it does about the economic crisis. The banks of the Sumida River in Tokyo were lined with the tents and boxes of the homeless. Hundreds queued up for hours to receive a free evening meal of two rice balls and a bowl of soup.

  2. Anonymous

    Wow, they all piled into commodities and are hoping that sector doesn’t cave in too.

    Factional reserve banking has just about a good of chance of surviving as Al Gore has stopping Red China from polluting.

  3. Michael McKinlay

    The Perfect Storm Cometh ”

    Peak Oil, Water, Food, the credit collapse, the $800 Billion trade deficit, the ballooning budget deficit, runaway inflation, public and private debt at 350% of GDP, the housing collapse, an economy in free fall and the absence of governance.

    Yes, the perfect storm … and , even knowing all these things, can we stop any of them?

  4. Escariot

    “I don’t believe we are going back to a 1930s environment with people living in tents.”

    I live across the street from a homeless shelter. Last month they opened a “safe” parking lot. There are now four cars permanently parked there with people living in them, others arrive in the evening and leave in the morning.

    I work in the construction sector and two of my sales representatives have changed employers three times each since January, twice because the divisions were sold or went out of business and once to get better positions. They are the lucky ones.

    On the ground here it seems precarious at best.

  5. Jim Driscoll

    Remember than the 1987 crash, the Great Depression, and the dotcom bust were not widely anticipated.

    What if the crash already happened?

    Remember, that if the deflator for GDP actually matched real inflation, instead of the inaccurate numbers that are currently put out, we’ve largely been in negative territory since 2000.

    With that in mind, it looks more like 1932 than 1929, doesn’t it?

  6. L'Emmerdeur

    Regarding the outbreak of gloom as a contrary indicator, this time is different.

    Unlike 1987, or the 1970s, or the 1930s, we have a massive media industry, with journalists jockeying to get the next big flashy, provocative headline. Frankly, there are too many news sources employing too many journalists, so every utterance by anybody of note is published.

    Furthermore, you have the Toms, Dicks and Harriets with blogs putting out their own opinions – a lot of which, like yours, are widely read and respected. There will always be bulls and bears at any given point in time, but with the population of published (MSM or blog) opinions and analyses having ballooned, the statistical chance of finding a meaningful number of either one has increased by many orders of magnitude.

    Put simply, if there were 100 articles published today on isues of economics and finance, and 5 were bearish, you would barely notice them. But if 10,000 such articles and posts were published, with 500 being bearish, you would.

    Therefore, I think the value of an opinion as a contrary indicator these days has changed when compared to previous crises.

  7. L'Emmerdeur

    Regarding the outbreak of gloom as a contrary indicator, this time is different.

    Unlike 1987, or the 1970s, or the 1930s, we have a massive media industry, with journalists jockeying to get the next big flashy, provocative headline. Frankly, there are too many news sources employing too many journalists, so every utterance by anybody of note is published.

    Furthermore, you have the Toms, Dicks and Harriets with blogs putting out their own opinions – a lot of which, like yours, are widely read and respected. There will always be bulls and bears at any given point in time, but with the population of published (MSM or blog) opinions and analyses having ballooned, the statistical chance of finding a meaningful number of either one has increased by many orders of magnitude.

    Put simply, if there were 100 articles published today on isues of economics and finance, and 5 were bearish, you would barely notice them. But if 10,000 such articles and posts were published, with 500 being bearish, you would.

    Therefore, I think the value of an opinion as a contrary indicator these days has changed when compared to previous crises.

  8. L'Emmerdeur

    Regarding the outbreak of gloom as a contrary indicator, this time is different.

    Unlike 1987, or the 1970s, or the 1930s, we have a massive media industry, with journalists jockeying to get the next big flashy, provocative headline. Frankly, there are too many news sources employing too many journalists, so every utterance by anybody of note is published.

    Furthermore, you have the Toms, Dicks and Harriets with blogs putting out their own opinions – a lot of which, like yours, are widely read and respected. There will always be bulls and bears at any given point in time, but with the population of published (MSM or blog) opinions and analyses having ballooned, the statistical chance of finding a meaningful number of either one has increased by many orders of magnitude.

    Put simply, if there were 100 articles published today on isues of economics and finance, and 5 were bearish, you would barely notice them. But if 10,000 such articles and posts were published, with 500 being bearish, you would.

    Therefore, I think the value of an opinion as a contrary indicator these days has changed when compared to previous crises.

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