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Wednesday, September 06, 2006

Comments

A. PERLA

"The IMF warns slower growth could be triggered by a sharp US housing market slowdown or by surging inflationary expectations that forced central banks to raise interest rates."

One would think that without the US housing market, that stimulator of the Feel Good Factor that so propels Americans to shop till they drop, there is little raison d'être for any US GDP growth.

Therefore, after euphorically stupid valuation rises, the US housing market must surely fall. The market has calmed, that is for sure. Flipping a condo in a year with a 30% gain is simply not on any longer. So, the American housing market is not printing money any longer. And, there were fewer rich Americans imbibing at Fouquet's on the Champs Elysees this year.

Whatever will happen next?

Well, since the world is not monochromatic, maybe we could count on a good upswing in consumer spending in Europe? After all, it has been dampened for the past decade, so it is about time. France is up-ticking. Maybe even the Germans will learn how to spend as if there were no tomorrow. If these two kick into gear together, then the IMF forecast is going to look pretty silly.

Has the IMF thought of this plausible possibility?

A few more months of statistics will tell. We should know by Christmas if the European upswing is here for a stretch or if it will wither away into the morning dew by next spring.

Arthur Eckart

Corporations of the S&P 500 had double-digit earnings growth for 17 consecutive quarters, which is unsustainable. So, profit growth will slow. Also, the U.S. economy has been expanding at above trend growth for four years. The Federal Reserve (or FOMC) is attempting to achieve a (rare) soft-landing, which means slower and more sustainable economic growth, while avoiding a recession. The bond market has predicted seven of the last three recessions. So, an inverted yield curve only reflects that the bond market is expecting slower economic growth, which is inevitable. The FOMC paused at its most recent meeting after raising the Fed Funds Rate at each meeting over the past two years from 1% to 5 1/4%. The subsequent bond and stock market rallies indicate confidence that a soft-landing will be achieved, only if the tightening cycle has ended, and an easing cycle begins next year. Also, I may add, stock market volatility has been low for several years, which is a reflection of the FOMC's stabilizing policies. So, if a soft-landing is achieved, the stock market may not fall much (compared to other cycles), although the cyclical bull market is getting old. So, mean reversion will be limited (i.e. there may not be an overshoot).

A. PERLA

Eckart: "Also, I may add, stock market volatility has been low for several years, which is a reflection of the FOMC's stabilizing policies."

Is that due to policy or the fact that the US stock market has gone nowhere in the recent past? (The DJ CGR for the past two and three-quarter years has been about 3%.)

Arthur Eckart

I wouldn't say the stock market has gone nowhere. The S&P 500 has been in a steady climb rising from the trough at 775 in 2002 to a peak at 1,325 in 2006. However, that rally reflects a cyclical bull market within a structural bear market. The U.S. had a structural bull market from 1982-00 and a structural bear market prior to that from 1965-82 (which by the way coincided with a baby boom and baby bust generation). The current structural bear market should continue for another 10 years or so. So, the stock market may end up flat, although there will be cyclical bull and bear markets within the structural bear market. Nonetheless, it's somewhat amazing so many segments of financial markets or the economy have been rising together, e.g. the goods market, money market, bond market, stock market, commodities market, and housing market. Also, major foreign markets have been rising with the U.S. market over the current cyclical bull market. It seems to be driven by overproduction in export-led countries and overconsumption in the U.S., although U.S. production has been strong. Basically, the U.S. is sucking-in imports, like a black hole, and it's being financed by those overproducing countries. So, they can keep overproducing.

A. PERLA

"However, that rally reflects a cyclical bull market within a structural bear market."

So, we must presume therefore that the dot.com bubble that burst in early 2000 was the product of a cyclical bear market in a structural bull market?

Yeah, right. The last time I heard this (sort of nonsense) was in the pre-bubble late nineties when people were being told that the stock-market was a long-term investment vehicle that "returns historically around 12% per annum".

Post early 2000, people lost thier shirts in the "short correction" that is now taking 6 years to correct (and counting. The US stock-markets are nowhere near thier pre-bubble valuations.

All that can be said "definitively" about stock markets is: Sometimes they go up and sometimes they go down.

Arthur Eckart

The Dot.com bubble came at the end of the structural bull market. The bursting of the bubble created a quick and massive "Creative-Destruction" process, which made tech firms more efficient and freed-up resources for emerging industries (tech firms received massive investment in the '80s & '90s). Historical data support long-wave business cycles (which may be caused by uneven labor supply). The stock market roughly ends a structural bear market period where it began. Nasdaq, which represents mostly tech firms, is still way below its all-time high. However, the Dow Industrials is near an all-time high. A lot of money was shifted from the stock market into other markets (including markets I stated above). Some lost and some gained in the tech bubble boom. Nasdaq rose through the '80s and '90s, and rose from below 1,000 in 1996 to over 5,000 in 2000. The bubble may have been the largest in history.

A. PERLA

Eckart : "The bursting of the bubble created a quick and massive "Creative-Destruction" process, which made tech firms more efficient and freed-up resources for emerging industries (tech firms received massive investment in the '80s & '90s)."

Thanks for the theory. Brilliantly exposed.

The fact remains that a great deal of personal fortune (read lifetime savings) was "destructured" definitively. So, whilst the theory is nice the reality of it (to common citizens who were foolish enough to believe that the stock market was a risk-less investment) is that they are now living less of a life-style than they had planned for. Or, some kids are not going to the universities they had hoped to go to.

I certainly blame no one but myself. I entered the stock market during a period of euphoria, in fact, at the very end of that period. An avid reader of the Economist, I read an excellent article in late 1999 on the Dutch "Tulip Boom Bust" of the 18th century that also destroyed fortunes and wasted lives. I cannot say I was not forwarned.

What I rail against is the manner in which brokers portray the market as a "wise investment" because it pays double even triple the return of a savings account. Yes, if you ask, they will tell you this is the "risk premium". But, you must ask and they will not underline the fact.

Finally, any good portfolio not only balances the investment across sectors but diversifies the spread within sectors. What happened is that even stockbrokers started spouting hubris in an effort to make their quotas and enjoy short-term commissions. "Technology, technology, technology" became a reckless mantra.

My point: An "ethic" was breached. This ethic had existed for decades in the asset management business, and it is called the Prudent Man Rule. This rule is simple. It means that advisors will counsel their clients prudently, investing their wealth as asset managers would invest their own. This rule was thrown to the winds in America's great leap forward to lucre.

All the stock market theory in the world will not suffice to explain to individuals who have lost small fortunes because others were imprudent. When you cross the street, you expect the traffic lights to be working properly. Or you might die.

NB: And, why the Fed let this happen is an altogether different subject. But, a good one for posterity. Life repeats itself, but not always in quite the same way. And, let's face it, as economists we are explaining mostly the past (sometimes the present) but rarely the future.

Arthur Eckart

A Perla, the point I was making above is the Nasdaq bubble generated abnormal gains. Although Nasdaq rose throughout the '80s and '90s, over the structural bull market, it rose from below 1,000 in '96 to over 5,000 in '00. Currently, Nasdaq is about 2,200. The stock market historically rises about 10% a year on average. Also, 30 years is a long enough period to realize a 10% average annual return. So, those personal fortunes were based on an unusual four-year period. Of course, if someone invested their life savings at Nasdaq 3,000, before rising to 5,000, and didn't sell, they may still be carrying a loss. Nonetheless, many made fortunes on the rise of Nasdaq, and some made fortunes on the fall of Nasdaq. The stock market crash was a correcting mechanism to keep future labor supply and demand in equilibrium (because the economy cannot accommodate too many early retirements at the same time). The U.S. Creative-Destruction process was quick, because the U.S. economy is flexible. So, the stock market crash made surviving U.S. firms stronger and released inputs for emerging industries efficiently. Also, the Fed doesn't posses the tools to control individual markets or fine-tune the economy. It controls the general economy through the general price level with its crude tools and working in the future economy (because of adjustment lags). If the Fed were to control one market, it would cause instabilities in other markets, leading to general economic instability.

A. PERLA

Eckart : "The stock market crash was a correcting mechanism to keep future labor supply and demand in equilibrium (because the economy cannot accommodate too many early retirements at the same time)."

Explain this. It seems specious argumentation.

How does a stock market crash have an influence on labor supply equilibrium?

Arthur Eckart

The stock market crash caused Americans to postpone retirements and in your example actually set-back retirements, since those haven't recovered their losses. Consequently, the stock market crash caused Americans to work longer and harder, since their retirement expectations deflated or bursted. When the Baby-Boom generation (born between 1946-64) retires, it'll consume more than produce. Consequently, the subsequent generation, i.e. Generation X (born between 1965-83), which is a Baby-Bust generation will have to work harder to provide goods & services, for both the retired Baby Boom generation and for itself, including taking up the slack in taxes to pay for medical care, social security, and other retirement services. Moreover, the 55-64 age group is the second most productive group (after the "prime-age" group between 35-54), because of education, training, and experience. So, the proportion of productive workers leaving the workforce will be large. When retirements accelerate, the quantity of labor contracts. However, consumption may not fall much. So, the supply of labor contracts more than the demand for labor. Consequently, there may be a large disequilibrium between consumption and production.

A. PERLA

"When the Baby-Boom generation (born between 1946-64) retires, it'll consume more than produce. "

Not if their working well beyond 65 ...

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