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Dow closed at 6,763.29 - are we heading for a repeat of the Great Depression?

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The Dow Jones Industrial Average hit its lowest level in 12 years on Monday, slipping below 6,800, as investors grew increasingly skittish over the state of the stock market amid the wave of government bailouts.

 

The latest financial industry demands for fresh capital and growing evidence of the depth of the economic downturn cast a pall.

European stock markets have already taken a battering. The FTSE 100 Index plunged more than 5% as a £12.5bn cash call from HSBC sparked a major banking sell-off. The index fell below the trading low of 3665 seen in October last year to hit levels not seen since April 2003 as troops rolled into Iraq and the markets were still coming to terms with the dotcom crash.

Treasuries rose after Warren Buffett said the economy is in “shambles” and American International Group Inc. reported a $61.7 billion loss.

The question is where in the Bear Market are we? Is it the beginning or the end? According to Robert Prechter, who predicted the 1987 stock market crash, we are at the beginning. He warns of deflation (a contraction in the volume of money and credit relative to available goods). A massive deflation in real estate is in full effect, and real estate's peak in 2005 was a leading indicator of US deflation risk. The worst thing about real estate is its lack of liquidity during a bear market. At least in the stock market, when your stock is down 60 percent and you realize you've made a horrendous mistake, you can call your broker and get out. With real estate, you can't pick up the phone and sell. You need to find a buyer. In a deflationary depression, buyers just go away.

The Swedish industrial workers' union IF Metall said Monday it will agree to pay cuts for its members to avoid further layoffs as a result of the international economic crisis. This was in stark contrast to Luxembourg, where there will be a general increase of gross salaries by 2.5% as of March 1st, to be paid out the first time with March salaries - at the end of the month. So called “index increases” are taking place on the basis of the country’s Cost-of-Living index system. Statec, the statistical department of the Ministry of Economy reports that after the next general increase of salaries (by 2.5%) this coming March 1st, the inflation rate (now 2%) in Luxembourg, indicates that there is no likelihood to be a further increase of the COL index before mid 2010.

Have we reached the bottom yet? An old-fashioned way to answer this question is to look at the historic P/E ratio. Over the past 137 years, the average P/E ratio is 15. At the end of February 2009, the P/E was 28.1. Yale Professor Robert Shiller, author of Irrational Exuberance, smoothes the P/E calculation by using the earnings average of the previous ten years as the divisor (see p. 5-6 of his book). With this method, the historic P/E average is 16.3, with a February monthly close P/E10 at 13.0. An overlay of the traditional P/E and Shiller alternate shows that the Shiller method is a more logical fit with historic index prices. However, by either method, the market appears to have been overvalued for most of the past two decades. For the market to move into bargain territory, something must change. Earnings must rise or prices must fall — or we get a combination of the two. See http://www.dshort.com/

Alan Greenspan made the most famous speech a central banker has ever made.

On December 5th, 1996 - when the Dow was at 6437 - he warned of "irrational exuberance", asking how we would know when enthusiasm had overcome common sense when people were buying shares.

The first part of his statement is the best known: "how do we know when irrational exuberance has unduly escalated asset values.....", a statement which usually ends with a question mark.

The second part - less often quoted - feels particularly relevant today. He went on: ".... which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" (see:http://blogs.news.sky.com/)

About the only certainty in the stock market is that, over the long haul, overperformance turns into underperformance and vice versa.

Colin J. Seymour produced in 2001 a chart which he calls "1927-1933 Chart of Pompous Prognosticators". This one is linked with quotes by important people of that time and their view of the stock market.

 

  1. "We will not have any more crashes in our time."
    - John Maynard Keynes in 1927
  2. "I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future."
    - E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928

    "There will be no interruption of our permanent prosperity."
    - Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928

  3. "No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment...and the highest record of years of prosperity. In the foreign field there is peace, the goodwill which comes from mutual understanding."
    - Calvin Coolidge December 4, 1928
  4. "There may be a recession in stock prices, but not anything in the nature of a crash."
    - Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929
  5. "Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months."
    - Irving Fisher, Ph.D. in economics, Oct. 17, 1929

    "This crash is not going to have much effect on business."
    - Arthur Reynolds, Chairman of Continental Illinois Bank of Chicago, October 24, 1929

    "There will be no repetition of the break of yesterday... I have no fear of another comparable decline."
    - Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929

    "We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices."
    - Goodbody and Company market-letter quoted in The New York Times, Friday, October 25, 1929

  6. "This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan... that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years."
    - R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929

    "Buying of sound, seasoned issues now will not be regretted"
    - E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

    "Some pretty intelligent people are now buying stocks... Unless we are to have a panic -- which no one seriously believes, stocks have hit bottom."
    - R. W. McNeal, financial analyst in October 1929

  7. "The decline is in paper values, not in tangible goods and services...America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin."
    - Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929

    "Hysteria has now disappeared from Wall Street."
    - The Times of London, November 2, 1929

    "The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."
    - Business Week, November 2, 1929

    "...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation..."
    - Harvard Economic Society (HES), November 2, 1929

  8. "... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall."
    - HES, November 10, 1929

    "The end of the decline of the Stock Market will probably not be long, only a few more days at most."
    - Irving Fisher, Professor of Economics at Yale University, November 14, 1929

    "In most of the cities and towns of this country, this Wall Street panic will have no effect."
    - Paul Block (President of the Block newspaper chain), editorial, November 15, 1929

    "Financial storm definitely passed."
    - Bernard Baruch, cablegram to Winston Churchill, November 15, 1929

  9. "I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress."
    - Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929

    "I am convinced that through these measures we have reestablished confidence."
    - Herbert Hoover, December 1929

    "[1930 will be] a splendid employment year."
    - U.S. Dept. of Labor, New Year's Forecast, December 1929

  10. "For the immediate future, at least, the outlook (stocks) is bright."
    - Irving Fisher, Ph.D. in Economics, in early 1930
  11. "...there are indications that the severest phase of the recession is over..."
    - Harvard Economic Society (HES) Jan 18, 1930
  12. "There is nothing in the situation to be disturbed about."
    - Secretary of the Treasury Andrew Mellon, Feb 1930
  13. "The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
    - Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

    "... the outlook continues favorable..."
    - HES Mar 29, 1930

  14. "... the outlook is favorable..."
    - HES Apr 19, 1930
  15. "While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us."
    - Herbert Hoover, President of the United States, May 1, 1930

    "...by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..."
    - HES May 17, 1930

    "Gentleman, you have come sixty days too late. The depression is over."
    - Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930

  16. "... irregular and conflicting movements of business should soon give way to a sustained recovery..."
    - HES June 28, 1930
  17. "... the present depression has about spent its force..."
    - HES, Aug 30, 1930
  18. "We are now near the end of the declining phase of the depression."
    - HES Nov 15, 1930
  19. "Stabilization at [present] levels is clearly possible."
    - HES Oct 31, 1931
  20. "All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
    - President F.D. Roosevelt, 1933
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