In Alan Greenspan's recent testimony he told a congressman that his "ideology was the framework of a belief of how to deal with reality". That hit home with us. We have been dealing with the framework of a belief of how to deal with reality for the past 11 years-starting in 1997.
During that period we felt that we were in the Wild Wild West for most of the time except for the correction years of 2000, 2001, 2002, and the past year. We first started discussing the outrageous valuations in the late 1990s and from the response it seemed that we were the ones "out of touch" with reality. We were beginning to think that we were insane in a very sane world. We were saying the same things over and over again in our research reports, which at the time, we sold for a nice piece of change. We got so frustrated that we sent the checks back in January of 2000 and started writing on this website where anyone who had a computer could find our comments and read them without charge.
Then the dot.com market finally broke after IPOs without any earnings, and in some cases no revenues, were going public at 20 and opening up at 100 or more. The money managers that paid out the most in commissions were the main beneficiaries of all this. During this financial mania an unfamiliar name, at the time, was on financial TV predicting that Amazon stock would quadruple and a large brokerage firm hired him on the spot since he was more bullish than their own skeptical analyst.
We thought the efforts we spent doing our homework was finally paying off when the stock market broke. The problem was it didn't break enough -- the most outrageous financial mania of all time resulted in the mildest recession on record, and even after a large decline, the stock market was still trading at high valuations previously seen at market tops rather than at bottoms. Greenspan lowered the Fed Funds rate from 6.5% to 1% and kept it there for a solid year as he put his blessing on esoteric mortgages and didn't have a problem with the dearth of supervision of mortgage lending policies. All of this caused another bubble in housing that the Chairman couldn't see although the evidence was obvious to those looking at reality rather than ideology or greed.
This situation is discussed at length in our special report of September 2003 on the left side of our home page, "Real Estate-The Catalyst for the Deflationary Bear Market". This was when the housing bubble coincided with another world wide stock market bubble and then a commodity bubble. Again, we thought we were going insane. All of this was followed up by a series of weekly comments and special reports highlighting the dangers of the housing bubble along with imbalances such as the huge trade deficit, record household debt, and low consumer savings rates. Since there are no more bubbles to inflate, this global bear market will have a very ugly ending and we may now stop asking ourselves if we are insane.
Some may say that just because there are no more bubbles to inflate, the money must go somewhere, so why shouldn't they invest in the stock market as it declines. As explained below in our comments on mutual fund redemptions, we don't expect massive public participation in the stock market for sometime. In fact, we expect many individuals to swear off the stock market forever before the stock market bottoms. The current crisis is that rare event that the current generation will never forget, and caution will probably be in vogue for a long time to come. Not until another generation arises with no personal memory of the crisis will another massive speculation occur.
How Low Can It Go?
We believe the stock market will decline to the undervalued levels displayed in "Limbo, Limbo, How Low Can It Go?" found on the right side of our home page. It did reach reasonable and normal levels when the S&P 500 dropped to the mid 800s and tested that level a few times recently. We guess it is possible that the market could bottom at reasonable levels but we don't think it is likely. After all, we are experiencing the worst global economic collapse as well as the worst global bear market of all time. Does it make sense that the largest economy in the world's stock market will not bottom at levels found at traditional secular bear market troughs? If that is the case, we believe the market will bottom at approximately 10 times or less for the S&P 500. This would take the S&P 500 down to 700 or under. Although we understand that the S&P analysts' estimate for 2009 reported (GAAP) earnings is now under $50 and we could achieve trough levels of below 500, we think the best way to measure valuation levels is using trendline earnings. This is all explained in "What is the Real P/E?" in the special reports section and Comstock in the News. We use smoothed earnings over two business cycles (or 9 years). This level is approximately $70 for the S&P 500 and that is why our target is about 700. If we used the earnings levels that were, and will continually be revised downward, it would be a futile effort and we would never reach a reasonable trough prediction.
We also believe that the last stage of the bull market which we have discussed in many prior comments --- "Fear & Capitulation" has still not been reached. We do understand that many market participants have shown enormous fear and, in fact are scared to death, but they have yet to capitulate to the levels we discussed in our October 9th weekly comment, "How Low Can It Go?" We attached a spread sheet showing the latest equity mutual fund redemptions (estimates by Trim Tabs). Since then there has been enormous redemptions, but not to the degree we expect before the market reaches a trough. As we said in that report, we expect domestic equity fund redemptions of over $450 billion and if you add foreign equity mutual funds the total would be over $550 billion.
We heard CNBC's Steve Leisman mention "competitive devaluation" a few times this morning. As we predicted, you will hear this term, as well as "beggar-thy-neighbor",used more frequently in the future. Expect to see the central banks of the U.K. and Euro zone to lower their rates next week and that trend will continue. There will be a race to see which country can move the fastest to get their currencies down in order to export more goods and services. Remember, the U.S. is by far the largest economy in the world, and now that our consumer has "hit the wall", our trading partners will have to lower their rates and hopefully their currencies as well to help their exporters.
Exports accounted for most of the growth in the U.S. GDP over the past year. Japanese exporters are in big trouble since they haven't been able to export to the U.S.the way they did in the past. And that will continue to be the trend with all countries, including China and Germany, that in the past have been able to export to what has been the ravishing appetite of U.S. consumers.
It is hard to imagine a very strong U.S. economy where debt deleveraging has only begun and where we have lost close to $18 trillion in wealth (including Real Estate, stocks, and bonds). It is similarly hard to imagine a strong global economy in which the loss of wealth figure is also very significant and the have just lost their main customer (U.S.) . In our view, the market decline to date has mostly reflected the credit crisis and has not yet discounted the potentially deep and protracted recession and its severe impact on corporate earnings.