And it had to happen in election season…
By Daniel M. Ryan
People who are hip to a certain old-fashioned nugget of political wisdom have certainly been confounded this election season. According to a rule of thumb beloved by central-bank watchers, even before there were even central banks in America or Canada, there is never a downturn in an election year. The downturn comes the year after the election. Because central bankers are appointed by government, they tend to favor the incumbent government – especially if they personally were appointed by the incumbents personally. One seemingly harmless way of doing so is to stick a little expansion into the money supply during the election year. The short-term boom that results makes people feel good, particularly towards the incumbent government. Once the election is over, it's safe to deflate a little and bring the economy back to normal. Although the good feeling will tend to turn sour during that time, the next election is a long way off. By the time the next one rolls around, the voters should have largely forgotten…especially if another goose-up is administered by the central bank by then.
This model, though not likely to get past peer review in the snazzier economic journals, is known as the "political business cycle." This year, it flopped.
The same incentives exist in the system, though. As the political theory flopped, the Bush Administration flip-flopped. No more talk about letting the free market sorting things out: the Administration leapt into action, as did governments in Europe and Canada. In fact, the rejection of the original bailout bill can be seen as evidence that Treasury Secretary Paulson acted too precipitously. "Helicopter Ben" is now living up to his name, making for an odd juxtaposition from the day he justified the Term Auction Credit Facility to Congress. Back then, he went out of his way to assure Congress that the TASF would not jack up the money supply; in Fedspeak, it would be "sterilized" so that inflation wouldn't be ramped up as a result. Not this time, though. According to the latest Fed report on the money supply, and using the preliminary September figures, M1 has increased at an annualized 19.5% over the last three months. M2 has increased 6.9%. In the period 2005-7, M1 usually stayed flat; it was M2 that grew in the high single digits.
This jack-up is short term, of course, and the weekly figures show that the furious rate of M1 growth is easing off. The 13-week increase from July 7 to October 8 (preliminary) is a less eye-popping 12.2%. M2's growth has similarly moderated: 4.1%, which was actually less than the 26-week annualized growth rate. M1 as of October 8th shrunk to a little below the same level it was on September 22nd, although the most recent Fed balance sheet report suggests that the one-week ramp-down won't carry over into mid-late October. This down-dip says that the Fed is no longer in emergency mode, at least for now. From the standpoint of the Fed, the immediate crisis is abating.
A similar story is shown in the credit market. Overnight LIBOR rates have plummeted to well below 2%, a figure roughly approximating sanity given current risk-free rates. Longer-term LIBOR rates have also fallen, though far less slowly. U.S. T-bill rates, except for the 1-month rate, are no longer miniscule; this rise suggests that the "panic into quality" is beginning to pass. And then there's the stock market…
What You Lived To See
The week before saw a slow-motion crash in the U.S. averages. Last Monday, though, we market watchers saw a beast that's rarely (or never) been seen in our lifetime. If a crash can be defined as a day where the averages are down more than 10%, then what we saw was a "reverse crash" on America's Columbus Day and Canada's Thanksgiving Day. A 10% decline is erased by an 11.1% rise. All three averages made that benchmark on Monday, making for a little spontaneous American celebrating of Canada's Thanksgiving holiday that night.
The rest of the week was choppy, of course, but the end of last week saw all three averages well above their Panic of '08 lows. Despite the now-notorious Oct. 15th hedge-fund-redemption date, despite option expiry two days later, despite the widespread fear that Monday's reverse crash was yet another sucker rally, all three averages didn't descend into new depths.
In the tracking market commentary, at least on CNBC, there was also an odd incongruity that tends to show up during certain times in the bull-bear cycle. After the pre-Thanksgiving worry fest, when it became evident that the averages were not going to give a huge whap to investors' wallets again, there was a lot of cautious talk about how tentative last week's rally seemed to be and how awful the economy was becoming. Laced in with these cautionaries, though, were investment professionals who recommended going into heavily oversold bargains. The unofficial play of the week was chasing high-yield stocks whose underlying companies could keep paying the dividend. More assertive professionals, such as CNBC's Jim Cramer, took the same approach but didn't limit themselves to dividend plays. The overall thrust in both groups was buying the wrecked stocks of good companies.
As of the end of last week, what we had was: worry over the entire economy; an emphasis on a selective approach; continual pointing out of bargains; general lack of consensus about where the economy is going, except for near-consensus agreement that a recession had started. This took place in the framework of eye-popping performance of the Dow, S & P and NASDAQ early last week. CNBC's Bob Pisani mentioned last Thursday night that the Dow's rise, from October 10th's end-of-day low to October 14th's inter-day high, was a smidgen above 20%. He said, explicitly, that this ramp-up made for an even rarer bird in the stock-market aviary: a two-trading-day bull market. Yep, a full-fledged 20+% bull market, in the space of two trading days. It made for a real contrast from the week before, which squeezed almost the equivalent of a full-fledged (if minor) bear market in the space of five trading days.
A similar kind of volatility does show up at a certain point in the typical bull-bear cycle. So does a peak in the more formal measure of volatility, the CBOE Volatility Index or VIX.
Birth Of A Runt, But A Birth Nonetheless
From time to time here, I've discreetly flaunted a bear call I made late last January. (Here, if you want it.) Unfortunately for me, I made a later call for the T-bond bull market to end. The latter prediction, to put it mildly, proved to be flat-footed: obviously, the Panic of '08 took me completely by surprise. Unsurprisingly, like any market prognosticator, I'm sometimes right and sometimes blindsided.
Nevertheless, the above-noted items – viz., the ever-present caution; the lingering worry; the peaking of fear-related values; the cautious bargain-hunting – all show up at a particular point in the bull-bear cycle. They show up at the beginning of bull markets. If these regularities hold up – and I'm going on record as saying that they will – then last week saw the birth of a baby bull market.
The bull market I'm calling for, though, isn't likely to be an impressive one. By this lack of enthusiasm, I'm not averring that the coming recession will be severe. To be honest, I think it'll be about the same as '90-91's. Part of the reason why I'm saying "runty bull" is because of future mortgage-related troubles that are due to arrive around 2010. The other reason I'm being an unenthusiastic bull is that the trailing valuations are too high at this point to make for a rip-roaring snorter. The S & P at 17 times trailing earnings is too high for a return to an ‘80s-style bull market.
A more realistic call, in fact, would be a comparison to the ‘70s. This last bear market had a lot in common with '73-4's, and not just in the extent of the drop. To take a more long-term perspective, ‘00s averages have shown the same kind of very-long-term trading range that the averages of 1966-82 had. From a very-long-term perspective, the American market this decade has neither been in a super-bull nor a super-bear. We've seen a near-decade-long trading range, which I expect to continue. This coming bull market should get toppy sometime in 2010, and I would be surprised if the averages set any new records at its peak.
This demur being noted, though, it looks like the current credit panic is over. Larry Kudlow's "mustard seed" depiction of the bailout will prove to be the most correct one. Times will be tough until at least the next inaugural ball, but things will get better for the U.S. economy starting in early '09.
And, there'll be no pressing need to worry about the next credit crunch arriving…until we see Fed Chairman Bernanke going out of his way to keep the Fed's powder dry again.