Sunday, June 21, 2009

Why Stocks Will Collapse This Fall

Written by Graham Summers
Thus far, 2009 has been a virtual repeat of 2008 for financial markets.

So far, both years have had:
  • A Crisis/ Market low in March (Bear Stearns & March collapse to 666)
  • A Government/ Federal Intervention (Bear Stearns & Stimulus Package)
  • Gold testing/ breaching $1,000 in the first quarter (March & February)
  • Stocks rallying into the summer on worsening fundamentals
  • Stocks rallying close to their beginning of the year highs in May/ June
  • Commodities rallying into the Summer on the China story/ inflation concerns
  • Various government figures using the rally to claim that the “worst is over”

Stocks rolling over in earnest in June as fundamentals take hold

Even the charts are similar… except for the fact that 2009 has been like 2008 on steroid (the chart has been rebased to 100).

The Fed claims that it cut interest rates and pumped trillions into the market to lower volatility and return stocks to “normal” trading action. Looking at 2009’s performance compared to 2008, I’d say their efforts have been a complete and utter failure. The stock market has become more volatile with larger swings.

As I’m sure you’ll recall, stocks completely collapsed in the fall of 2008. I think that stocks will suffer a similar fate in 2009. My reasoning is simple:

1) The Fed’s moves have not solved the critical issues facing financial markets
2) The economic and financial fundamentals have worsened dramatically

The primary issue facing the financial markets is system solvency. In extremely simple terms there is too much debt, too many crummy assets, and not enough capital. Debt permeates our entire economy from the consumer level to the federal government. Debt became some out of control that at its peak, people could buy the largest single asset of their lifetime (a house) with no money down.

Since that time, Americans have done the sensible thing: deleveraging by paying off debt ($40 billion in credit cards debt Feb-May) and raising capital (saving their money). The In contrast, the Federal Reserve (the alleged back-stop for the financial markets), has done quite the opposite: issued more debt and spent even more money. Small wonder volatility has worsened.

The other critical issue facing the financial markets is accounting. To this day, no one knows the real value of the assets sitting on the banks’ balance sheets. No one knows if the banks are even solvent (I have my doubts). No one knows what the financial markets would look like without the Fed’s props in place.

To use a metaphor, the Fed has propped up a collapsing home with a few stilts and buttresses. Has the foundation improved? NOPE. Is the structure more stable? Definitely NOT. Do we even know the extent of the rot or damage that needs to be fixed? NOPE again. Have we spent a ton of money on the issue? YEP.

Now, onto issue #2 (economic and financial fundamentals are worsening dramatically). Sentiment and trading patterns may dictate short-term moves, but ultimately the market is driven by earnings. Well, earnings have fallen off a cliff. Consumers are not spending as they used to (they probably won’t ever again).

Year over year, retail sales are the worst seen in the post–WWII period. The last few months have shown the rate of collapse is slowing… but getting horrendous at a slower pace isn’t a sign of a turnaround.

Moreover, unemployment is rising which means even less spending (who goes on shopping binges to celebrate getting fired?). And this is happening at the same time that oil and other commodities are rising (which means operating costs will go up).

In very simple terms, higher costs + lower sales = much, much lower earnings. It’s simple math, but Wall Street analysts don’t seem to get it. Neither do any of the “green shoots” crowd.

So in summation, we have a MORE volatile stock market, rallying even harder on worsening fundamentals, with no real solutions to the structural issues plaguing the financial system.

If this isn’t a recipe for a potential Crash, I don’t know what is.

Good Investing?
Graham Summers

Courtesy From Jesper Lee - Cimb

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