A Self-Fulfilling Rally in Stocks

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Can we just fast forward to February third already? That’s when the Reserve Bank of Australia meets next to determine the price of money (interest rates). Based on recent data, rates should be headed down again. How low can you go?

It reminds us of the old song that played on the juke box from our days as a soda jerk at the local Malt Shop. “Every limbo boy and girl, all around the limbo world, gonna do the limbo rock, all around the limbo clock.”

Data released yesterday by the Commonwealth Bank and the Australian Industry Group showed the ninth consecutive month of contraction in the service economy. Last week, a similar survey of the manufacturing industry showed a seventh consecutive month of contraction. If Aussie interest rates are headed lower, you’d expect an end to the brief but respectable recent rally of the Aussie dollar.

A weaker Aussie dollar wouldn’t be that unwelcome to exporters, especially if it meant that the decline in the nation’s economic fortunes could be reversed. But frankly, what happens to Australia’s economy at this point is beyond the control of the government and the Reserve Bank. If global demand further collapses in 2009, it is going to be a grim year for the Aussie economy and Aussie stocks.

The economy is not a car. You can’t simply tap the breaks, change gears, put on an indicator, and drive off into the sunset. It is not nearly as mechanical as unimaginative economists would have you believe.

No. The problem Australia faces, along with the rest of the world, is that the whole global economy is oriented toward producing goods bought with credit. With a savage bear market in credit, there is entirely too much productive capacity to match the steep decline in aggregate global demand. Too much stuff being produced, not enough people buying it. The government answer is to get people to buy more stuff by giving them more money. This is, to use a precise term, really lame.

If you’re the anti-materialistic type, the bear market in credit and the fall in demand for “stuff” is a good thing. Stuff is clutter. If you get too much of it, you have to rent a shed to store it in. George Carlin once did a great skit on this. Warning, you’ll find some profanity there. People should probably have listened to Carlin, by the way, before buying houses. “That’s all your house is. A place to keep your stuff while you’re out getting more stuff.”

Stocks are stuff too. And yesterday, in New York at least, the stuff owned by investors didn’t do too well. You can sense the indecision investors have. It’s hanging in the air over the entire market. It would be nice to believe that financial markets have bottomed and that the economy, even though it won’t recover in 2009, won’t get a lot worse.

The so-called experts disagree on this matter. Economist Jeffrey Sachs told the Spanish daily El Pais that the world faced a severe recession but not a Great Depression. He’s right in at least one sense. This will not be the Great Depression. That already happened in the 1930s. This would be the Greater Depression, as our friend Doug Casey calls it.

Sachs would like to reassure people. Recession? Yes. Depression. Not a chance. But why not? San Francisco Fed President Janet Yellen says this recession will be no “garden variety” recession and will be “longer and deeper” than normal. But what does that really mean? It probably means continued contraction in employment, services, and production.

“The current downturn is likely to last much longer than previous downturns… We will be lucky to see the recession end in 2009,” says Martin Feldstein, former head of the U.S. National Bureau of Economic Analysis. Feldstein added that the government is going to have to step in and spend in a big way to make up for the collapse in consumer spending and business investment.

Here’s a thought, though. Maybe governments are trying to prop up a whole economic system that’s simply not fit for purpose any longer. We predict a tipping point in mass psychology where people stop thinking of themselves as consumers…and start thinking of themselves as people. What’s more, they might even think of themselves as creative producers…of their own food, or work that does not produce a feeling of alienation.

Not that we have any idea what all of that means for stock prices. But we’re sticking with our prediction from last year. The U.S. Treasury bond bubble could still go Nasdaq (soar to utterly irrational and unimaginable heights). But you may see a first quarter shift out of cash and government bonds and into equities.

It’s the stock rally we have to have, just to preserve our emotional well being. It’s not hard to see how it happens. People tend to buy stocks because they’re rising and sell them because they’re falling. We are due for a counter-cyclical rally.

After that? You’ll see the long reorientation of global economic life. Scarcity-of capital and raw materials-will reassert itself. Excess productive capacity will rust, idle, and otherwise gather cobwebs. There will be real work to do with your hands. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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13 Comments on "A Self-Fulfilling Rally in Stocks"

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Coffee Addict
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Hi Dan. I would like to coin the term “Credit Depression”. Just about everyone is suffering from it as a state of mind to start with. The term “credit depression” also correctly identifies the cause and consequence of the crisis. There is confusion over what constitutes a “depression” but a few consecutinve quarters in which most global asset and commodity prices fall is enough for me. This has all happened on the back of receding economic activity for some time now but politicians and the popular press don’t like to call it a depression lest they be blamed for talking… Read more »
beyondtool
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I’d be interested to now your take on the markets this year, is gold really worth getting into. I’ve got a considerable amount of cash that was earning good interest but that has now dropped below inflation. I can’t see any huge improvement in most stocks this year as the economy continues to unravel. So what other options are there?

Coffee Addict
Guest
Beyondtool. Perhaps Dan (and other commentators) could each list several reasons why you would or would not get into physical gold and gold equities and gold derrivatives. The significance (and indeed validity) of each dot point will vary for each investor. A key risk for all gold related investments is unknown future demand for jewellery. Investor demand goes up when retail jewellery demand goes down. I agree with Bill Bonner in that even if gold goes nowhere and does nothing, it may still outperform other asset classes. Another key risk area is potential sales by central banks. My own key… Read more »
Pete
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beyond: it sounds like you are only considering the short-term. Surely no-one can offer you the advice that you need because the markets are so volatile Question: Does your cash always need to be getting a rate higher than inflation? And why? Consider scenarios: a) You put all your money into assets such as shares because they appear to be offering a better return than cash in the short-term. Shares drop in price leaving you with assets that you can now only sell at a loss. or b) You leave your cash in the bank whilst it very slowly loses… Read more »
Greg Atkinson
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Coffee Addict. Marc Faber is not a big fan of gold at the moment. Check out his video clip on bloomberg.com.

Coffee Addict
Guest
Greg: Marc is sounding considerably more bullish than he did in December, even if he doesn’t quite admit it. He hints at taking stakes in all things with a probable rebound potential, which includes some gold juniors (I guess). I was surprised the he has included some major miners and technology stocks (with staying power) in his grab bag. Concerning junior gold rebounds some have and some haven’t yet. Of the 2 Crusoe picks I left here a few weeks ago ALK is up about 60% (11c to 18.5c) while CGT (a much smaller company) continues to jump about (in… Read more »
Greg Atkinson
Guest

Coffee Addict, I have to say that is the most bullish I have seen Marc in a long time…my goodness he even said the words “recovery” and “oversold”! I think he threw in the WW3 comment so we did not think he had gone soft:) Anyway what he says makes a little sense and if he is buying then maybe things are turning for the better?

Pete
Guest
??? Have you guys learned nothing? It’s a bear market rally based on exactly the kind of change in sentiment I am hearing from you two (and Marc by the sounds of it). That does not mean that it will last…why on earth would it? Think of all the fundamental problems with the world’s finances at the moment…things won’t magically go back to normal, and even if the rally does recover a lot of the losses it will only be temporary. Enjoy it while it lasts, and take the opportunity to relieve yourself of some bad stocks if you have… Read more »
Coffee Addict
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Hi Pete. I’m not that bullish in that I’m only playing around with about $10K of my own money on some speculations. If the companies I pick can move to production a 10 to 50 fold ROI may be possible. That’s my punt, but as intimated, I’m much more worried about so called “cash” superannuation balances. To use an old phrase in an investment sense I’m just a “gentleman’s gentleman”. Yeah, I’ve been worrying incessantly about a range of corporate investments over the last 18 months and have been using this forum to form, question, reform, then requestion then reform… Read more »
Neville Angove (alarchdu)
Guest

A week ago the F\DR said that there was almost as much cash salted away as the total value of all stocks in the market. This issue (Jan 8)you say that cash is scarce. Erm….we have a technical term for this: a lie.

rod parker
Guest

gold is still drifting along: take inflation away from its rise over the year and it still sucks!!!

Pete
Guest
Hi Coffee Addict I think I agree with everything you just mentioned. I am very bullish on gold and a little bit bullish on oil as I previously mentioned, due to the ‘war’ factor. That said, I am a novice investor, being that I started with the same balance as yourself back in September 07. Not the best time to start really, but really my only goal was to learn about the sharemarket through experience. Thanks to sites like this I managed to avoid most of the hefty losses the rest of the country got hammered with :) In fact… Read more »
Greg Atkinson
Guest
Hi Pete, Marc Faber is a long term bear and is worth listening to in my opinion. Mind you like all long term bears they miss many bull market opportunities, just as bulls cost you money in bear markets. That is the way investing goes, you have to be prepared to miss some great buys and also take a few nasty hits from time to time. As for exchanges rates, I focus mainly on the Yen/AUD and wrote about the impact of the RBA cuts on rates in: The Reserve Bank, rates cuts and a possible nasty turn. But the… Read more »
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