Friday, October 24, 2008

Economic update

It has been a while since I wrote anything down about the economy because frankly it is a huge bummer, but I have still been watching with interest what is going on. Here is where I think we are this week:

The world has avoided a "systemic financial meltdown" after unprecedented coordinated action. The world was at the brink, but has backed off. Governments put all the chips on the table saying, "we will exist." The downside to that bet was literally the collapse of nations - but luckily they won. Even Iceland looks like it will survive. They even used the Swedish model!

The TED spread which measures how much risk banks see in other banks rose to 4.63% - 30% higher than the black Monday crash of 1987 - but has since subsided to 2.66%. It has historically been between .5-1.5% so things are not good but they are not going to explode either.

So it seems that we are past a phase I of this crisis, the banking phase. Now on onto phase II, the global recession.

As everyone has noticed, the stock market has gone insane. It is not that it has just gone down, it has going up and down violently almost every day, and sometimes even during the day there are massive swings. This is measured by the VIX Volatility index that is at an all time high since it started in 1990. And if you look at this month, even the Volatility index has been volatile! So the basic assumption that the market is driven by value has taken a leave for the foreseeable future.

The reason I started this post was because of this Bloomberg article showing the value of the Baltic Dry Index, an index that measures international freight. It has plunged 90% since May making it a bigger drop than the .com boom, or the housing bubble. Shippers can't get credit for cargo, so they are not moving goods. This is what will really drive Phase II of this crisis I believe, as developing and emerging markets (Brazil, China, etc) get slaughtered by what will be an already severe rescission in the powerful G8 nations, as their currency gets drained of value as investors flee towards the dollar.

So some "predictions." Right now everyone is apocalyptic but so far things have not been as bad as 1973-76 when the market declined 45% and then recovered over 26 months as shown here:

Right now markets have declined 41% over 13 months. If you want to correlate 1974 to today, that means the DOW hits a low of 7,750 next October, and finally recovers at the very start of 2011. That seemed like crazy talk a month ago, but now seems optimistic!

Now the pessimistic side. John Authers put forward a disturbing concept today though that is worth watching. Basically, he says that after Japan's financial crisis of the 1990s their interest rate was effectively 0% through out the 90s and is still very low today. So smart investors would borrow Japanese Yen and pump that money into the stock market to turn a free profit. This is called the "Yen Carry Trade" and it has gone bust along with everything else. But what Authers is suggesting is that we have been in a Yen Carry Trade bubble for the past 10 or 15 years that is now busting.

If that is true, that would be deeply shocking and fundamentally change the understanding of the economic landscape going back to the late 1980s. It would also mean the DOW should fall to around where it really broke off from the Japanese Nikkei stock market, which has floundered for decades.

That was in 1995, at 3,900...

And Rubbini is sounding more like he believes that even when the rescission is over it might recover "recover" in an "L" shape like Japan experienced in the 1990s as shown above. To this day 18 years later, the Nikkei has never recovered. He stresses the "might" here though. As of right now he is still thinking in "U" shapes a-la 1974.

So like I said, a bummer. The only thing I can hope for is that in the past decade, the top 1% has gained wealth in huge disproportion to the rest of us, so perhaps this downturn will disproportionally affect them too. One can hope.

EDIT: This is interesting. Draw a line using the basic trajectory of the stock market before it took off in 1995 and you get this:

So if the Dow had kept a steady climb since 1995 it would have been at about 7,500, or about 10% lower than the market is right now...

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