Having received more than 60 million votes, president-elect Barack Obama has
earned a spectacular personal victory and a clear mandate to bring some form of
change to the United States. Obama's decisive and masterly election campaign,
where he first had to outmaneuver the formidable Hillary Clinton machine, may
bode well for his ability to implement a government response of unprecedented
magnitude. Time will tell if this is a blessing or a curse.
In the short term, markets may likely rally on the grounds that election
uncertainty is over and that Obama and a Democratic Congress may institute
massive infrastructure spending along the lines of Roosevelt's New Deal. The
larger question for investors will be whether government spending will make any
difference to
long-term performance, or whether the markets are already locked into a
downward spiral that no amount of pump priming can counteract.
There is increasing evidence that the severe recession or depression that we
have long forecast is now becoming reality. One has only to look inside local
shopping malls to see the physical effect of a visible loss of consumer
confidence. Once confidence is lost, it is exponentially more difficult to
regain.
To avoid a deep recession, as the government now hopes to do, massive
intervention would have been required - months ago. But, in the absence of
extraordinary political cooperation with the sitting president, we can assume
no significant changes in policy until Obama takes office in late January. When
new programs do come, the big question will be size.
The outgoing George W Bush administration, which is responsible for creating
the vast asset booms, has thus far provided only US$172 billion in a stimulus
package and some $700 billion in authorized asset purchases, mainly to bail out
Wall Street. Historically, these are large numbers, but today they are dwarfed
by losses already suffered by real estate and stock investors.
Losses incurred on the $14 trillion US mortgage market will be significant, and
we can expect government initiatives to try to replace these vanished assets.
Of course, not all of these mortgages will go bad. But with rising corporate
and individual bankruptcies and increasing unemployment, an increasingly large
number will default.
Almost $5 trillion of these mortgages were "sliced and diced" into the now
notorious mortgage-backed securities. Despite their toxic waste content, these
so-called "securities" were sold to conservative investors, including US-based
pension funds, the solvency of which will be a major issue for the Obama
administration.
But the losses don't end with the mortgage market. As we had forecast, state
governments and corporate America, including insurance, credit cards and auto
companies, have arrived in Washington, hat in hand, asking for taxpayer money.
Looming rapidly into sight is the more than $20 trillion of private sector
corporate and consumer debt. As is reflected in widening credit spreads and the
threatened bankruptcy of national business icons such as GM and Ford, this debt
is also being called increasingly into question.
How many trillions of dollars of government spending will be necessary to make
whole the institutions and individuals swamped by this tide of credit defaults?
Is the government prepared to float multi-trillion dollar annual deficits?
Apparently so. If such sums are palatable to our creditors, then perhaps the
worst can be avoided.
Regardless of government action, we feel that the recession will be both severe
and long lasting. The resulting fall in corporate earnings will be reflected in
future stock prices. In light of this, we urge investors to be wary of claims
that US stocks are cheap.
It is worth remembering that prior to the stock market crash of October of
1929, the Dow had peaked 381 earlier that same year. It was not until some
three years later, when severe recession and then depression took hold, that
the Dow reached its low of just 42, a fall of some 90% from its 1929 highs.
In a historical context, the Dow's recent fall from 14,164 to some 8,200 (a
decline of just over 40%) does not necessarily indicate that stocks are cheap.
Today, a 90% fall would bring the Dow down to a level of 1,416!
John Browne is senior market strategist, Euro Pacific Capital. Euro
Pacific Capital commentary and market news is available at http://www.europac.net.
It has a free on-line investment newsletter.
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