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Just as market tops are marked by expectations that economic strength will persist indefinitely, stock markets hit bottom when an economic downturn is taken as full fact, when conditions are widely expected to get substantially worse, and when investors have largely given up on any hope that the economy will improve in the foreseeable future.
With the U.S. Dollar Index breaking decisively below its long-term support level, the sun is finally setting on the golden age of American consumption. As America's economic dominance fades, so too will the faith in the central thesis that has explained its apparent success and has shaped the majority of recent economic theory.
...A proper bailout must take a completely different approach and cannot be limited to “just” a quarter million homeowners. Someone who purchased a house that is too expensive to maintain is best helped by downsizing to a less expensive home. However, homeowners are often “locked into” their mortgages as the mortgages are higher than the market value of their homes. Leverage is great when home prices are rising, but is painful when prices are falling.
The U.S. trade deficit with the rest of the world leapfrogged in recent days: aside from goods and services, we are now importing “consensus based crisis management” from Japan. Out of fear that a cleanup of bad loans would trigger widespread defaults, Japanese banks got themselves deeper and deeper into trouble by hushing up the problems. We are talking about the crisis at Bear Sterns’ subprime hedge fund.
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Let's look at this argument closely. First, why does Siegel say that the earnings yield is an estimate of the real return on stocks? Think of it this way. Reported earnings subtract out depreciation, which is another way of saying that earnings are reported as if the company reinvests only enough to replace depreciation and keep its stock of productive assets constant over time. If the company were not to invest anything for growth, it would theoretically be able to pay out all of its net earnings as dividends. If earnings on the fixed stock of capital could grow at the inflation rate by virtue of monetary factors alone, you would get zero real earnings growth. Then holding valuations constant over time, the earnings yield would be a measure of the real return on stocks. Fine if you believe the assumptions. Now let's look at the data.
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Remember also that banks operate on a ratio of about $10 of assets (generally loans outstanding) per $1 of shareholder equity capital. So a 1% loss of existing loans can wipe out about 10% of shareholder capital. Since banks are required to hold such capital against their loan portfolio, wiping out capital also wipes out part of their ability to originate new loans. Importantly, bank capital requirements are a separate constraint from the reserve requirements placed on a bank's demand deposits.
Despite my fairly pointed concern about risks here, it's very important not to establish a specific forecast or time frame for the direction of the market. It is true that we currently observe a narrow set of conditions that has previously been followed by abrupt market declines in relatively short order, and I've felt a responsibility to wave my arms around to emphasize that risk in recent weeks. But I cannot emphasize enough that our current defensive position is not driven by the forecast of an abrupt market decline – it is based on a more general set of conditions under which the stock market has underperformed Treasury bills, on average.
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The world is awash in money. This money has flown into all asset classes, from stocks to bonds, from real estate to commodities. In a world priced for perfection, should we enjoy the boom or prepare for a bust? Let us listen to Wall Street’s adage and “follow the money.”
After the tech bubble burst in 2000, policy makers in the U.S. and Asia set a train in motion they have now lost control over. In an effort to preserve U.S. consumer spending, the Federal Reserve (Fed) lowered interest rates; the Administration lowered taxes; and Asian policymakers kept their currencies artificially weak to subsidize exports to American consumers.
A government report in Britain showed consumer prices in that country rose at their fastest pace in a decade: up 3% from a year earlier boosted by higher transport and furniture costs. Because this increase in consumer prices exceeded the median estimate of economists’ predictions, of 2.9%, the market reacted by selling British bonds and driving up interest rates. Higher interest rates increase the yield on British debt, supposedly making pound denominated debt investments more attractive, so the British pound rallied against the dollar this week.
