Seems Like Old Times
The question we need to answer is whether it feels like 1998 or 2001.
“Hold me closer tiny dancer. Count the headlights on the highway.”
There’s a certain sense of déjà vu in the market these days. The question we need to answer is whether it’s 1998 or 2001.
We’ve been pondering this topic since last summer when the Federal Reserve and global central banks began their furious offensive. We offered at the time that if the wheels fell off the financial wagon, we would be well warned.
We must now discern whether those actions were a sign of troubling times or the building blocks of a wall of worry.
At the heart of the matter is the structural integrity of the U.S. financial system. In a finance-based economy, that has profound implications for livelihoods around the world.
We often say that to appreciate where we are, we must understand how we got here. There is a distinct difference between taking our medicine and being injected with fiscal and monetary drugs. The former is a function of time and price. The latter matter is a quick fix.
Recession Can Lead to Rebirth
In 1998, the Federal Reserve slashed rates and ushered in the massive technology boom at the turn of the century. That period redefined market perception as housewives flocked to stocks and the promises they held.
When that bubble burst—and remember, most folks vehemently denied that we were in a bubble at the time—the Federal Reserve stood at the ready.
In January 2001, they began their series of rate cuts. The S&P, saddled with capacity and littered with false hope, swiftly lost 40% of its value.
Despite the fright, we never entered a conventional recession. To this day, that concept is considered anathema, a curse that befalls those who fail to do their jobs.
I was schooled to believe that recessions were a natural part of the business cycle. Like a forest fire, they are frightening and destructive but necessary to clear the way for a rebirthing.
Alan Greenspan wouldn’t have it.
He published dollar bills, sacrificing the value of the greenback for the benefit of stateside psychology.
He encouraged credit creation in lieu of legitimate economic growth, paving the way to the highest ratio of debt to GDP in history.
He endorsed adjustable rate mortgages, shifting the burden of responsibility from corporate America to homeowners, many of which failed to recognize the risk.
Indeed, our former Fed chairman passed the buck, figuratively and literally, before riding into the sunset whispering warnings of recession as he hit the talk circuit.
A Harsh and Pervasive Comeuppance
If you believe that for every action there is an equal and opposite reaction, the comeuppance will be harsh and pervasive. The question we must wrestle with is whether it has finally arrived or again pushed out with hopes that a legitimate global recovery takes root.
The bulls will point to an election year and the Beijing Olympics as they look for a successful retest of the latest lows.
The bears will argue that the imbalances have been cumulatively building since the tech bubble and we never really took our medicine.
Either way, make no mistake. We’re dancing on the head of a pin as we toggle between the two.
Two weeks ago, when the market was staring into the abyss, we offered five reasons for optimism.
The resulting rally recaptured 1200 DJIA points and 125 S&P handles in eight sessions—a 50% retracement of the most recent decline—before slamming into technical resistance at DJIA 12,800 and S&P 1405, respectively.
Leadership was narrow as banks and homebuilders led the way. The sharpest rallies occur in the context of a bear market, we know, and the ascent was fierce as we worked off the oversold condition.
Other dubious elements are starting to line-up, including a stronger dollar and weaker commodities, both of which endanger equities. This is subject to change, quite naturally, but it would be wise to understand the ramifications if it doesn’t.
The disconnect for the bulls is a function of juxtaposition. We’re half way through the easing cycle while in the early innings of the debt unwind. While we’ve seen sub-prime slippage and the resulting write-downs, credit card delinquencies, auto loan defaults and the other side of zero percent financing—not to mention any commercial contagion—has yet to manifest.
Keep Risk Low; Have Patience
The deflationary process of this debt unwind is squarely in the crosshairs of the Federal Reserve. Nobody—not Hank Paulson, not Ben Bernanke and certainly not I—can possibly know how far it will fall or how fast it will arrive. Why? The global financial machination is tied together with upwards of $500 trillion worth of derivatives, ever-changing and constantly in motion.
As Mr. Practical recently wrote on Minyanville:
“Every bailout plan is designed to stave off asset price depreciation but the irony is that as asset prices decline, the problem grows worse. You can try to participate in the crazy volatility but it will eat almost everyone up. The only stance that makes sense is a defensive one. Stay out of debt, keep your risk low and have patience.”
Indeed, while I’ll lay three to one that our current juncture is akin to 2001 versus 1998, I’m hopeful that it will stop there. For if risk appetites continue to contract and social moods sustain their swing, we could be looking at an entirely different analogy.
That of 1929.
Capital preservation, debt reduction and financial intelligence remain the hallmarks of any successful financial agenda. It’s impossible to know which scenario will play out but the path that we take to get there, along with our preparedness along the way, remains entirely more important than the destination.
Fare ye well.
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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