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Will Financials KO the Market?


The US economy is vulnerable.


As a boxing fan, there's a clear cut sign a boxer is in terrible trouble (outside of saying "No Mas" and lying on his back) and that's when his corner begins to implore the fighter to do it "for your family".

If the market was in a professional prize fight (and in there may be no better analogy) the bulls would be screaming to fight on for pride, family and country. The sad part is it was the iconic companies that were down for the count including General Motors (GM), Boeing (BA) and Citigroup (C). Lets face it, Kroger (KR) had a good week but we can't expect a supermarket to lead the broad market higher. (The success of Kroger, Safeway (SWY) and others do underscore how adapting to competition is vital to business and why Wal-Mart (WMT) might have been a lot better for American business than its critics give it credit for. Okay, I digress, but had to make the point.)

The stock market is on the verge of taking its worst drubbing since the Great Depression, down 496 points for the week, and there's nothing to suggest things will get better. Ironically, that's one of the silver linings to this current meltdown- nobody is predicting it will get better. The epicenter of the meltdown is the financial sector which completely broke down last week. As their next round of earnings come around the tension is palpable. The weird thing about last week was the fact I didn't sense a lot of fear, except in the financials where investors are quaking in their boots. The kinds of losses expected in the sector are mind-numbing. In fact, everyday one firm is lowering expectations for another and offer guesses on losses that simply don't seem real. Is it possible an industry could write down a trillion dollars of assets in a year and still survive? Is it possible any industry could lose and or write down assets of a trillion dollars in a year?

It's a great thing that Ben Bernanke is a student of history because his work is certainly cut out for him now. The Great Depression came about for a number of reasons but none more so than the flatfooted non-action of the Federal Reserve. In 1928 Benjamin Strong passed away and the Fed was left without a leader. Moreover, when the recession began in August 1929 most members of the Fed thought it would be cathartic. At the time the young monetary policy making organization saw the decline in industrial production, money supply and consumer prices as the perfect antidote to the Roaring 20s. While they were putting their collective heads in the sand at the Fed the White House and Congress moved into overdrive. Massive tax hikes coupled with legislation like Smoot-Hawley that led to trade wars and global protectionism were akin to using kerosene to put out a fire.

As an amateur historian I know it's difficult to avoid mistakes of the past even with those mistakes serving as reminders of what to do and what not to do. The key is to not allow a recession to become something worse, something it really doesn't have to become. With that in mind the one element of the current financial malaises is the credit crunch. Money is going to become more expensive once the Fed begins to increase rates but the reality is financial institutions weren't opening the spigots even with the tsunami of funds the Fed made available. I guess banks are hording cash to counter write-downs and their own troubles with more expensive funds. It's a mistake in my assessment. At some point banks have to get back to business and make the wheels commerce start to move again. Many (real) economic historians believe there has to be bank failures to clean out the also-rans and create opportunities for those banks left standing.

During the run of the Great Depression consumer prices plunged (yes, we have to be careful about wanting prices to come down, there are consequences), exports were eventually sliced by 70% and the unemployed climbed from 3.1 million in 1929 to 25.2 million in 1933.

The reality is the Great Depression got substantially worse during the trough of bank collapses in 1932 but that final nail sped up the healing process and the new business cycle began in March 1933. I think the stock market isn't accurately reflecting the economy, the United States isn't in a Great Depression, but it is vulnerable. This is a delicate time. The negative wealth effect of the housing market needs to be curtailed and contained but there are other things that must be addressed, too. Memo to the next President:

  • Don't raise taxes.
  • Don't start a trade war.
  • Don't protect jobs that are not globally worthwhile.
  • Don't over regulate.

As for the current Fed I would say first and foremost articulate your game plan, bending to the whims of the market is suicidal. Let some banks go out of business if saving those means taxpayers foot the bill for years to come. Pay attention to the numbers but also be cognizant of what's happening in the real world beyond the reams of data that never stops piling up. The Fed is going to raise rates soon but should take each rate hike as a one-off event with a clear mind about their next move. If prices remain stubbornly high then a signal to the markets about a longer term rate hiking cycle would be necessary.

This week will be more about economic data than corporate earnings.

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