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Generational Dynamics Web Log for 06-Oct-05
After 3 days of sharp losses on the stock market, the "Octoberphobia" mood is increasingly gloomy.

Web Log - October, 2005

After 3 days of sharp losses on the stock market, the "Octoberphobia" mood is increasingly gloomy.

Is this a panic? Just what IS a panic, anyway?

The market took a steep fall on Wednesday, for the third day in a row, falling 2.4% in three days. As I'm writing this, the noontime reading of Japan's Nikkei index shows it's fallen almost 3% today alone.

The economic bad news just doesn't seem to stop.

Consumer spending in August had its sharpest decline in four years (Source: WSJ)

Consumer spending in August had its sharpest decline in four years (Source: WSJ)

Consumer confidence fell sharply in September, to nearly a two-year low (Source: WSJ)

Consumer confidence fell sharply in September, to nearly a two-year low (Source: WSJ)

Investors have gotten more cautious in the last month. After keeping the P/E ratio at 20 for a year, last month they pushed it down to the 18-19 range. (Source: MarketGauge ® by DataView, LLC)

Investors have gotten more cautious in the last month. After keeping the P/E ratio at 20 for a year, last month they pushed it down to the 18-19 range. (Source: MarketGauge ® by DataView, LLC)

On Wednesday, the Institute of Supply Management released its non-manufacturing business activity index, showing that it fell sharply because commodities prices, led by oil and gas, have spiked up.

Earlier this week, on Monday, the ISM released its manufacturing index, which showed unexpected strength. That should have made investors happy, right? Just the opposite. The "prices paid" component was up sharply, once again led by oil and gas prices, and the market immediately took a dive.

The logic is this: When businesses pay more for commodities, it means that they'll have to increase prices, leading to inflation, which means that Alan Greenspan's Fed will continue to raise interest rates, which means that credit will be tighter, which means that business will be bad.

This is all on top of exponentially increasing public and private debt, with little fiscal control following the destruction wrought by hurricanes Katrina and Rita. And sky-high oil and gas prices are keeping consumers out of shopping centers and eating into discretionary income.

In fact, Alan Greenspan warned that the market may be in danger, a speech he gave on September 27.

This would be really hilarious if it weren't so serious. Greenspan said that the market was in danger because his clever rate-setting policy has stabilized the economy, which has reduced "risk premiums", which has made investors less willing to invest. It reminds me of the statement last year by Greenspan's colleague, Fed Governor Ben Bernanke, blaming America's astronomic credit imbalance on other countries for spending so little that they've created a "global savings glut." These guys just can't stop patting themselves on the back.

There's a great deal of anxiety in the marketplace now, because of "Octoberphobia," the fear of a stock market panic, such as those that occurred in 1987 and 1929.

Are we in a panic situation already? No we aren't. Not even close. A 2% or 3% loss could easily be made up in a single day. (Though as I'm writing this I'm watching the Nikkei index continue to fall, more and more.)

In 1987, the stock market fell 22% in ONE DAY (Oct. 19), and in 1929 the stock market fell 24% in two days.

When a real panic comes, you'll know it when you see it. A "panic" means what it says -- an unreasoned frenzy to sell faster than anyone else does.

Today, the mood is right for a panic. Investors are highly anxious today, and race to the bottom could easily result in a lose of 20% or more in one or two days. That would bring the DJIA down to around 8200, which is where it was in July, 2002, anyway.

But what would happen after that? Would the market keep on falling, as it did in 1929, or would it begin to recover, as it did in 1987?

Most journalists, pundits and high-priced analysts are saying the same thing: There won't be a panic, but if there is, the market will recover soon, as it did after the 1987 panic by 1989.

But those analysts would be wrong, and here's why: As we've said many times, both I and other analysts have computed, the "true value" or book value of the market today is around Dow 4500, which means that the market is overvalued by more than 100%. In fact, the market today is priced at 216% of book value.

In 1929, the market was at 173% of book value when the panic occurred, following the 1920s bubble. The market continued to fall for three more years, ending up at 24% of book value by July, 1932. This shows how a bubble can cause an "anti-bubble", caused by strong risk-averseness among investors; instead of stopping at 100% of book value, the market fall overshot the book value, and fell substantially further.

By contrast, in 1987 the market was just at 105% of book value when the panic occurred. The panic caused a 22% fall, which brought the market price well below book value, so that an early recovery was to be expected at that time. [22-Jan-2006 correction: in 1987, the market was at 127% of book value, still within the normal variation.]

That's why we're entering a new 1930s style Great Depression, as I predicted in 2002, and that the market will fall to the Dow 3000 level, or lower. (If the market again falls to 25% of book value, then it will fall to the Dow 1000-1500 range.) There's no way to predict when a panic will occur, and if it doesn't occur before Thanksgiving, then it probably won't occur until we're well past the Christmas/holiday shopping season.

But October is the cruelest month, and it's a good idea to be prepared for the worst. If you do it right, then you'll be OK whether the worst occurs or not. (06-Oct-05) Permanent Link
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Generational Dynamics Web Log for 06-Oct-05 After 3 days of sharp losses on the stock market, the "Octoberphobia" mood is increasingly gloomy.

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Generational Dynamics Web Log for 06-Oct-05
After 3 days of sharp losses on the stock market, the "Octoberphobia" mood is increasingly gloomy.