Generational Dynamics
	Forecasting America's Destiny ... and the World's
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Stock market increasingly volatile

For two straight weeks, global stock prices have plunged sharply on bad news. Stocks have fallen 10-20% in Asia and 5-10% in Europe and America.

Can you believe this? Did you ever think you'd see stockbrokers protesting? That's how angry they were in Bombay (Mumbai) after the stock market crashed 11% [Shashi Ashiwal, Hindu Business Line]

On Monday (5/17), the Bombay (Mumbai) India stock market crashed 11%, the largest drop in its history, as a result of loss of confidence following last weeks upset in the Indian Presidential elections.

There's no way to predict how long it will take for the global markets to recover from the losses, but it's fairly certain that the stock market is entering a period of increasing volatility. The problem is that with stocks overpriced by a factor of 2-3 (according to standard price/earnings computations), there's no cushion left for bad news.

And there's been plenty of bad economic news lately. Here are some things that have been going on, just in the last 2-3 weeks:

• Following the April unemployment report, it became the common wisdom that the Fed would raise the overnight funds rate (interest rates) in July. Just the mere threat of an increase in interest rates can cause stocks to fall, because price/earnings ratios are around 30 (meaning roughly that each $30 of stock is earning only $1 per year, or 3.3%). Such ratios are tolerable to investors only as long as interest rates are close to zero. As soon as interest rates start rising, then stock prices must fall.
• Food and oil prices have been spiking recently, and are expected to spike even higher this summer. Already, oil has reached an all time high of almost $42 per barrel (where typical prices are in the $20s). High oil prices often signal a recession, and high food prices often signal increased looting and low-level violence in poverty-stricken regions of the world. All of this contributes to the level of anxiety depressing the stock market.

During the last three weeks, the Chinese government has been applying harsh controls to "cool down" the economy, with the goal of achieving a "soft landing." China has been growing at 9% per year for almost 20 years, and international economists have been expressing concern about overheating since early 2003. China appears to be in a generational "unraveling" period stock market bubble that has to burst at some point, and that a bursting bubble is very hard to control with a "soft landing." This is of major concern to South Korea and Japan as well, which explains the near 20% drop in those countries' stock markets.

• There have been major terrorist attacks during the last two weeks.
  • Akhmad Kadyrov, the President of Chechnya, was killed in a suicide bombing during a national celebration, throwing Russia's Chechnya policy into chaos.
  • In Karachi, Pakistan, a suicide bombing killed dozens in a Shi'ite mosque, threatening the stability of Pakistan which is plaqued by frequent violence between the 20% Shi'ite minority in the mostly Sunni population.
  • Ezzedine Salim, President of the Iraqi Governing Council that we're counting on to take the reins of government on June 30, was killed by a suicide bomber. In a separate incident, an attempted suicide bombing unleashed deadly sarin nerve gas, raising the possibility of additional use of chemical weapons being used against American forces.

  It appears that major terrorist attacks are going to continue at a frequent rate, and there's little doubt that there terrorists would love to strike at a major oil processing facility, pushing the price of oil up even farther.

• The level of violence between Israelis and Palestinians in the Mideast has been growing for years, and has become particular turbulent in the last few weeks. Meanwhile, world opinion is becoming increasingly hostiles to Israel's disengagement plan from Gaza, particularly the destruction of a number of Palestinian residences.

The reason to expect further volatility in the future is, basically, because all of these reasons represent bad news that is likely to continue, while the good news we've been seeing in unemployment and corporate earnings is already priced into the overpriced market.

As every reader of my book or this web site knows, I've been predicting since 2002 that we're entering a new 1930s style depression, and it's exactly this kind of volatility that occurred in the weeks preceding the 1929 crash (except that the 1929 volatility occurred on a national basis, while this volatility is occurring internationally). My expectation has been that some financial shock will start a chain reaction causing an event similar to 1929 in the next 2-3 years. That doesn't mean that the Indian crash and the current volatility will have that result, though it may; it means that something similar to what we're seeing now will have that result in the next 2-3 years.

Finally, it's hard to see how the Fed can justify raising the overnight funds rate in June. I would expect any increase to be postponed until next year. If I'm wrong, then expect substantial further global stock market convulsions. One way or another, I would not be surprised to see a return to core deflation (ignoring commodities like oil) in the next few months.