US presidential election rally for stocks, but then what?

Posted on 29 October 2008 with no comments from readers

Global stock markets are looking increasingly oversold after six weeks of carnage, so yesterday’s bounce back in the Dow should not be unexpected. Indeed, a rally is almost certain to take hold with the US public finally getting election fever and deciding that their saviour is called Barack Obama.

Of course, he is no such thing. The US economy is in a serious mess, and appointing a new CEO in the middle of a crisis is not a wise action: this tends to make things get worse before they get better, and that assumes that the right CEO for the job is chosen.

America might get that much right in electing Barack Obama. But there is a great deal of real pain to come in the form of the worst recession at least since the early 1980s: 2009 and also most likely 2010 are going to be the hardest years for the US in decades.

This reality will probably dawn on the stock market by mid-December at the latest. And as investors consider the New Year outlook for their portfolios they will most likely decide to sell as the profit outlook is truly awful. Indeed, many will only view today’s rally as an opportunity to exit stocks altogether.

Nasdaq, not 1987 bounce

Bear markets are like that – a big sell off is followed by a big rally because those who sold stocks high decide to buy back at ‘bargain prices’. But that is an error. This is more than a cyclical downturn in the stock market – it is like the 2000 slump in the Nasdaq, a permanent loss of value for stocks in the majority of asset classes.

There are always winners, even in a bear market. In the late 1970s stock market investors crowded into energy and precious metal shares. The circumstances of the 1974 Wall Street and London stock market crashes are similar to what we see today. The consequences will be similar.

Then as now the central banks and governments flooded markets with liquidity and bailed out what we used to call ‘lame duck’ industries (this resulted in a huge waste of public money supporting companies that were eventually laid to rest in the 80s and even the 90s). Then as now the macroeconomic impact was chronically high inflation.

Here is a quote from Anna Schwartz, the 92 year old co-author with Milton Friedman of ‘A Monetary History of the United States’, who has worked with the National Bureau of Economic Research for 67 years and retains her emeritus professorship at the Graduate Center of the City University of New York:

“Since mid-summer, Fed credit appears to have ballooned greatly, and that’s behind the upward pressure in the consumer price index. The Fed pooh-poohs inflation because of a perceived slowdown in oil and gas prices. But theoretically any increase in the monetary base must be met with a tightening if inflation is to be avoided. Right now the Fed is pursuing a pro-inflation strategy by lowering interest rates and showering the banking system with liquidity. They’re not even considering inflation.”

Spring bottom

We live for today but invest for tomorrow. Gamble on a short term rally in stocks if you like, but be careful you are not caught out like the hedge funds who lost $38 billion shorting VW shares last weekend. Personally I will be waiting for the real stock market bottom next spring.

Some readers have questioned my qualifications to comment on these matters. I can only say that nobody is forced to read or accept my analysis. But for the record I started studying economics at Trinity College, Oxford University 30 years ago, was a trainee elite civil servant at the European Commission in Brussels, and then followed a career for 25 years as a financial journalist. I covered the 1987 stock market crash, 1990s housing recession, came to Dubai in 1996 to launch Gulf Business magazine, set up the AME Info news bureau and made a small fortune when it was sold.

At the end of the day my own successful track record is probably the only guide to whether my views of the future are worth considering. And if you want to hear more about my investment record then a detailed explanation is presented in my new book ‘Opportunity Dubai’ available now on Amazon or from the publisher. Anybody wanting to make the best out of the future should learn about the recent past. But the main problem now is avoiding errors like buying back too early in a bear market.

For more on gold and silver buy my new book online from this link