By Ambrose Evans-Pritchard
Last Updated: 8:16PM GMT 23 Feb 2009
“What has become increasingly clear since the intensification of the crisis in mid-September is that strains in the financial sector are spilling over into the real economy,” he said. “This has set in motion a process of negative feedback.”
Mr Trichet said the bank was disturbed by signs of an fully-fledged credit crunch as banks shut off lending to healthy borrowers. Credit has contracted in absolute terms for the first time in recent weeks.
“There are indications that falling credit flows reflect tight financing conditions associated with a phenomenon of deleveraging. If such behaviour became widespread across the banking system, it would undermine the raison d’etre of the system as a whole” he said.
The ECB has been caught off guard by the ferocity of the recession, which is now ravaging Europe’s steel, car, aeronautics and chemical industries. The bank’s hard line has led to criticisms from trade unions and business leaders as the eurozone’s economy contracted at an annual rate of 6pc in the fourth quarter of 2008.

Rick’s Picks
Tuesday, February 24, 2009
“Phenomenally accurate forecasts”

For those who have been patiently waiting for a day of climactic selling to end the bear market, yesterday surely was not it. It was instead more of the same death-by-a-thousand-cuts bloodletting that has halved the Dow Industrial Average since the 30-stock index recorded an all-time high at 14198 in October of 2007. At Monday’s close the blue chip average stood at 7115, down 3.4 percent on the day and 18.9 percent so far this year. Don’t give up hope, though. A respite from the selling could conceivably come soon, since the Indoos are just 232 points from a Hidden Pivot at 6883 that has served as our minimum downside target since January 12, when a bearish “trigger pivot” at 8537 was hit.

We would caution investors against dropping their guard, though, since even if the Dow’s expected bounce from 6883 is powerful, it could still turn out to be nothing more than a bull trap. There is another possibility as well – that the blue chip average will fall to 6883 and keep on going for another 10 to 20 points. That would be an extremely negative sign, since Hidden Pivots as clear and compelling as the one at 6883 almost invariably evince a tradable bounce, however feeble. If one is not forthcoming we would infer that there is still plenty of selling power remaining to push stocks even lower. How much lower? Better sit down for this one, because the next major target beneath 6883 lies at…4670! That would equate to a 67 percent drop from the highs, making it the worst bear market since the Dow shed 90 percent of its value following the 1929 Crash.

Help from Arithmetic

Some investors might be heartened to learn that simple arithmetic argues against a sudden and devastating collapse of the Dow Average. That’s because so many of its component stocks have fallen so low that, when weighted for capitalization, they have practically ceased to matter. One calculation we saw suggested that if every Dow stock currently trading for less than $10 were to fall to zero tomorrow, it would knock the Dow down by less than 300 points; and if all Dow stocks selling for $20 or less were to experience a similar fall, the Dow would shed only about 700 points. What that implies is that, for the Dow to plummet to the 4670 target flagged above, so-far hardu survivors such as IBM, McDonalds, Proctor & Gamble, Exxon Mobil and Johnson & Johnson that still sell for more than mere pocket change would have to crumble. Unlikely, perhaps, but hardly impossible if the economic recovery that most investors will always deem inevitable is not so obliging this time.

***

From MoneyWeek:

How shares are becoming more, not less, expensive

A company’s share price generally consists of two basic elements.

The first is the after-tax profit made by the business, divided by the number of shares in issue. That’s known as earnings per share (EPS).

Then there’s the valuation that the market places on those earnings – otherwise known as the price to earnings (p/e) ratio.

So when shares plunge as they have recently, at least one of these variables is being reduced. Either profits are crumbling or the valuation’s tumbling. Or maybe both.

America’s S&P 500 index has now halved from its October 2007 peak. But what’s remarkable is how fast profit forecasts are being slashed. Since the start of November 2008, the S&P 500 index has sunk by some 22%. But during that time, the ‘experts’ have slashed their forecasts of ‘operating earnings’ – i.e. profits before income and tax, and excluding ‘one-off’ items – by around 28%.

In other words, the market’s p/e is actually rising, despite prices falling. You are paying a higher share price to buy fewer earnings. So shares are becoming more, not less, expensive.

That’s bad enough. But there’s yet worse news.

As Charles Minter at Comstock Partners points out, US investors are watching the wrong profit gauge. Instead of monitoring operating earnings, they should be looking at ‘reported’ earnings. After all, these are the profits that companies actually make, as they include all those one-off, so called ‘exceptional’, items that companies like to hide away.

Why? Think of company profits as a game of golf with a difference. Just looking at operating profits is like playing a round where you’re allowed to get away with all your blunders. Like you keep slicing it into the trees, but your ball keeps being replaced on the fairway, and everyone pretends nothing’s gone wrong.

But as any golfer knows, it never works like that. ‘Exceptional’ items have a habit of recurring over and over again.

Why does this matter so much? Because since early November 2008, estimates for reported earnings have plummeted by about a third. So on this basis, US shares are getting even more expensive than when measured by operating profits. So much so, that on the charts produced by Ned Davis Research going back to the mid 1920s, the S&P 500 is still well above its 25-year average valuation multiple of 21 times.

The really bad news for stocks

The really bad news for stocks is that big bad bear markets like this one generally cut overall p/e ratios to near single-digit levels.

In short, US shares could have much further to fall. This week, Minter caused a stir by suggesting the S&P 500 could still plunge by a further 60% – yes, sixty percent – if the low point of valuations in this bear market turns out like the other really nasty ones.

Too gloomy? Maybe. But other analysts are now catching up quickly. Yesterday David Kostin at Goldman Sachs slashed his own S&P 500 earnings forecasts to factor in a 56% peak-to-trough profit drop. At the very least, a further 20% US market fall looks on the cards.

Ambrose Evans-Prichard from the Telegraph today has it right:

As ordinary citizens with no power over the levers of policy, we watch from the sidelines, and weep. The whole global economy has tipped into a downward spiral. Trade and output are contracting at rates that outstrip the leisurely depression of the 1930s. Debt deflation has simply washed over the drastic measures taken by governments everywhere.
Judging by the latest Merrill Lynch survey of fund managers, investors have a touching faith that China is going to rescue us all and re-ignite the commodity boom. How can this be? Taiwan’s exports to China fell 55pc in January, Japan’s fell 45pc. These exports are links in the supply chain for China’s industry. Manufacturing output in the Shanghai region fell 12pc in January.
My favourite China guru, Michael Pettis from Beijing University, is in despair – as you can see on his blog (http://mpettis.com). The property bubble is bursting. Developers have built more offices in Beijing since 2006 than the entire stock in Manhattan. There is a 14-year supply glut. We have seen this movie before.
Factory output is collapsing at the fastest pace everywhere. The figures for the most recent month available are, year-on-year: Taiwan (-43pc), Ukraine (-34pc), Japan (-30pc), Singapore (-29pc), Hungary (-23pc), Sweden (-20pc), Korea (-19pc), Turkey (-18pc), Russia (-16pc), Spain (-15pc), Poland (-15pc), Brazil (-15pc), Italy (-14pc), Germany (-12pc), France (-11pc), US (-10pc) and Britain (-9pc). Norway sails blissfully on (+4pc). What do they drink up there?
This terrifying fall has been concentrated in the last five months. The job slaughter has barely begun. Social mayhem comes with a 12-month lag. By comparison, industrial output in core-Europe fell 2.8pc in 1930, 5.1pc in 1931 and 3.9pc in 1932, according to RBS.
Stephen Lewis, from Monument Securities, says we have been lulled into a false sense of security by the lack of “soup kitchens”. The visual cues from Steinbeck’s America are missing. “The temptation for investors is to see this as just another recession, over by the end of the year. But this is not a normal cycle. It is a cataclysmic structural breakdown,” he said.
Fiscal stimulus is reaching its global limits. The lowest interest rates in history are failing to gain traction. The Fed seems paralyzed. It first talked of buying US Treasuries three months ago, but cannot seem to bring itself to hit the nuclear button.
As the Fed dithers, a flood of bond issues from the US Treasury is swamping the debt market. The yield on 10-year Treasuries has climbed from 2pc to 3.04pc in eight weeks. The real cost of money is rising as deflation gathers pace.
US house prices have fallen 27pc (Case-Shiller index). The pace of descent is accelerating. The 2.2pc fall in December was the worst month ever. January looks just as bad. Delinquenc-ies on prime mortgages were 1.72pc in September, 1.89pc in October, 2.13pc on November and 2.42pc in December. This is the trajectory eating away at the banking system.
Graham Turner, from GFC Economics, fears the Dow could crash to 4,000 by summer unless there is a “quantum reduction” in mortgage rates. The Fed should swoop in to the market – armed with Ben Bernanke’s “printing press” – and mop up enough Treasuries to force 10-year yields down to 1pc and mortgage rates to 2.5pc. Monetary shock and awe.
This remedy is fraught with risk, but all options are ghastly at this point. That is the legacy we have been left by the Greenspan doctrine. We are at the moment of extreme danger in Irving Fisher’s “Debt Deflation Theory” (1933) where the ship fails to right itself by natural buoyancy, and capsizes instead.
From all accounts, the Fed was ready to launch its bond blitz in January. Something happened. Perhaps the hawks awoke in cold sweats at night, fretting about Weimar.
Perhaps they feared that China and the world will pull the plug on the US bond market. If so, it is time for Washington to get a grip. America remains the hegemonic global power. The Obama team should let it be known – and perhaps Hillary Clinton did just that on her trip to Asia – that any country playing games with the US bond market in this crisis will be treated as an enemy and pay a crushing price.
Pacific allies already know that they cannot take the US security blanket for granted. As for China – and others pursuing a mercantilist strategy of export-led growth – they must know that the US can shut off its market and wreak havoc to their economy.
To Europe, they might make it clearer that unless the European Central Bank is brought to heel by the Continent’s leaders (whatever Maastricht says) and forced to play its full part in emergency efforts to save the global economy, the NATO military alliance will wither and the region will be left to fend for itself against a revanchist Russia.
Should the main threat come from an exodus of private wealth, Washington may have to impose temporary capital controls. Never forget, America is the one country with enough strategic depth to go it alone, if necessary. The US is not going to let foreigners keep it trapped in a depression.
I doubt matters will ever come to this. Japan is already in dire straits. Exports crashed 46pc in January, year-on-year. The Bank of Japan may soon start buying US Treasuries for its own reasons – just as it did from 2003 to 2004 – in order to reverse the 30pc rise of the yen over the last 18 months. If it helps preserve the Sino-US defence alliance in the face of Chinese naval expansion, so much the better.
In any case, the storm has shifted across the Atlantic to Europe. Germany faces 5pc contraction this year (Deutsche Bank). The bill has come from the burst bubble in the ex-Soviet bloc. Europe’s banks are on the hook for $1.6 trillion (£1.1 trillion). For the first time since the launch of monetary union, Europe’s leaders are speaking openly about the risk of EMU break-up.
A run on the US dollar looks a remote threat as the euro drama unfolds. The Fed may soon have all the room for manoeuvre it needs. Small comfort.

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