Going below 7,000 on the Dow, 3,300 FTSE?

On September 29th this blog published an article predicting a fall in the Dow Jones to 7,000 points and the FTSE to 3,300. This is now increasingly looking like an accurate call, but it may now not be low enough. Just to recap the main thrust of that article, which concluded:

“I also doubt very much that we have seen the end of problems in the global financial system. As more and more financial institutions get into tougher trading there are going to be business failures led by the hedge funds and as their inter-linked derivative products come under pressure the whole shadow banking complex may collapse. Estimates for that bailout start at $5 trillion.

This is all going to be highly inflationary and very bad for the US dollar whose devaluation will resume just as soon as the reality of the inadequacy of today’s bailout becomes apparent. You will not see the Chinese racing to buy US assets in this environment but then China’s domestic stock market is down 67 per cent and its $1.3 trillion in foreign reserves is just a drop in the derivatives ocean.

We will eventually hit a real bottom in global stock markets – perhaps around the levels I have indicated or a little lower. By then gold will be $2,000 an ounce or more and silver $60-70. Precious metals will be the best performing asset class by far in a sea of red ink. I think this will all take 18-24 months. But it could come very much quicker with a stock market crash as early as next month.”

October crash

Well we got the October stock market crashes big time this year. The global banking system is also in huge trouble and massive amounts of money are being spent – total commitments already pass $3 trillion. That is close to the $5 trillion total mentioned above but it could just be a deposit on the total amount.

In the meantime the collateral damage to the real economy is mounting, and this is clearly going to get much worse as the credit freeze continues. And make no mistake, even the nationalized banks are not going to lend as in the free wheeling days of their youth, while the others will remain under severe financial pressure.

The whole over-leveraged edifice of Western economies is going to have to de-leverage. That means anybody with a loan that they can not repay is going bust. However the governments try to offset this chain reaction of debt obligations, this is going to lead to a long period of low economic growth as more banks go under and real estate companies collapse.

Profit illusion

Profits for the surviving companies will be squeezed by the recession and the taxes and public spending cuts needed to pay for the bank bailouts. As profits fall the idea that stocks are cheap on a price-to-earnings multiple will be seen for the illusion that it represents, and stocks will fall further.

Eventually stocks will reach a base, and then there will be a case for selective buying of companies that can profit from the very new economic environment. In that inflationary environment stocks in precious metal companies will be a screaming buy as the price of the metals will have gone up (they already have) while the stock prices are falling (they are). 

But how low will stocks go and how long will they stay there. It could be a steeper fall than I thought at the end of September and the recovery take much longer. This is not a normal cyclical recession in which stocks will bounce back. It is a once in a generation global financial crisis and will take very much longer to put right. 

The 1929 crisis started a downturn that only really ended in the Second World War but we do know some of the mistakes made in that era and will avoid a deflationary spiral. Inflation is by far the best way out, and incidentally will eventually support nominal share prices, although in real terms shares will be worth far less than they are today. In that important sense the loss of value will be permanent.

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