How bad is the economic collapse? Where's the bottom?

Dave Simonds (from KMOX "Dollars and Sense") sent out an email yesterday that answers a few of the common questions about the economic collapse:

Hello everyone,

Don’t be intimidated by the length of this e-mail. If you don’t feel like reading the whole thing, then scroll down and pick the questions that most pertain to your situation. I sent this same e-mail to my client base, but have deleted certain issues that pertain only to them. However, the general themes remain the same.

“Is this one of the worst bear markets in history? Where does it stack up historically?”

The numbers are staggering. Through today (10-9-08), the S&P 500 was down roughly 39% for the year. That is the worst performance during any given year since 1931. Think about that for a second. The market is behaving as if we were in another depression, taking us down to levels we haven’t seen in more than 7 decades.

Here’s another one that helps put this destruction in perspective. Over the past 200 years, there have only been four cases where U.S. stocks produced zero growth over a 10-year period. That’s pretty rare, right? Well, you can add a fifth as of today. The market (as measured by the S&P 500) is now down about 15% since October, 1998. We are all living in historic times, although it’s not exactly the kind of history any of us care to make.

“So where is the bottom?”

Ah, yes, the eternal question that unfortunately has no answer. Remember, you’re talking to a guy who sent an e-mail last week detailing how bullish he was becoming. The Dow has only dropped another 1,700 points since that e-mail was sent. Granted, I wasn’t predicting a bottom or forecasting that the worst was over. But I did remark how I thought the market would be higher in a few months and I’m going to stick with that…for now.

Virtually every major indicator that we follow started flashing bullish signs last week and I’ve always been wrong in ignoring them. But I’ve had to come to the conclusion that using traditional methods to track this market have proven useless. I wish I could provide some comfort by exuding confidence that the worst is definitely over but, alas, I cannot do that. What I can do is follow the underlying fundamentals of the economy and develop a reasoned prediction of where we’re heading. But the market is trading on fear, panic, and angst. When human emotion takes over, it’s absolutely fruitless to try to predict a bottom.

“Jim Cramer of CNBC made headlines by predicting continued calamity in the market. What’s your reaction to his comments?”

Cramer is a very brilliant, if not eccentric, man. Part of his intelligence lies in the fact that he knows how the medium of television works. Make very provocative, even outrageous, predictions and watch the spotlight fall on you. But remember that Cramer was NOT sounding the “sell, sell, sell” alarm at Dow 14,000, or 13,000, or 12,000, etc. No, he told people to start going to cash as the Dow approached 10k. So he was a mere 4,000 points late in warning people, and his track record of predicting the direction of the broader market is very suspect. We prefer to follow the folks who work quietly behind the scenes, and who correctly flashed the warning signs many months ago. These same folks are now ADDING to the stock market so that’s quite encouraging.

“What about the future? Is there anything we can move to that’s more defensive?”

Unfortunately, even the “safe” stuff has broken down. In past bear markets, like 2000-02, we were able to move assets into bonds (including emerging market bonds that made us money), as well as small-cap stocks and international equities that didn’t fall as far. We were down in 2002 but not nearly as much as the market because of other areas we were able to find that provided some support.

We have no such luxury this time. I heard one market strategist say that if a bear market like this had occurred in past years, gold would probably be at least $1,500 per ounce, if not higher. And yet, it’s BELOW where it was when the market really started to drop off the table in mid-September. If you can’t make money in gold during times of distress like this, then there’s nothing I can offer that gives me any comfort, outside of federally insured money market. Even Treasuries have gotten whacked in the last couple of days. I know of one gentleman (not a client) who moved all of his money into gold and U.S. Treasuries, and he’s DOWN!

So if you really feel compelled to move a portion of your investments to higher ground, then going to cash is the only real solution. Crazy, but true.

“Do you see ANY good news? Any light at the end of the tunnel at all?”

There actually are some bullish signs that are developing. One of the most impressive is the volatility index (VIX) that is hitting levels not seen since Black Monday on October 19, 1987. As we know, that was a once-in-a-lifetime opportunity to buy cheap stocks. When the VIX rises above 30, it almost always flashes a BUY signal. It’s extremely rare for it to ever get above 40, and when it does it has ALWAYS meant a bottom in the market. Well, it hit 58 on Monday, shot above 60 today, and has remained above 50 for most of the week. Unprecedented.

As I mentioned earlier in this e-mail, the “worry warts” we follow have been adding to equities over the past few days. One example is Ned Davis, the highly regarded strategist who charges a minimum of $40,000 per year for institutions to buy his research. Mr. Davis just moved 25% of his fixed-income position over to equities. These guys won’t necessarily hit the bottom exactly, but you have to figure they see something to their liking.

Lastly, the market always bottoms at maximum pain. I don’t know if we’re there yet, but I can tell you that this is the most pain I’ve personally seen and felt in my career. But don’t take my word for it. I’ve talked to some of the elder statesmen of my business who’ve been around for 40-plus years and they also remark how they’ve never seen anything like this. They’ve had more people cash out than on Black Monday, and that’s saying a ton.

“Promise, last question. What’s going to happen after the elections next month?”

I don’t know, you tell me who’s going to win! I’ve been saying for months that I believe we’ll get a post-election rally but I want to amend that somewhat. Because the average American/investor is so fed up with what’s happening, the mantra of “change” is becoming less of a desire and more of a demand. That helps Obama and hurts McCain. So if the former wins, I do believe we’ll get a post-election rally. Could be a short-lived rally, I don’t know. But my conviction of what happens with a McCain victory is less certain. The market may view it as more of the same (whether that’s fair or not is immaterial) and we may not necessarily see a rally that I would have hoped for a couple of months ago.

But let me clear, this is just a short-term prediction. I believe if Obama gets what he’s campaigning for, namely higher taxes on wealthy individuals while adopting some protectionist legislation in THIS environment, that could be detrimental longer term for the economy and the markets. But I’ll wait to see if those kinds of policies are even enacted before commenting further.

That’s it. I’m off to Chicago tomorrow afternoon to run the marathon this Sunday, so I will not be hosting the show this weekend. I have so much pent-up energy right now, you may see this shocking headline: “St. Louis native shocks the world by beating the Kenyans in world record time!” And then in true Forrest Gump fashion, I’ll just keep running for months on end.

Dave

David W. Simons, CFPâ

Vice President

Wealth Management Advisor

Senior Financial Advisor