Searching for a Market Bottom

The question of the day--every day, it seems--is whether the market has reached a bottom. Let's look at the evidence.

Bottom. The market has dropped over 40% from its all time record high, almost as much as it dropped during the OPEC oil embargo era in the 1970s. That was a time of stagflation, when the economy was bedeviled by high inflation and stagnation. We have the stagnation today, but not the inflation.

The government is taking a variety of actions to combat the credit crunch and economic slowdown. One can find a number of problems with the government's approach. But inaction isn't one of them. In total, the argument goes, the government's monetary and fiscal measures should prop things up well enough that the economy can reboot and get going again.

After a brief pause, during which the market fell 20% after Election Day, President-elect Obama is selecting the key officials needed for his economic policies and programs. Following the Friday (11/21) news report of the expected selection of Timothy Geithner, president of the Federal Reserve Bank of New York, as Treasury Secretary, the market jumped 6% in an hour. Moreover, with Citigroup having spent the last week fighting off speculation about its potential collapse, the government is expected to announce tomorrow, Nov. 24, 2008, that it will backstop some of Citigroup's losses (i.e., assume the losses if they occur) and invest in Citigroup. From a certain perspective, there's never been a better time to be a major bank.

It's clear that the government will continue to fight against economic decline. President-elect Obama has proposed a massive jobs program that would employ 2.5 million people. You'd have to go back to the 1930s to find anything comparable.

Not a Bottom. There's no good economic news. The economy is, by all indications, shrinking, perhaps by as much as an annual rate of 5%. (If so, that would be a shocker; the U.S. economy doesn't often shrink so fast.) Unemployment is rising rapidly, up to 6.5% now and likely to reach 8% or 9% next year. That's nasty. We're in the middle of the fourth quarter, and information about corporate earnings is scarce. Much more will be available 4 to 8 weeks from now. But there's not much reason to expect good overall earnings news. While some companies do well in bad times (e.g., Wal-Mart), the economy as a whole doesn't benefit when consumers are cutting back and bargain hunting. And the export market is looking sorrier and sorrier, with the dollar strengthening and the world economy weakening. Without good economic news, there won't be a true market bottom. After all, stock values ultimately depend on the performance of the real economy, and that isn't good these days.

The quantity of federal action shouldn't be confused with the quality of federal action. There are reasons to be concerned that the government has quality control problems. When Treasury Secretary Paulson proposed the Troubled Asset Relief Program in late September, he said it would be used to buy hinky assets from banks. This induced banks to hold onto these bad boys, instead of selling them, in the hope that the Treasury would give them a better price than those greedy bottom fishers who, investing private capital, would only offer small beer. But then, a couple of weeks ago, Secretary Paulson said "never mind" to the idea of spending taxpayer money on asset purchases, preferring to use the funds for capital infusions into financial institutions. That left the banks that held this dodgy paper dangling. They were whipsawed by the government's on again, off again idea for TARP. Citigroup held a large bundle of dodgy assets, and it's no surprise that it began circling the drain when the only potential high-paying buyer for the stuff headed off to play in a different sand box.

Federal regulators have, perhaps too much, focused on the fact that the economy won't be healthy without a sound financial system. That's true, but there won't be a sound financial system without a healthy economy. Right now, the economy is getting mushier and mushier. Almost all the federal money spent on economic measures has been devoted to the financial markets' problems. But things there aren't getting much better. Although the credit crunch for banks seems to be easing, that's not doing the rest of the world much good because the banks are deleveraging and cutting back on lending. A bunch of healthy banks who lend to each other because they're all backstopped by the government aren't, from a societal standpoint, terribly useful. They should get taxpayer money only if they do the taxpayers some good. And the damndest thing is that many bank stocks fell last week along with Citigroup's stock. So, for all we know, more banks will soon be looking for another bailout. Meanwhile, the federal government is doing little for the rest of the economy.

So, do we have a market bottom? It's hard to say yes. Right now, the stock market is all government, all the time. It goes up when there's positive news from the government (e.g., the expected appointment of Timothy Geithner as Treasury Secretary). Otherwise, it goes down as more bad economic news rolls out. This is troubling, since the government cannot ultimately prop up the stock market. Only a healthy economy can do that. The 6% jump in the last hour of trading on Friday is symptomatic of a market that still harbors false hopes, that the appointment of any particular individual will save the day. There is no messiah for the economic crisis. And as long as investors look for an easy way out--a single individual or a single government proposal to make all the boo boos go away--stock valuations will probably be unrealistically high and further market drops will be likely. Be cautious about putting money into the market now. You aren't necessarily making a mistake, but be sure that you invest only money you won't need for a long time.