Having received 62.5 million votes, Barack Obama has earned a spectacular personal victory and a clear mandate to bring some form of change to the United States. Obama’s decisive and masterly election campaign, where he first had to outmaneuver the formidable Clinton machine, may bode well for his ability to implement a government response of unprecedented magnitude. Time will tell if this is a blessing or a curse.
In the short term, markets may likely rally on the grounds that election uncertainty is over and that Obama and a Democratic Congress may institute massive infrastructure spending along the lines of Roosevelt’s New Deal. The larger question for investors will be whether Government spending will make any difference to long term performance, or whether the markets are already locked into a downward spiral that no amount of pump priming can counteract?
There is increasing evidence that the severe recession or depression that we have long forecast is now becoming reality. One has only to look inside local shopping malls to see the physical effect of a visible loss of consumer confidence. Once confidence is lost, it is exponentially more difficult to regain.
To avoid a deep recession, as the government now hopes to do, massive intervention would have been required – months ago. But, in the absence of extraordinary political cooperation with the sitting President, we can assume no significant changes in policy until Obama takes office in late January. When new programs do come, the big question will be size.
The outgoing Bush Administration, which is responsible for creating the vast asset booms, has thus far provided only $172 billion in a stimulus package and some $700 billion in authorized asset purchases, mainly to bailout Wall Street. Historically, these are large numbers, but today they are dwarfed by losses already suffered by real estate and stock investors.
Losses incurred on the $14 trillion U.S. mortgage market will be significant, and we can expect government initiatives to try to replace these vanished assets. Of course, not all of these mortgages will go bad. But with rising corporate and individual bankruptcies and increasing unemployment, an increasingly large number will default.
Almost $5 trillion of these mortgages were ‘sliced and diced’ into the now notorious mortgage-backed securities. Despite their ‘toxic waste’ content, these so-called ‘securities’ were sold to conservative investors, including U.S.-based pension funds, the solvency of which will be a major issue for the Obama Administration.
But the losses don’t end with the mortgage market. As we had forecast, state governments and corporate America, including insurance, credit cards and auto companies, have arrived in Washington, hat in hand, asking for taxpayer money. Looming rapidly into sight is the more than $20 trillion of private sector corporate and consumer debt. As is reflected in widening credit spreads and the threatened bankruptcy of national business icons such as GM and Ford, this debt is also being called increasingly into question.
How many trillions of dollars of Government spending will be necessary to make whole the institutions and individuals swamped by this tide of credit defaults? Is the government prepared to float multi-trillion dollar annual deficits? Apparently so. If such sums are palatable to our creditors, then perhaps the worst can be avoided.
Regardless of government action, we feel that the recession will be both severe and long lasting. The resulting fall in corporate earnings will be reflected in future stock prices. In light of this, we urge investors to be wary of claims that U.S. stocks are cheap.
It is worth remembering that prior to the stock market crash of October of 1929, the Dow had peaked 381 earlier that same year. It was not until some three years later, when severe recession and then depression took hold, that the Dow reached its low of just 42, a fall of some 90 percent from its 1929 highs.
In a historical context, the Dow’s recent fall from 14,164 to some 8,200 (a decline of just over 40%) does not necessarily indicate that stocks are cheap. Today, a 90% fall would bring the Dow down to a level of 1,416!