Post Crash Dynamics

John Hussman wrote a nice piece on “Post Crash Dynamics,” which is worth reading. Here are some highlights:

When markets crashes are coupled with changes in the fundamentals that supported the preceding bubble – as we observed in the post-1929 market, the gold market of the 1980’s, and the post-1990 Japanese market, and currently observe in the deflation of the recent debt bubble – they typically do not recover quickly. Indeed, the hallmark of these post-crash markets is the very extended sideways adjustment that they experience, generally for many years.

The chart below (please click on above link to view chart) updates the position of the S&P; 500 (red line) in the context of other post-crash bubbles. The horizontal axis is measured in months. Note that very strong and extended interim advances have been part and parcel of similar experiences.

The intent here is not to argue that the U.S. stock market must by necessity follow the same extended adjustment that followed prior burst bubbles. Rather, the intent is to underscore that it is dangerous to infer that structural difficulties have vanished simply because a market enjoys a strong post-crash advance.

I understand the eagerness of investors to put the entire credit crisis behind them and look ahead to a recovery of the prior highs, but these hopes are based on the assumption that a positive boost to GDP, once achieved, will propagate into a full-fledged recovery. Again, however, no economic improvement is evident in the behavior of consumer demand and capital spending, once you adjust for the impact of government spending (particularly transfer payments).

Yes, we have observed a massive reallocation of global resources from savers (who have bought newly issued Treasury debt) toward mismanaged financial institutions that made bad loans. Yes, there are certainly favorable short-run economic numbers that can be achieved by running a year-to-date federal deficit equal to seven percent of the U.S. economy. The problem is that this money does not come from nowhere. We have effectively sold an identical ownership claim on our future production to those individuals and foreign governments who bought the Treasuries. Government “stimulus” is not free money. The continued attempt to bail out bad loans with good resources (largely foreign savings) will end up costing our nation some of our most productive assets, which will be acquired by foreign countries and investors for years to come.

From my perspective, investors have gotten entirely too far ahead of themselves with the assumption of a sustained recovery.

My sentiments exactly. I continue to support the view that this entire rebound rally was stimulus induced and not based on solid economic fundamentals. When that reality eventually sets in, be prepared to head for the exit, because markets tend to go down a lot faster than they go up.

I am not a doomsayer, I merely belief that any stimulus packages take away from a natural future demand in goods and services for the benefit of instant gratification. In other words, let’s not deal with any (economic) pain right now, but kick the can down the road.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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