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THE MESSAGE OF THIS ELECTION Do you think that the stock market is doing badly this year? It may be even worse than you think, on the “curve,” which I will describe shortly. By one measure, at least, this is the worst market since the Great Depression--which is why it might be signaling the next one. The “curve” arises from the fact that 2008 is a year in which a Presidential election takes place in the United States. The stock market almost goes up in such a year, because the incumbent Administration usually pumps up the economy to help elect its candidate in the fall. The most recent exception to this rule took place in 2000 (foreshadowing the current one). The time prior to that was 1960, when the defeat of then-Vice President Richard M. Nixon inspired economists in both parties to later manage the economy with an eye to re-election. All other election years since the 1940s have seen rises in the stock market indexes. My (2004) book, “A Modern Approach to Graham and Dodd Investing,” opined that the bear market of 2000-2002 was a “dress rehearsal for something far worse in 2004-2006,” because of the U.S. economy’s flimsy foundations (as discussed below). Right idea perhaps, wrong starting (election) year; I now amend “2004-2006” to read “2008-2010.” And 2008, at least, has started off “far worse” than 2000. Why a three year slump? A useful analogy might come from tennis, where having the serve is a major advantage. (Players share this advantage by alternating serves.) In the U.S. stock market, the bulls have “the serve” in the two years before an election like 2007-2008, while the bears have “the serve” in the two years after an election year, 2009-2010. If one wins against the odds when the opponent has the serve, that is known as “breaking serve.” The bears are “breaking serve” (of the bulls), and in a big way, in 2008. And while the bulls “held serve” in 2007, last year’s paltry gain was a narrow victory for them; something akin to winning in the “ad-deuce” (overtime) phase of the game, after an earlier tie. Logically, it follows that the bears will likely have their way even more in 2009 and 2010 when they have “the serve.” (Likewise a “set” in tennis is often decided by three consecutive won games; a “service break” sandwiched between two “service holds.”) It might be 2011, the bulls’ next “service year,” before we see another annual up market. So how does the current election-year stock fall stack up against the previous ones? Besides exceeding the two already mentioned, it is worse than the two drops of 1940 and 1948. One has to go back to 1932, the worst Presidential election year on record, to find a steeper decline. And this year’s “worse than 1940” means “worse than the first full year of World War II.” Can the U.S. market recover in the last quarter of the year? At this point, the election-year dynamic that ordinarily would earlier have helped the market will hurt it. That’s particularly true given the certain change of Administrations, and likely change of the Administration’s political affiliation in November. (Although a Republican, I believe Barack Obama had his (John F) “Kennedy moment” in the first debate, at least holding his own with the longer-serving John McCain, canceling out the latter’s experience advantage.) Changing political parties (as in 2000), tends to create uncertainty, thereby depressing the stock market, especially in the last quarter of the year. Can the Depression that the market is signaling be avoided? For once, members of the Federal government, both Democrats and Republicans, are alert to this possibility, and doing their best to stave it off. A completed bailout package certainly would have been a step in the right direction. And there are sufficient safety nets in place, and sufficient other means by which the government can use to prevent the worst ravages of the 1930s; unemployed city folk that have no better recourse than soup lines, and displaced farm workers heading off to places like California in order to look for jobs harvesting Grapes of Wrath, both literally and figuratively. But in the longer run, the government may be unable to prevent a Depression per my definition in a previous article--a two-decade pullback (to 1980s levels) of the U.S. and possibly global standard of living. (This would parallel the two-decade pullback to the 1910s in the 1930s.) For instance, U.S. GDP growth in the new century has kept pace with its 3% historical average. But according to my reading of some statistics put out by John Mauldin, 2000s decade GDP growth would have averaged only 1% without the spending allowed by mortgage equity withdrawals tied to the housing bubble. These withdrawals, courtesy of home equity loans (HELOCs), have now come to a screeching halt, and must be in fact repaid; pushing likely GDP growth below its “true” trendline of 1% for some years. The dirty secret of the recent housing bubble is that it was used to prop up this decade’s growth—at the expense of the next decade’s. That’s why it was considered a good thing by most (with the exception of yours truly and many readers of this site), until it wasn’t. And assuming that they don’t fall, recent incomes would have supported only a 1980s standard of living, without HELOC and other borrowing. Absent such borrowing, living standards may have to regress to that level or lower. If the 1930s is any guide, the country will spend the better part of a decade in a “workout” mode before being able to re-start with more or less a clean slate. What would be required for the next secular bull market? Probably at least two back-to-back up Presidential election years, that would signal the progression, and finally the end of the “workout.” These couldn’t occur until 2012 and 2016 at the earliest, which is why we won’t see the next bull market until at least 2017. Putting aside the 1930s, which few remember, the experience from 2000 to that time will resemble the decade-and-half bear market from the late 1960s to the early 1980s, which many people living today have gone through. We’re actually about half way through the secular bear market of 2000-2016. This realization may make the second half easier to bear, although the remainder may be even less pleasant.
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