What China Giveth China Taketh Away

On Wednesday the market was up 3% on word that China had a new stimulus package. Today it came out there is no such package and the market went down 4%. Now I am not sure why world markets would react much one way or the other to a China stimulus package, as it is more the victim than the cause, but I think the market was simply looking for an excuse to bounce. Unfortunately the market picked one that did not exist. Oh well, the bounce was doomed to fail eventually in any event.

http://www.nakedcapitalism.com/2009/03/is-chinas-wen-whistling-in-dark.html

Why doomed to fail? Most reading undoubtedly already know the answer but perhaps you will read on out of morbid curiosity. Things still really stink out there on many fronts and not a lot of promising signs of an uptick. Sure maybe a dead cat bounce here and there, but the market is sucking wind. The best we can hope for is that we find a bottom for now and stay in the range where we are for a while.

The good news is that McDonald's has a new item on its dollar menu, a Citigroup stock certificate (okay I heard that one elsewhere). Yes Citigroup traded under a dollar a share briefly today and closed at $1.02. It has gone from a market cap of over a quarter of a trillion dollars all the way down to under $6 billion today. Now that nicely beats AIG, which is now down to under a billion in market cap, but still not promising. AIG, by the way, went from a stock price of well over $70 a share in mid-2007 to 35 cents today. This is what happens when those seeking quick profits rule over risk management.

Here is another factor keeping us down; there are over 8 million homeowners underwater on their mortgages, mostly in California, Florida, Nevada and Arizona. But under the Treasury's baseline stress test model, by the end of 2010, that will increase to 17 million and under the more severe assumptions, 23 million. Yes, nearly a three-fold increase off current levels. Combine that with job losses and figure for yourself where mortgage foreclosures will be going.

http://www.calculatedriskblog.com/2009/03/more-on-negative-equity.html

Wait, before you take your socks off and start the math, let me give you a base from where you can calculate. Let's look at where we stand at the moment:

• The delinquency rate on mortgages for 1-4 unit residential properties is at 7.88%, a record;
• The combined percentage of loans at least a month delinquent and those in foreclosure was well over 11%, another record; and
• 48% (60% in Florida) of subprime ARMs are at least a month delinquent.

Okay, you can start.

http://www.mbaa.org/NewsandMedia/PressCenter/68008.htm

http://www.calculatedriskblog.com/2009/03/report-record-54-million-us-homeowners.html

Here is a non-surprise for you, bankruptcy filings up 31% last year. But for the bankruptcy law changes in 2005 we would likely be off the charts. Then again, Congress is looking to change the bankruptcy laws again to let judges change (cram-down) mortgages, so expect these numbers to rise. By the way, these cram-down features in bankruptcy are not likely to ease mortgage credit any, just the opposite.

http://www.calculatedriskblog.com/2009/03/bankruptcy-filings-up-31-in-2008.html

http://www.bloomberg.com/apps/news?pid=20601087&sid=aoyMWtlsj27A&refer=home

So, you have to be wondering, are we heading for a full-blown depression? The difference between a "d" and a "r" is just the level of pain. We are very close to the "d" level already, especially in certain states. I personally think we are heading for a small "d" but not a big "D." Let us consider where the markets went in the Great Depression. In the Great Depression the Dow drop from peak was 89%. The markets now are down roughly 56%, depending on the market you watch. So we need another 33%.

Mind you, this is not 33% off present levels, this is another 33% off the peak. So what does that mean? The Dow would need to drop to a bit over 1400, from its close today of 6594, the S&P 500 would need to be at around 150, versus its close of 682 today. That is some serious pain, life-changing pain, that I do not think we will face. We have seen the worst of it in my opinion. Sure we can see, and I think will see, a further drop from here. Especially if the government does not start doing the right things we will see a significant drop from here. And unfortunately I continue to be quite disappointed in the government efforts under the new Administration. I don't have a crystal ball so I am not about to give you percentages here, but I do see the overall direction to continue to be down for a while. Even if I am wrong, I do not see a quick recovery even when we do bottom. I agree with those predicting an L shaped recession or depression. If that is correct, I do not have to be right on the short term direction. I do not need to guess the bottom, just wait for it. In an L shaped recession or depression, we will be there for a while and will have time to figure this out and react. So if you agree that we will likely have an L shaped recession or depression, you have a good bit of freedom here to sit and wait for us to hit bottom, which obviously no one can say we have yet.

Why an L shape. Well, if others and I are right that the economy, housing and such, are just returning to where they should be, if I am right that financial institutions will not return to their past profits -ever, if I am right that consumers living off credit from their homes is gone for perhaps a generation, then I think it will be an L shape. We are returning to reality and will be there, hopefully, for a very long time when we get there. Which means what we return to will be where we stay. Look at charts of the Great Depression. It took decades for the market to return to where it did before the crash. Not because the economy did not recover sooner. More because the market was at unsupportable highs before the collapse in 1929, just as it was in 2007. So there is no V in this type of correction. Look at the NASDAQ. It reached an unsupportable high of over 5000 in 2000. Here we are nine years later at about a fourth of that. Part of this is the recession and part of it is the fact that the market was not at a natural, sustainable, level.

I have talked a lot about what I consider our new reality. I will not repeat it here as you can easily check my past articles/posts. The point is that where we were in 2007 is not where we belong, whether you like it or not.

Now let me qualify a bit on the L shaped market. The market will likely overshoot during this recession. So if you assume the Dow needs to go down 65% to reach natural, real, sustainable levels, it may actually go down 70-75% or more. So from the very bottom of this we may see a 10-20% bounce before we level off for a while before what I view as a long slow recovery beyond that. This is what I am seeing. Again, no crystal ball - just looking at the reality of it all.

You may disagree, which is fine. I expect I have one friend who has been following my thoughts more than anyone else for many months and he might comment on how wrong or right I have been to date.

Disclosures: None.