Oh what a difference two weeks can make!

Well, since my last post, we have seen the beginnings of what I have expounded to date. We have seen the DOW fall from roughly 11k to 8500 as of today. The DJIA is down a full 40% from it's highs exactly one year ago today of roughly 14150. A historical analysis of secular bear markets indicates that we usually see a drop from market highs of 30-50%, dependent upon various economic conditions. Given the fact that we're as close to a "perfect storm" of economic stressors as we can get without entering into a bonafide depression, I'd say we have farther to go before we see a market bottom. We're already at 40%, 50% would put us closer to DOW 7000. Only time will tell how low we will go. Secular bear markets are also characterized by lower than average PE (Price Earnings) ratios. A historical analysis of PE ratios since market inception indicates an average PE ratio of 12:1. More recent averages over a period of time post inception (the last 25-50 years) show an average PE ratio of 15:1. We're sitting close to 12:1 at this moment at DOW 8500, however, it is important to realize that we're talking a mean or an average here, and in secular bear markets, we usually see the lower side of the historical average, so it is likely we'll see DOW 7000 with PE ratios falling to 10:1 or perhaps even a bit lower.

One thing we've learned over the past two weeks is that the false assumptions made a year ago regarding the nature and extent of the problems we're experiencing are in fact far more widespread than originally expected. It was after all the very same Hank Paulson who uttered in testimony two summers ago now that the subprime mortgage problems would be contained and would not spread to other markets. Surprise! We're now suffering through the largest financial meltdown since the Great Depression itself. Some 59% of Americans, according to CNN polls, believe an economic depression may become a reality. While I am all but certain that we will suffer through a major recession, I remain somewhat optimistic given the failsafe government institutions and extraordinary measures currently being undertaken in an effort to minimize the effects of the global banking crises that we're bearing witness to. Yes folks, this is indeed a global crisis. While we're hearing about how over-leveraged the U.S. investment banks were at 30:1 on average, the European banks on average are leveraged some 50:1. Iceland has nationalized their three largest banks, and the chances of an economic depression seem likely. Overall, while it may be difficult for us to fathom, the European nations are in even worse shape financially than the U.S. banks are, and with the much higher leverage ratios, have much more pain and turmoil to look forward to. The developing nations and emerging economies, especially China and India, are heavily dependent export economies, meaning these export dependent nations primarily depend upon the U.S. and European nations to consume their exports. With the massive and inevitable financial de-leveraging process that the U.S. and European nations must undertake, which will require less lending due to tightening credit markets, export dependent economies will also be hard hit. Look for India and China to continue to experience downward economic pressures. In short, we are quite possibly looking at a global economic recession. As Thomas Friedman expounded in his book The World Is Flat, we are all connected, all of our economic systems are intimately intertwined together. A large failure in any one part of the global economic system cannot be contained, as we thought in the case of the subprime mortgage problems, and therefore by definition such a failure will have widespread effects on the global economic system.

Whatever solutions to the global economic problems we're currently experiencing will be measured in years, not days, weeks, or months. The average secular bear market lasts 17 years. The bull market ended in year 2000. We have seen below average market returns since that time, and the recent market declines take us all the way back to 2003. Chances are we will not see a return to a true bull market until the latter half of the next decade. This means we can expect single digit market returns for a number of years. For those with a 20+ year timeframe from an investment perspective, there's not much to worry about. For those with a five year timeframe, it's time to worry, even ten years out, I'd be concerned based upon historical secular bear market analysis.

Goodnight all! :-)