``When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see money flowing to those who deal, not in goods, but in favors – when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.” Ayn Rand, Atlas Shrugged
Most of us would like to know when this crisis might come to a close. Most of us would also like to know when life might ‘normalize’.
Of course, life, as we know it, won’t likely be the same or “normalize” as it had been during the past decade.
We are likely to live in a world which will be governed by more regulations, higher interest rates, lower leverage, higher taxes, possibly diminished ‘globalization’ in terms of trade, and capital flows and reduced political freedom especially seen through the lens of the once liberal Anglo-Saxon world, as discussed earlier in 2009: Asian Markets Could OUTPERFORM.
Yet even as they undergo rehabilitation, we can’t discount the reemergence of bubbles through other asset classes and the reorientation of the conduct of the world’s political economy. Remember, bubble cycles are the inherent character of our paper money system.
Historical Roadmap
Moreover, while history may not exactly repeat, the lessons of the past may provide us with some essential clues or may function as some sort of a roadmap to help guide us in navigating our way through the present financial crisis.
As we have discussed in Will Previous Crisis Serve As Deserving Guidepost For Today’s Crisis?, Harvard Professor and former IMF chief economist Kenneth Rogoff and Carmen Reinhart recently updated a study of the previous world crises, see figure 1.
Figure 1 Rogoff-Reinhart: Learning From The World’s Past Real Estate-Banking Crises
In the Rogoff-Reinhart paper, the ‘Aftermath of the Crisis’, we are treated to 18 major post war banking-real estate crises of advanced economies including some of the recent emerging markets crises and its consequent impact to domestic real estate and the equity market in terms of pricing based losses and the periods of agonizing adjustments (peak-to-trough).
We can observe that the typical or average housing cycle (right window) losses of real housing prices have been 35.5% and has lasted an average of 6 years. As you may notice, the Philippines, in the wake of the Asian Crisis in 1997, suffered the second biggest loss of 50% after Hong Kong, and where our painstaking market cleansing cycle culminated after 6 long years. It is also important to note that the longest real estate bear market cycle was recorded in Japan and which registered over 15 years of losses.
Next, equity losses averaged 55.9% which lasted for about 3.4 years.
In addition, a defining characteristic of such crises is that the real public debt exploded as governments suffer from falling tax revenues and increased spending to fight off recession. On the average, real public debts ballooned by 86%.
Applying Past Lessons Today
So where are we today?
If we are to base our analysis on the epicenter of today’s crisis which is the US, then housing prices based on the Case-Shiller index has lost 30% (see figure 2, left window), and is almost near the average loss of 35% during similar crises. Peaking in 2005, the housing bear market is now on its 4th year which is also approaching the average of 6 years.
In terms of the bear market cycle in equities, the major US bellwether as signified by the S&P 500 has lost over 50% and is now 16 months old or 1.3 years. Compared to the average of 3.4 years, the equity bear market cycle suggests of a transition for about two years more.
So simplistically speaking 2011 should be a turning point for the US real estate and US equities…if we are to base it on the average.
But as our earlier caveat, all crises aren’t the same.
Further, the average alludes to the typical. Since today’s landscape is global in scope compared against a regional or national phenomenon in the past, it is likely that the disposition of today’s crisis will be distinct.
Besides, the collective global government response has been unprecedented in scale. Importantly, today’s crisis jolts the foundations of the world’s monetary architecture. Hence, today’s crisis may not be the archetype.
What seems to be relevant is that the US government has been implementing almost similar policy responses as with Japan in the 1990s following its bubble bust.
The Keynesian approach of Zero Interest Rate, government infrastructure spending, tax cuts and rebates and monetary manipulations via the purchase of commercial paper, shares of public companies and provision of bailout funds for bailouts only resulted to a prolonged era of distress from which Japan’s real estate fell by over 15 years (see right window) and whose stock market went nowhere from 1990s until today.
Just recently, Japan’s key benchmark, the Nikkei 225 crashed below its support level shaped during the trough of 2003 to register a NEW low. The Nikkei which presently drifts near the 2003 lows reflects a loss of over 80% from the peak in 1990, nearly 20 years ago!
Of course some may argue that the rapid fire response by the US government may do the magic trick. Well, for us, the fundamental defiance of nature’s economic laws will either bring short term panacea with long lasting torment similar to Japan or precipitate another set of collapse.
Conclusion
Nonetheless, in our opinion, the US won’t probably see a bullmarket for years to come, even if the economy manages to emerge out of the recession. The indemnity from the recent crisis will be scathingly enormous and will contribute heftily to the suboptimal growth outlook. Besides, the intensity of government interventions seems likely to create substantial inefficiencies in the economy that should weigh on its productivity. Moreover, the US will have to deal with its ballooning unfunded entitlement liabilities.
Remember, it took almost 25 years for the Dow Jones Industrial to breach its 1929 peak. In the same vein, US benchmarks haven’t successfully broken through the dot.com pinnacle set in 2000, which makes today’s bear market nearly 10 years old! Hence it is likely that the US could be rangebound or muddle through over the next few years or even in the next decade.
Of course, we’d argue otherwise that if the Obama-Bernanke tandem prints an ocean of money similar to Dr. Gideon Gono’s policy approach in Zimbabwe. While this may boost share prices, not out of earnings, but because people may shun the destruction of its currency and seek sanctuary in hard assets or in stocks as ‘stores of values’, the net effect is that any nominal gains will be offset by currency losses.
Thus, the lesson we can get from the Rogoff-Reinhart study may possibly apply NOT to the US or the credit bubble infected economies. But as possible beacon to the performances of economies or markets untainted by the credit bubble structure but had been affected by the contagion from the implosion of the proximate epicenters of the bubbles.
While 2008 had been a year of convergence as we discussed in Will “Divergences” Be A Theme for 2009?, we’d probably see the resurrection of an unpopular discarded theory.
