Asian Suckers' Rally?

Have a look at a chart of the Dow Jones Industrial Average covering the period 1929 to 1933. It took until July 1932--almost three years after the October Wall Street Crash--to reach bottom. To the people living through that time, not only was the slide down into the Great Depression happening in slow motion, to most it was not apparent for a long time that anything particularly serious was happening at all. They knew of course that something was going on: already by the summer of 1929 many people had come around to the view that the economy was heading into a slowdown (and that the stock market was overvalued and due for a sharp fall). But there was an almost universal belief that the Federal Reserve could and would temper any recessionary forces simply by easing the money market (lowering interest rates). By the end of 1929, after the initial panic, the Wall Street Crash was seen only as a more or less inevitable consequence of the undeniable financial excesses of the late twenties, and which this event had swept away. There was to be some contraction, then recovery. The authorities would see to it.

Davidson and Rees-Mogg put it nicely in their book 'The Great Reckoning' (page 375 in the revised 1993 edition). "The economy had already turned down in August 1929. It was many months later, after the crash, after the Suckers' Rally, after a slow year with no recovery, after the banks started to collapse, that people began to realise what had hit them. By then, it was too late."

Japan experienced a similar slow motion collapse from 1990 on. Seven years later, it has not recovered.

Over the last half year, much of East and South East Asia has experienced a financial meltdown every bit as serious as those that began in the United States in 1929 and in Japan right at the end of 1989. This meltdown has proceeded, as usual, in slow motion and with the usual blindness as to its true severity: despite all those current commentators who start off their articles with " The crisis, which began in Thailand on July 2nd when the currency .... " --leaving the reader with the distinct impression that the writer knew back then in early July that a big crisis had started--almost no one thought it very important (at least that is until the Hong Kong stock market crashed in October).

Now, judging by the behaviour of the Asian (and the United States') equity markets, there seems to be a widespread belief that the worst is over in Asia and that the bottom is in. This flies in the face of all historical precedent. And in the face of common sense. I think our cognitive tendency to compress historical time scales, as pointed out by the history professor I referred to above, is distorting many investors' perception of the speed at which such economic processes unfold. A working hypothesis that the bottom will be in 2000 looks much more sensible to me, until and unless I see some solid evidence otherwise.

EXTERNAL LINK Chronology of the Asian Crisis [New York University].

A Suckers' Rally, such as that of Wall Street in 1930, is quite easy to understand:-

Phase 1: Beneath the surface and invisible to all but the most astute of observers, severe economic or financial strains have built up. A huge mismatch between perception and reality has developed.

Phase 2: The initial crash. Something happens that triggers a sharp break: there is a stock market crash and perhaps a currency crisis. During this event the huge and rapid sell-off of financial assets is not by investors and asset managers who are redoing their calculations and assigning new, lower, values to financial assets on the basis of their new understanding: the fact is nobody has the foggiest notion at this point of where the economy, the market, or individual companies are going to be down the road. Selling is totally defensive (and those few buyers who come in at this point are gamblers).

Phase 3: Stabilisation. Panic selling slows and then stops. Market volatility declines.

Phase 4: The Rally. Because markets are no longer falling, there is a natural tendency to believe and hope that the worst is over and the bottom is in. Investors and asset managers begin to add up the damage: a bankruptcy here, a liquidation there. Its been nasty while it lasted, but the damage overall doesn't look too bad. Out come the pocket calculators and the spreadsheets ... this here will knock a half percent or so off growth, this much off profits ... alright, that is not so bad so there are some real bargains to be had at these sharply lower stock prices ... lets buy! So the markets start to go up again.

Phase 5: But there is a problem. Most people are focussed solely on the crash itself. They do not understand or accept that this was largely a manifestation of some more fundamental, underlying economic or financial weakness which is still there. And that the consequences of this weakness and of the crash will manifest themselves in perverse, counter intuitive, and largely unpredictable ways that will take years to work through the economy. Most of the real, direct economic fallout is yet to come. As this fallout actually arrives, a much more direct correlation between the steadily emerging bad news and falling markets develops. Phase 5 is typically characterised by a long, grinding bear market in stocks, lasting several years.

Phase 6: Renewal and recovery.

This sequence of events of course did not happen in the United States following the 1987 crash. Then, a recovery occurred within a matter of months. This fact is being used by some analysts as a precedent that supports a similarly rapid recovery today. But the sheer scale of the equity and currency collapses in Asia dwarfs the (relative) size of the events of 1987. I am unable to accept that there is any parallel to be drawn.

I believe that what we are witnessing right now in Hong Kong and other Asian markets is probably nothing but a Suckers' Rally. The ultimate real direct effects of the crisis on businesses and the economy will become apparent only over a period of many months to years with, as my early guesstimate, the nadir being reached in 2000. And I continue to believe that Japan is probably going to be affected very severely and will slide into a bad recession or possibly a depression.

I also believe that North America is much more vulnerable than many imagine. Again, the fact that there has been little visible effect so far is almost entirely irrelevant. The direct economic impact is going to take time to be felt. I do not expect anything very significant to appear in the data for 1Quarter98. Or even perhaps in 2Quarter98. But by the end of 1998 we should have a pretty good idea of where things are going. Watch for the start of a stream of corporate profit revisions - and for banks and other financial institutions to start booking losses on their Asian exposure.

CANUCKS' CORNER: The Canadian Federal Budget

EXTERNAL LINK 1998 Federal Budget [Doane Raymond assessment]

The rot began with the election of Pierre Elliot Trudeau in 1968. The Trudeau government began and rapidly ramped up ruinous tax and spend policies that have been continued and worsened by every successive Federal government--Liberal and Progressive-Conservative alike--and by most Provincial governments too. The Federal debt alone is now approaching C$600 billion. As a consequence of this waste of capital, Canada has been in continuous relative decline, steadily sliding down the international league tables until it is now, what, fifteenth or something like that? Then, about five years ago--depending on which data one chooses--we went from relative decline into absolute decline based on living standards. The real average income of Canadians is now decreasing in real terms. This decline is ongoing.

EXTERNAL LINKBeyond A Balanced Budget [Reform Party of Canada: Report]

The Federal deficit has been eliminated by (1) downloading a significant part of it on to Provincial governments (who themselves are partly passing it on to municipalities, and increasing taxes--it is still being spent, wherever it pops up) and, worse, (2) by massive increased taxation and other forms of confiscation (the low dollar being the biggest of the latter).

In other words the "cure" is no better than the disease. It is the waste of productive capital though taxation and government spending that destroys the economy. Canadians are suffering under a still increasing burden of income taxes, payroll taxes, consumption taxes, bracket creep, property taxes, compulsory fees, user fees, hidden government subsidies in the price of basic foodstuffs such as milk and poultry, compliance costs . . . and of course the lousy dollar.

In its recent Budget, the Canadian Federal Government made it crystal clear that it has no intention whatsoever of decreasing its spending. Federal spending was increased! It also signalled that it has no intention to begin any meaningful paydown of the debt. They are going to put aside a mere C$3 billion per Fiscal Year for this (200 year debt reduction plan?). That is an insult to anyone's intelligence: and a kick in the groin to taxpayers.

And taxes will continue to go up for the foreseeable future.

Canada is and remains a deeply socialist nation crippled by irresponsible tax and spend governments. The Prime Minister and Finance Minister are long on rhetoric, but their policies will continue to destroy the nation's economy.

The Forex markets behaved in line with this assessment. Their reaction to the first balanced Federal Budget in 30 years was a big yawn. I continue to expect no noticeable strengthening in the dollar for the immediate future: indeed interest rates may have to continue to creep up just to hold it near 70 cents US.