When even Jim Cramer is somber about the market, things can’t be good. In a post published today, Mr. Cramer outlines what he thinks “Armageddon” would look like, should it come to pass:
Throw in the towel and buy lower and later if you think the worst is coming. Or stay the course. At this point, the choice is yours, and I don’t want to make it for you. I did it last time and didn’t get much credit for it, even though I was right, and even that is being disputed, although I don’t know how that can be. I tire of criticism, so let me lay it out. You decide whether you want the pain.
Here’s the worst-case scenario:
1. Greece defaults. Presumably that reveals all of the credit default weaknesses where banks and insurers, chiefly in Europe, go belly-up. So do Portugal and Ireland. Spain, too. We get a Latin American moment where huge amounts of debts are canceled and reissued in the form of bonds that nobody wants, but at least the hit is taken.
2. The hit wipes out a huge number of foreign banks which, we discover, had insured the government paper and the bank paper that went under. We have the equivalent of Lehman, Bear, AIG, Fannie, Freddie. Washington Mutual and Wachovia. Throw in a Citigroup(C_). These banks are closed or merged by the surviving countries’ financial institutions.
3. Huge layoffs occur, and Europe is thrown into a great recession. Companies with decent balance sheets that have decent yields become accidental high-yielders and become attractive, because companies have much better balance sheets than governments do.
4. The recession pulls down the U.S. because of the tie-ins and the collapse of at least two or three banks that have hidden exposure to Europe. We learn about it too late. These banks are merged with healthy banks that raised a lot of capital. But the stocks get hammered close to 2008-2009 lows.
5. Big layoffs happen here because of Europe. Our economy wasn’t growing anyway. We’re sinking under the weight of higher commodity prices and Washington dithering and a president who hasn’t succeeded in creating a lot of jobs.
6. Money goes, again, from risky stocks into higher-yielding companies that weren’t higher yielding that long ago. Safety stocks rally because commodities collapse and their margins widen. This move happens on the way down.
7. New leadership emerges that is basically of the Coca-Cola(KO)-Pepsi(PEP) variety, as all industrials are hammered back to accidental high-yield levels. These stocks, along with the knock-offs and the pharmas, don’t need growth. They are winners.
8. China stops tightening because commodities have collapsed and wage inflation ends. That stems the decline in the likes of Caterpillar(CAT) and United Technologies(UTX).
9. Many companies fall back to their cash levels. .The companies buy back their stock, but they were buying at the highs so it doesn’t matter.
10. People leave the market in droves and stocks go to P/Es of 10 or lower, but it turns out the earnings aren’t there, so the P/Es are actually about 14-15, which is historic norm territory.
11. We get close to a 63% pullback of the entire run of 6000 Dow run. Let’s say we touch 7500 on the Dow. There are bargains galore. No one wants them.
12. We bottom out at levels that aren’t as bad as 2009 but are really bad, and people have had it with the market. We bottom because sellers are exhausted and earnings turn out to be bad but not terrible.
You can read the rest here.
I’m reminded of the generic Jewish telegram:
START WORRYING. DETAILS TO FOLLOW.
7 Comments
Well, who knows. Cramer is not saying that Armageddon is going to happen — he’s just saying that this is what would happen if it occurs. You could make the contrary argument that everybody knows the bad news, and it’s already incorporated into share prices. The way to make prescient predictions is to make a lot of predictions. Some of them are bound to be right. Stock market forecasters exist to make weathermen look accurate. As someone who has been investing for thirty years, the one thing I have learned is that the market will do whatever it needs to do in order to make fools of the greatest number of people.
I hope things work out for George Papandreou, not least because we lived in the same dorm in college. (His roommate later became the opposition leader.) Things do look grim. However, I think there are a few points which are worth making.
First, we’re the best house in a bad neighborhood. Europe is going down the tubes, and Japan has a sclerotic economy and a debt which is close to double their GDP. In the developing world, China, India, and Brazil have runaway inflation. Russia and India have runaway corruption. China and India both have populations expanding at a rate which is very difficult to support economically, and India has a horrible infrastructure. I’m not saying that everything here is hunky dory, but in the aftermath of a global economic collapse, we came out in pretty good shape.
Secondly, while the unemployment rate gets an inordinate amount of attention, it is only one economic metric among many. GDP is at an all time high. In other words, we make more stuff than we have ever made before. However, we’re doing it with seven million fewer workers than in the pre-recession peak. Economists have a word for this: productivity. It’s a good thing. There were a lot of gnashing teeth a few years ago because our corporations were inefficient and couldn’t compete with upstarts in the developing world. (This follows by a few years the teeth which gnashed because Japan was going to be eating our lunch forever.) While productivity is a good thing systemically for the economy, for the redundant workers who lost their jobs: not so much.
Third, one of the main reasons why unemployment is so high is the persistent weakness in housing construction, which is labor intensive. We’ve had many years where low interest rates, the homeowner tax deduction, and speculative froth created far more homes than we need. The home building industry won’t recover until the excess inventory is sopped up, which is a multi-year process. There’s not much the government, banks, or anyone else can do about it except wait for Schumpeter’s creative destruction of capitalism to finish destroying.
All of this gets evaluated through a political lens, as the bipolar body politic went from one end in April (which had a pretty good monthly employment gain of 250,000 private sector jobs) to the other end in May (when we had a dismal jobs number). Whether you think the administration’s economic plan is good or bad, the fact remains that its ability to control economic forces is constrained both by political opposition and the simple fact that most of these forces are beyond the power of the state to alter. The proximate cause of Cramer’s putative Armageddon is an external shock. Can’t do much about those, just as you can’t do much about a tsunami which shuts down Japanese production and causes Toyota workers in the US to be laid off. Increasing productivity is a competitive necessity but also a double edged sword. The housing bubble, like all speculative excess, takes time to reach bottom and even longer to go from lower left to upper right. The President and the Fed Chairman are like drivers of a car with really bad steering. You can sort of make it where you want it to go, but that’s about it.
To quote from the book of Saint James: the future’s uncertain, and the end is always near. But I prefer the advice of Saint Thomas (Lehrer): ignore all this and just slide down the razor blade of life.
Yes, Europe is in big trouble, as its unsustainable social-welfare chickens come home to roost. (Note to US: we may not be the “best house in a bad neighborhood” much longer, if we can’t get our own social-entitlement spending and sovereign debt under control. If oil suppliers should stop setting prices in dollars, for example, things will get very bad here very fast.)
Another reason jobs are down: businesses aren’t hiring. Why? Because they can’t form a reliable estimate of their future regulatory burden. (And of course there are all those ATMs.)
I didn’t know you roomed with Papanadreou in college!
He wasn’t my roommate – he lived in the floor above me.
You may have met him when you came to visit. As you recall, you had never met another Malcolm in your life before visiting me at Amherst, when you met two Malcolms in the same day.
I think you have the social welfare argument half right. Europe is not teetering because countries like France and Germany have generous social welfare programs. These countries like their safety net and are willing to tax themselves to pay for it. Also, the German economy, for one, is firing on all cylinders. The core of the problem is that with a single currency, both public and private capital flowed at low rates to countries like Greece, which not only has a corpulent public sector but also doesn’t really make anything. If Greece had the drachma, their borrowing costs would have been commensurate with the weakness of their economy, but because they are a euro country, they could borrow at rates which did not reflect their profligacy.
I don’t buy the argument that businesses don’t hire because of regulatory uncertainty. It’s a weak excuse: when do you ever have certainty in business? Moreover, the Clinton administration had a very muscular regulatory environment, and the economy flourished. It’s axiomatic to say that we should have more good regulation and less bad regulation. It’s equally axiomatic that business will invariably oppose regulation, because it restricts their sphere of action, while the things which benefit from regulation — whether it is clean water, toy safety, or preventing oil spills — have different constituencies, which typically lack the lobbying resources and political leverage of big corporations.
Well, I didn’t expect you to buy that argument, even though the burden is far worse than it’s ever been. The point is that businesses are buying it; if you listen to business leaders themselves, they’ll tell you that this is what is scaring them off.
You’re mostly right about the European welfare states. When they were homogeneous societies, with high social cohesion, and each with its own currency, this crisis wouldn’t have happened.
I have my doubts about the SBA report, and not only because I don’t know how you can quantify the cost of regulation. However, it’s worth noting two things.
First, even if the authors’ thesis is valid, you can’t blame it on His Awesomeness. Their data stop at 2008.
Also, how is it that during the Bush administration – which took a blade to regulation which would make Occam jealous – that the cost of regulation increased?
The point here isn’t Obama vs. Bush — Lord knows Bush wasn’t much of a conservative in any practical sense, and Lord knows Obama is no friend of business — but why we’re drowning.