Climbing A Wall of Worry?

Traders in the financial markets hav a whole series of aphorisms much like people who work in any other trade. Like those of other trades, these aphorisms are based on years of experience passed down over the generations. For example, there is "Sell in May and Go Away, come back again on St Ledger Day." This could be taken as being like the Banking aphorism known as the 3-6-3 rule, borrow at 3%, lend at 6% and be on the golf course by 3 o'clock. That is it could simpy be advice to go on holiday for several months during the Summer. In fact, its not. Stock market records going back over 100 years show that if, in fact you did, sell your shares at the beginning of May, and came back after St. Ledger day, and began buying again you would on average have made 30% more than if you had held your shares throughout that period.

In America, they have an aphorism that as the first week in January goes so goes January, and as January goes, so goes the Year. There are other similar seasonal aphorisms, for example, they talk about a Santa Claus Rally, as stocks often rise in the run up to Xmas and New Year. There are similar predictions of performance based on the coming to Ofice of a new President and so on.

One of the other aphorisms is of the market "Climbing a Wall of Worry". What this means is that before the Market can begin to engage in a sustained recovery from prolonged declines it has to be able to encounter a whole series of bad news without selling off disastrously. It is a symptom of the psychology of the market that when it is entering period of sustained declines - a Bear Market - then any piece of bad news, or even news that can be interpreted badly, or is just not as good as it could have been, is used by traders and investors as an excuse to sell on the esxpectation that things will get worse. Conversely, there comes a point when that psychology goes into reverse. Everyone has already thought the worst, sold up, priced shares as though the end of the world is coming, and so when things turn out not so bad a few brave souls dip their toes into the water, and buy.

In fact, the most succesful investors over the years have probably been those known as Contrarians, those who do the opposite of what the majority are doing. So when the world and his dog were buying shares, particularly technology shares in 2000, the contrarians, were selling, even if they had bought in the first place. Warren Buffett never bought technology shares to begin with saying he didn't invest in things he didn't understand. Conversely, the Contrarian buys, precisely at that point when everyone else has sold when they feel they will never buy shares ever again. In the 1930's people like Sir John Templeton made their fortunes precisely by buying a wide range of very cheap shares.

The point? Yesterday, the US announced the worst increase in unemployment since 1974, an increase of more than 1/2 million. It came on the back of a whole series of bad news. If there was something for investors o worry about, it was the string of bad news that had hit the markets over the last week or so. Yet, the DOW Jones index rose more than 200 points. The broader based S&P 500 rose also more than 2%, and the technology and energy heavy NASDAQ rose by a similar amount. Is this an indication that indeed, the market is climbing a wall of worry? Possibly. The market has been extremely volatile in recent weeks moving down several hundred points, then up several hundred points often within the space of a single trading session. That is often a sign that a bottom is being formed in the market as traders and investors jostle over whether prices can move lower or not.

There are good reasons for believing that it is, though that doesn't mean that there cannot be sudden large dips along the way. What reasons are there. First of all, the market tends to anticipate developments in the economy by around 6 months. Typically, a Credit Crunch lasts for two years. This has been the Mother of all Credit Crunches so it is risky to anticipate its demise will occur on cue. But, it began in the Summer of 2007, and that means it should begin to unwind by the Summer of 2009 i.e. in a round 6 months time. There are some signs that that is beginning to happen not unrelated to the unprecented intervention of the capitalist State throughout the world economy in increasing liquidity, in recapitalising the banks, in underwriting risk and so on. It is slow, but there are signs that it is beginning to happen. Rising share prices will help that as it strengthens Bank Balance Sheets itself, and begins to create a climate of greater confidence, necessary for banks to begin lending to each other again.

It is almost exclusively the Credit Crunch which has been responsible for trhe economic slowdown. It was inevitable that economies like the US and UK with huge debt overhangs would have to slow down in order to achieve the necessary rebalancing of the world economy between these huge debtor nations, and the rapidly growing creditor nations in Asia, and the Middle East, but it is the Credit Crunch which has sharpened that necessary adjustment intensely. The unwinding of the Credit Crunch will have a marked effect on economic recovery. In a world economy which is till likely to be growing at around 4% - way above the 2.5% required for a global recession - and where the world's fourth largest economy - China - is projected to grow by 10% next year, any such recovery is likely to quickly spread.

Moreover, Capitalist governments throughout the world are engaging in huge Keynesian demand management programmes to stimulate economic growth. In the US, Obama is promising, am economic stimulus package that could be up to 1 trillion dollars, focussed on infrastructure projects. Last week a group of technical specialists said that such a programme could create millions of new jobs within months, because States have the capability to begin work on road and bridge building and repair almost immediately. Obama is giving them an icnentive saying that if they don't use the funds provided quickly they will lose them.

In Britain, the measures of the Pre-Budget Statement have been largely misunderstood. There has been a focus on the 2.5% VAT cut as though the intention were to encourage people to buy this or that item. The idea is that in ocnsumer's overall spending they will have 2.5% more to spend. If you spend £10,000 in a year you will have £250 more to spend than you otherwise would have had. Its also likely that Brown is keeping some powder dry in order to encourage a more unified fiscal package throughout the whole of Europe, which itself has announced a fiscal stimulus, but which is so far inadequate, and shows the need even on the basis of Capitalist rationality for a centralised European State with centralised Fiscal and Monetary Power.

A certain stimulus has already been given by the fall in the price of oil and other raw materials. However, as I have said previously these falls have to be treated cautiously. In large part the falls have been the consequecne of forced selling by Hedge Funds, Financial Institutions, and speculators with Long positions. The hedge Funds and Financial Institutions became forced sellers to shore up their cash positions as the Credit Crunch bit deep. The speculators found themselves trying to catch a falling knife as prices careered downhill, and had to rush to get out. Now conversely, doom and gloom about the severity of recession is probably causing those same speculators to sell energy and commodities short forcing prices lower still. I'm not alone in that view. Last week I saw leendary commodities trader Jim Rogers on CNBC making pretty much the same argument.

According to one report I saw recently, the marginal cost of a barrel of oil is around $85. With oil at current prices that means that companies would make a loss on any new production. Capitalists do not produce things to make a loss, and any prolonged weakness in the price will simply result in new ventures being cancelled, and output reduced, forcing prices back up. And as the Financial Times reported a couple of months back the same is likely to be true of other commodity prices. The main demand for those materials comes from China, and its bilateral deals with countries in Africa and Latin America remain in place. In the meantime domestic demand in China is set to increase rapidly.

So, if the Financial markets have been climbing a wall of worry over the last week it could indeed be a sign that the market has bottomed signalling an end to the economic downturn around the middel of next year. Its likely, in the nature of things that that recovery will be patchy. Its unlikely that the US will simply let the big three motor companies simply disappear, for example. Its likely that what is happening is a jockeying for position. The companies will undoubtedly declare Chapter 11 Bankruptcy to gain protection against Creditors, and will use that - which is its purpose - to massively restructure i.e. get rid of thousands of workers, scrap th pension scheme and Health Insurance Scheme etc. - prior to the Government recapitalising them on the basis of producing new greener vehicles, possibly also tied to some joint ventures and investment of foreign Capital. That will not be without its consequences for the rest of the US economy.

But, that is the reality of Capitalism now for workers in the West. They face huge reductions in living standards over a period of years even as their economies grow, because that is required by Capitalism in order to bring about a semblance of equalisation with the Value of labour power in the global market place.