Eye of the Hurricane

Right now we are in the eye of the hurricane. For weeks we’ve heard economists talk about recovery and green shoots. Nonsense. Note that these economists are the same ones the missed the recession and credit crisis in the forecasts. For me, I need to see two things before I can believe a recovery is on the way.

1. Bad debt must be defaulted on and removed from the system. Mathematically we can not grow from these levels of debt. Denying the true value of assets is only delaying the reality. Japan went through a 20 year period of denial. We are in a deflationary period. Credit is being pulled from the system at a historic rate. We have too many houses, too many cars, too many malls and too many of about anything created via leveraged financing. There is no growth around the corner to absorb the excesses.
2. The criminals must prosecuted. At the height of every bull market, there are individuals who play fast and loose with the law. Boesky and Milken in the 1980s. Bernie Ebbers and the boys at Enron during the dot-com days. There will be no market bottom until you start seeing old rich guys in handcuffs. Everyone knows the financial markets have been riddled with fraud for the past few years. Where are the arrests? The problem with this recession is not only have we not gone after the criminals, but the bailouts have created another wave of fraud. Until investors have their faith restored that laws will be enforced and the accounting is honest, they will not take risks, start companies and hire workers. They will sit on the sidelines.

If you are still long the stock market now, I’d be selling. You got a nice bounce. The boys at the top are selling. From Insiders Exit Shares at the Fastest Pace in Two Years:

Sales by CEOs, directors and senior officers have accelerated to the highest level since June 2007, two months before credit markets froze, as the S&P 500 rebounded from its 12-year low in March. The increase is making investors more skittish because executives presumably have the best information about their companies prospects.

The captains of industry are telling you recovery is on the way, while they sell their stock to you. P/E ratios are now insanely high. The rally we have experienced is common in bear markets. The bounce between hope and fear is human nature.

I stand by my 2009 Financial Predictions. Even though I was too optimistic on unemployment, I think everything else still has a decent chance of playing out this year.