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The DOW A Year From Now

By Denver Research Group

November 11, 2008 "DSG" -- Saturday, October 11, 2008

When will the crisis end?

"Wild" understates the last two weeks of US and global stock movements. Friday, the DOW swung 1,000 points before closing at 8,451, down 128 points. Tokyo's Nikkei lost 9.6% and other Asian and South Pacific markets lost similar amounts. Today, global stocks are making up those losses after the G7 and Eruopean leaders took coordinated action to loosen credit that met at least the minimum standards required by stock traders.

Many analysts watching the US DOW are suggesting the floor appears to be roughly 8,000 (the International Monetary Fund said markets will fall further). The Global Power Barometer (GPB) predicted in March that the DOW would fall to the low 8,000 range in "the waning days of the Bush Administration."

But the real question is not how low the DOW will go in the next month, but where will it be in a year when the dust of the global credit crisis settles.

That obviously depends on the actions of a new US Administration. Right now, the wild swings are due primarily to a horrible market psychology. But it is possible to generally bound the October 2009 DOW.

Let's start with some assumptions. First, let's assume governments solve the credit crisis...albeit with new restrictions such as larger down payments for home mortgages and a lowering of credit card limits.

Second, let's assume the US follows the pattern of the last 8 years in which real median income for working age families continues to decline or stays flat and income disparity between the bottom 99% of Americans and the top 1% remains at levels which, according to the Economic Policy Institute, have not been seen since the late 1920?s. It's a reasonable assumption since neither party nor Presidential candidate have proposed programs that would raise the economic success of the vast majority of Americans.

If these assumptions hold through the first few months of the next Administration, here's what will happen:

  • Housing prices will likely fall to around 130 on Standard & Poor's Case-Shiller Index (their 20-city composite was at 166 in the July), a level not seen since early 2002...meaning average housing values would fall another 15-20%.

  • Consumer spending likely will decline and spending on non-essential items will plummet. According to the Federal Reserve, 2nd Quarter consumer credit dropped by a whopping 3.75% in August (before the crash) with a 5.4% drop in the category that includes car loans and a 0.8% drop in the credit card category. This is the first time in a decade that has happened and economists worry that consumer spending will follow and actually decline in the 3rd Quarter, the first time that's happened since 1991. None of this portends a good Holiday shopping season, which would be a significant blow to the 2009 economy.

  • Consumer confidence won't turn around (Gallup presently has it at 2% positive and 83% negative). And following consumer pessimism, spending won't increase.

Offsetting these negatives of course is the decline in oil prices and the fact that US productivity is high...corporate profits in the non-financial services sectors have yet to crash. Indeed, IBM reported profits Friday exceeding estimates (its stock still fell 1.4% on Friday).

So what does this say for the DOW in October 2009?

Without new dollars flowing on a consistent basis to middle class consumers, many analysts believe the DOW would necessarily fall below the level of the post, post 9/11 crash of 2002 (8,000)...most likely to the range of 6,500-7,000. That's because even with the trauma of 9/11, baby boomers were still in their investing prime and increasing home prices were offsetting lost stock prices. Additionally, at the time, US leadership was still perceived as strong. There may have been uncertainty of outcome, but there was not uncertainty of purpose. Consumer Confidence as measured by the University of Michigan's Index of Consumer Sentiment was still in the 90?s (as opposed to 59.8 in the last pre-financial crisis month).

Not a very rosy outlook for the future.

So, let's change assumptions: 1) We'll still assume the credit crisis is solved (though credit will be tighter for years to come); 2) but let's assume the new President does what he absolutely must do and shortly after November 4 (preferably the next morning) takes command of the economy and announces new policies designed to dramatically increase good paying jobs for the middle class (we suggested in our last Observation an infrastructure revitalization program that would accomplish this); 3) let's assume the new President announces quickly his economic team...a mix of well known old hands not associated with Republican trickle-down economics or the last 8 years of Republican rule, and younger people with new ideas for managing a 21st Century economy; 4) let's assume the new President immediately after inauguration begins executing earlier announced policy initiatives (perhaps one per week for several months) designed again to get money into middle class hands quickly; and finally, 5) let's assume the new President and Congress enact in the first 6 months of his term a series of tough regulatory programs that prevent future credit crises and raise middle class opportunities to reduce their income disparity with the top 1-2%.

How much would have to be spent to revitalize consumers? At least $1 trillion (to start) and not in the form of one time, ineffective stimulus packages (the last one flopped completely) but in the form of programs that produce jobs perceived as stable.  New Jersey Governor John Corzine in his Sunday appearance on NBC's Meet the Press supported the need for massive jobs creation.

Understand this won't bring the DOW back to 14,000...demographics, markets and the psychology of boomers in their later stages of life just won't allow it. But here's how these alternative assumptions would change the DOW dynamic:

  • They would put money in the pockets of consumers who would actually spend it, dramatically improving the fundamentals of the US and global economies;
  • They would raise confidence in both the economic system and the future of the economy. Looking back at the period after World War II, it was a much more regulated period but it was a more economically stable period in which people felt secure in the future of their jobs. That allowed people to plan their lives, spend without worrying their jobs could disappear the next day, and save for retirement. That stability and security began to disappear in the Reagan years and was completely gone by 1990. Presently, many analysts believe the remaining members of the Greatest Generation and many boomers may never come back into the market, depressing long-term demand for stocks. But only stability of middle class jobs and income, and confidence in the future of markets will bring anyone back.
  • They would restore confidence in America's leadership. The current crisis could not have come at a worse time, when no one believes in the current leadership and negative campaign politics have prevented either Presidential candidate from presenting a clear path forward (even if they happen to have one).

What would these assumptions mean for the DOW. As we said, not 14,000...fundamentals just do not justify it and October 2009 is too soon for a broad based program of returning income stability to the middle class to take hold.  However, fixing fundamental problems and electing a new President who can motivate and instill confidence should do wonders for increasing critical consumer optimism.

That in turn could allow the market, at least based on the fundamentals rather than smoke and mirrors, to recover to roughly the 10-11,000 range, which is where many believe it should have been all along

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