How low can we go: Dow 1500

How is the US going to fund the President-elect Barack Obama’s stimuli plans?

With a projected $1T in economic spending to go along with an announced $300B tax cut, as the 2008 tax revenues are projected to be much lower with capital loss deductions eating into revenue collected.

This number is on top of the estimated $12T Federal Reserve balance sheet in asset swaps. Projections on future swaps have that figure rising to $20T. Crank up the printing presses.

The European Central Bank floated a trial balloon about the possibility of lowering rates due to a reduced threat of inflation. One must assume the treat of inflation for 2009 is almost nil until September at the soonest.

The ECB must see that inflation was nearing less than 1.5 percent, which is much closer to a level where the Euro-zone is sliding toward deflation rather than inflation, since the ECB’s sole mandate is to control inflationary pressures.

Many central banks have interest rates approaching zero, which puts handcuffs on the bankers’ ability to spur growth. With rates at or near zero, liquidity is constrained due a lack of mobility in rates. Lending rates cannot go below zero.

This situation is why you see many unorthodox monetary initiatives instead of traditional measures. The fed buying Fannie Mae and Freddie Mac toxic paper, injecting capital into troubled banks and purchasing corporate bonds are all examples of more dire moves by central banks.

Deflationary pressures will also lengthen the recession, with falling prices making the cost of money far more expensive as well as making existing debt service costs soaring.

Bear-market rallies contingent on a second-half recovery are doomed to fail. Stimuli plans will only keep us from moving into a full-blown depression until 2010. Corporate profits will plummet with fourth-quarter results losing 5 percent to 10 percent year-over-year.

Friday’s employment – or lack thereof – number will be large and disruptive to markets by reaching the 7.1 percent level.

I’ll have more to say on this in Thursday’s post.

Let’s put some prospective into the markets. The Dow Jones industrial average is off 34 percent for 2008 and 38 percent from its October 2007 high, despite its 5.5 percent run up in the closing weeks last year on low volume by market makers doing a little window dressing. The S&P plunged 38 percent in 2008 and 45 percent from its high in 2007.

If you look at these two indices in the context of what the markets did in the last depression it looks like this:

From peak to trough the DJIA fell 89 percent from 1929 highs to 1932. Over those three years the markets had peaks and plunges along the downward trend.

• 1929: DJIA lost 17 percent in final two months.
• 1930: 34 percent
• 1931: 53 percent
• 1932: 23 percent

All losses calculated from pervious year’s close.

If these losses were translated to today’s markets we would have a Dow at around 1500, an S&P at 170 and a NASDAQ hovering at 300.

The biggest misconception from the last 100-year event was that the Federal Reserve was on the sideline for most of the collapse and made the losses even worst with its inactivity. Albeit the fed’s easy monetary policy during the Roaring 20’s was a direct result of the 1929 Crash, but the fed was flooding the market with liquidity in an attempt to jump start a recovery, but made the decision in early ’32 that they could not prop up the economy until sentiment changed and stopped throwing good money after bad.

In the late ‘20s banks flooded the market with cheap money, which was being lent to investors by brokers to the tune of 26 percent or $2.8B of all stock purchases in 1927 were made on margin. In August of 1929 margin equity buys soared to just over $6B. Margin calls created the panic that popped the bubble.

So despite the thought that Federal Reserve chief Ben Bernanke is a scholar of the Great Depression and is doing what his predecessors did not do is a bit disingenuous.

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