Market Update - August 18, 2009

Just back in from a great end of summer vacation/baseball tourney in Maui....summer is over for the Herriage household and it's back to school today. During a layover yesterday I noticed that the market was getting hammered. Then, when I ran my research this morning Isaw that it was not only a 180 point down day, but that it happened on 90/10 down to up volume.This big rebound needs a breather--small caps jumped 67% from the 343 close on the Russell-2000 on March 9th....all without a 10% correction along the way.

If you go back in history and chart recoveries out of recessions you will NOT find a single 50% rebound off a recession low in only five months except for the bear market rally in 1930, which was eventually erased with an further 82% drop in 1932.

Since 1950 the average length of time to achieve a 50% rebound is 18 months BUT those figures were only produced with real GDP growth of +4.5% from the bottom, an average of 850,000 jobs added to the economy, corporate profits jumping by more than 12% and bank lending increasing by more than 5%. None of those events has occurred in this rebound.

We're likely to see another big plunge lower for one really big reason--the consumer which makes up70% of GDP is NOT ABLE to spend enough money to fuel meaningful growth in GDP over the next several quarters.

The reason they are 'not able to' as opposed to 'not willing to' is because they are still in debt up to their eyeballs and pinching every penny. The consumer is maxed out, has no credit, and will not have for many years to come....so where is this big economic recovery going to come from?

Eighteen months into a deep recession triggered by a credit bubble and consumers have made little progress shrinking a mountain of debt. Until they do, the economy will struggle to grow... likely for years.

Household debt peaked at $13.9 trillion in 2008, almost double the figure from 2000. Since then consumers have cut up credit cards, refinanced outsized mortgages and slashed spending, but they've barely made a dent with household debt STILL at $13.8 trillion, according to the Federal Reserve.

"We really have a long way to go," says economist James Hamilton of the University of California-San Diego. Until the fourth quarter of last year, American consumers had never reduced their total debt in the post-World War II era. Yet the payback or "deleveraging" since then represents a very small step along a very long road.

Household debt peaked at 133% of disposable income in 2007 vs. 65% in the mid-1980s. To pare it back to a sustainable level, consumers will have to pay off - or walk away from - roughly $5 trillion of the total debt outstanding, says David Rosenberg, chief economist of the investment firm Gluskin Sheff. That's more than China's total economic output.

Some debt will be erased through home foreclosures and credit card defaults. But the remainder must be painfully repaid, by consumers holding expenditures below earnings for years. Already, the savings rate, which fell into negative territory before the financial crisis, has jumped to 6.9%.

That's a big change from the pre-crisis period when consumers fueled a consumption binge by borrowing against the bubble-inflated value of their homes.

But it's not enough.

The twin collapse of the housing and stock markets has destroyed more than $12 trillion in wealth since 2007. And wages now are flat-lining amid the recession even as interest charges continue adding to the debt tab.

So as you can see excessive debt will hold back the economy over the months and years ahead. And the recent government efforts are not helping the problem they are making it worse. The 'Cash for Clunkers' program is taking thousands of Americans from driving paid-for cars they can afford into new cars with auto loans creatingmorebad debt in an unsustainable attempt to revive the auto industry. Folks, we've been down this road before. Reinflating this bubble of ours is not the answer. It didn't work in the 1930's and it won't work now.

In addition, insider trading is not telling us it is time to buy. Last week there was 29 times more insider sales by dollar volume than buys by insiders. These are the people who should know when a company is doing good and when there is trouble ahead. Until that sales trend reverses it may be wise to hold off on those long term bullish bets.

Finally, it still looks like the market wants to make a run at 10,000 (after this short term correction). However, if this doesn't start soon, people will begin focusing on September/ October of 2008, along with September/October of 1930.We remember the crash of 2008, and historians remember what happened after the big rally of1930...and the chart comparison is eery tosay the least.