A friend who is a trader at a big investment firm recently told me he sees the IMF rescue of Greece as the equivalent of the Federal Reserve arranging the sale of Bear Stearns to JPM Morgan.
“The question is not whether Greece will be saved. It’s whether anyone can save the next sovereign Lehman Brothers,” he said.
That sounds pretty dire. And since I’m usually a contrarian, when I hear people sound this bearish I start looking for reasons to be optimistic. I found them today in James Altucher’s column. You can read it right here. Altucher, whom I regard as one of the smartest guys I’ve ever met, thinks the next stop for markets is Dow 20,000—and he thinks we’ll get there in the next 12 to 18 months.
I’m not convinced. In fact, I think there’s a good chance my trader friend is right and Altucher is wrong. What we saw Wednesday might be a prelude for a much larger decline in the markets.
Here are some reasons:
1. Stocks have overperformed. Since 1900, the average yearly price appreciation in the Dow Jones Industrial Average has been just under 5 percent. If you start counting after the stock market crashes of 1929-1931, the average yearly price appreciation is around 7 percent.
Last year, stocks rose 11 percent. In the past 12 months, we’re up almost 20 percent—even if you count yesterday’s sell-off.
Year-to-date, we’re up almost 6 percent.
In other words, I think there’s a good chance that we’re at the end of the bull run in stocks—at least for this year.
2. Politics. Our political system is so broken that it is threatening to produce the worst possible short-term combination of economic policies: tax hikes, tighter credit and lower spending just as the economy slows down.
Obamacare is basically a tax hike on job creation, making it more expensive for businesses to take on new workers. We’re intentionally tightening bank credit through financial reforms and higher capitalization requirements. The Republicans have gone from the party of tax cuts and growth to the party of austerity—and the Obama administration seems to agree.
You don’t have to be a Keynesian stalwart—actually, I’m not any sort of Keynesian—to see that this is bad news.
3. Quantitative easing did not work. The attempt by the Federal Reserve to stimulate the economy by buying financial assets did not work. It helped recapitalize banks, but this didn’t spur bank lending.
Both inflation and employment remain below target levels.
What went wrong? Economists will be sorting that out for years. But I think it was rather simple. Ordinary central banking tools—such as lowering interest rates—create the illusion the country is wealthier than it is and savings higher than they actually are. This illusion of wealth tricks businesses into investing in ways they otherwise would not. This investing leads to economic growth.
But with interest rates already at zero and the Fed communicating its credit strategy so clearly, there was no illusion. This time around, the old tricks just didn’t work. The zero interest rate really is the lower boundary for central bank monetary policy.
4. The European bailouts aren’t working either. Europe’s politics are even more broken than ours. The public in wealthier European countries do not want to bail out their impoverished debtor neighbors.
But the banks of those wealthy countries—including the European Central Bank—are so exposed to the credit risk of Greece, Spain and Portugal that their financial systems would collapse in the event of massive defaults. This fact, however, seems to be lost on both the public and many politicians.
Because this dynamic is so poorly understood, the wealthy European countries keep trying to force Greece to adopt punitive austerity measures. But there’s just no way Greece can ever be austere enough to pay off its debts, so the entire Greek austerity program is either a fiction or just mean-spirited revenge.
5. We’re still too fragile. Our economy and especially our financial system are still too vulnerable to sudden shocks and still too homogenized according to the shared ideology and interests of bankers and regulators. So much of what we’re doing to try to repair ourselves from the damage of the financial crisis depends on everyone getting everything right—sticking the landing, as they say in gymnastics. We’re not prepared for the unexpected, which makes the world a riskier place.
I’m not a forecaster. I don’t have a target number for the Dow. In fact, every single one of the circumstances I’ve just outlined could change dramatically in the next few months. Or maybe they just won’t matter as much as I fear. Markets are like marriages: You never can tell whether it’ll turn out to be for better or worse.
I’m not invested in any individual stocks and I’m not short the market. But to make this interesting, I’ll put my money where my pixels are. If Altucher—who is much smarter than I am—really thinks we’ll see Dow 20,000 within 18 months, he should bet me a steak dinner on it. I’ll take the under 20,000.
Questions? Comments? Email us atNetNet@cnbc.com
Follow John on Twitter @ twitter.com/Carney
Follow NetNet on Twitter @ twitter.com/CNBCnetnet
Facebook us @ www.facebook.com/NetNetCNBC