The 'R' word is everywhere. It's being discussed at World Economic Forum at Davos and now we have clients calling in at Orpheus, asking us about "recession" and how bad it is. And, is there a chance that the global depression might be starting? Such worries, though, important and critical, do highlight the mass psychology and how it reads the Federal interest rate cut and subprime crisis as a start of something bigger and problematic.
First and foremost, recession is not an event, it's a process. It happens again and again. And, when the recession lasts for more than three successive quarters of negative growth and prolongs, we call it a depression. We have had one depression in the US and one in Japan from 1929-1932 and 1980-1993, respectively.
A part of the market sees this as a sectoral crisis, just in the financial sector. But, crisis is never sectoral, it's always linked to credit and is across market. This is why a financial crisis is also called a confidence crisis. As liquidity dries, the counterparties panic and everyone wants to move out at the same time. This is the reason one-time write-downs might not be enough.
Markets need confidence more than write-downs. It's like saying if the Fed cuts the benchmark again, things will be fine. Some might however, look at it differently i.e. if the Fed cuts it again, we have a more serious problem. In any case, a Fed cut does little to boost confidence, the most needed commodity today. Markets follow their own rhythm; no wonder the S&P 500 has rallied, on the same day as a Fed rate cut, only six of the last 13 times. And, if all this was not enough, we have Alan Greenspan doubting Fed's ability to avert a recession, everybody seems ready.
But, the recession or great depression does not start till we have these negative quarters. All we are doing now is anticipating. And, even if we are anticipating, are we not a bit too late? The housing crisis started more than a year earlier and has already pushed prices substantially lower. We have more than a million foreclosures.
The Philadelphia housing index has dropped by 60 per cent from 2005 high and sales of new houses are at 25 year low. Even the subprime has seen a lot of wealth erosion. The overall economic loss is estimated at $2.3 trillion. The third indicator, considered as the most reliable predictor of US slow down, is the S&P 500, which is still negative for the last seven years, as it failed yet again when it reached previous 2000 highs.
This suggests that the slow down, what we talk about today, is already under play for the last few years, and that is why anticipating a recession is different from what is happening.
Robert Prechter, market thinker, compared Dow Jones with gold and proved that the slowdown is already happening with the Dow Jones falling 67 per cent compared to gold, over the last eight years. This, he calls,