When Will It End?

You've probably heard by now: Stocks closed yesterday at their lowest level since 1997.

Anyone remember 1997? Google (Nasdaq: GOOG  ) wasn't even a company. General Motors (NYSE: GM  ) was one of the most profitable companies in the world. Bob Dole had just run for president. Stocks were still quoted in fractions rather than decimals. Hanson was crazy big.

More relevantly, 1997 was around the same time then-Fed Chairman Alan Greenspan gave his famous "irrational exuberance" speech, warning that "…we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy."

But he did. And we did. Almost everyone underestimated how complex the intertwining relationships between Wall Street and Main Street were, and more importantly, the relationships between the global economies. China needed demand from American consumers; American markets needed capital from Chinese savers; consumers relied on that capital to fund a free-for-all real estate market; banks rerouted the proceeds into a secondary credit market that couldn’t care less about loan quality. It was a disaster waiting to happen, and as soon as one end of the self-fulfilling cycle shut off, the entire house of cards came crumbling down in a historic way.

Just how historic? Using peak-to-trough declines, here's how our current situation looks against other market crashes:

Period

Event

S&P 500 decline

1929-1932

Great Depression

(89.2%)

1973-1974

Oil embargo

(48.2%)

2000-2002

Dot-com crash

(49.1%)

2007-present

Unrivaled financial insanity

(52.5%)

Source: dshort.com.

Yep -- we're now officially in the biggest market crash since the Great Depression. In fact, we found out courtesy of the World Economic Forum that more than 40% of total global wealth has been destroyed since the crisis began. You have plenty of company, dear sufferers.

Who to blame?
The big driver of this crash right now is obviously banks. Confidence in them -- as well as in the government's ability to save them -- is shot to pieces. The recent rumor that Citigroup (NYSE: C  ) would be swapping government preferred shares for common stock, for example, is a step in the right direction, but woefully inadequate.

Citi has around $23 billion of tangible common equity, which equates to a 1.2% "TCE ratio." To get that ratio up to the historical norm of around 6%, it would need something along the lines of $100 billion of fresh capital -- and that's assuming asset writedowns are over (which they aren't). Bank of America (NYSE: BAC  ) would need in the neighborhood of $75 billion to reach the same capital levels. While a gazillion dollars has already been thrown at banks to stop their hemorrhaging, it's still not nearly enough, and that outlook is flushing the economy down the toilet and scaring the pants off the market.

Be that as it may, it's not hard to make an argument that markets are currently being controlled by witless hysteria, opening the doors to investment values we haven't seen this generation. As Oscar Wilde once said, "We are all in the gutter, but some of us are looking at the stars." I'm looking for silver linings here, people.

To illustrate what I mean, I ran a quick screen to find stocks trading at less than three times 2008 earnings. Dozens popped up, including these three:

Company

Market Cap

2008 Net Income

ArcelorMittal (NYSE: MT  )

$22.0 billion

$9.4 billion

United Rentals (NYSE: URI  )

$262 million

$302 million*

United StatesSteel (NYSE: X  )

$2.5 billion

$2.1 billion

Source: Capital IQ, a division of Standard & Poor’s. *Latest 12 months, through Sept. 30.

I'm not advocating that you buy any of these; all three are in industries that have blown up in the past few months. Nonetheless, the spectacular declines in businesses that will have demand and staying power after the economy recovers is truly amazing.

Markets always, without fail, overshoot on the way down when deflating from an asset bubble. In fact, the best three-year period ever to own stocks was from 1933-1936 -- right in the middle of the Great Depression. No one argues that the economy isn’t in horrendous shape right now, but arguing that stock valuations are equally as grim is another thing completely.  

When will it end?
No one knows. These are problems that took years to create, and hence won't be solved overnight. The only certainty is that we're 7,000 points closer to the bottom today than we were when stocks peaked in October 2007. For long-term investors with patience and a desire to tear apart the market in search of bargains, that's all that really matters.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Google is a Motley Fool Rule Breakers recommendation. The Motley Fool is investors writing for investors.


Read/Post Comments (5) | Recommend This Article (30)

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  • Report this Comment On February 24, 2009, at 10:37 AM, SteveTheInvestor wrote:

    I guess you should clarify that "long-term" should be at least 25 years. After all, the last decade has been a loser and those who jumped in within the last few years will likely spend the next ten just trying to break even.

  • Report this Comment On February 24, 2009, at 3:41 PM, jacoborjake wrote:

    Now heres what, take what you learned from the past 12 years and apply to your investment strategy!

  • Report this Comment On February 24, 2009, at 3:52 PM, TideGoesOut wrote:

    Coincidentally, I just finished reading this MarketWatch article basically saying the bottom may have been reached, kinda.

    http://www.marketwatch.com/news/story/evidence-mounts-recess...{71467556-3683-4018-906C-7FFC8A3F9E8C}

  • Report this Comment On February 24, 2009, at 5:46 PM, pedorrero wrote:

    I just read today that we are halfway retracing the losses from the great depression. Some quick by the fingers counting would mean that, if the down period was about the same, then we'd see the bottom just around 1500-2000 DOW ("OW!") about August, 2010. Of course, history rhymes, it doesn't necessarily repeat. Still, pessimist that I am, I think there is a lot more grief coming. Figure: the last bubble (housing) is blamed on the Fed's super-low interest rate policy. Well, that magic is gone. Now what? Creating money out of thin air? Bailing out everybody left and right? Where will it end?

  • Report this Comment On March 02, 2009, at 10:16 PM, DMWARDFOOL wrote:

    I have a hard time seeing the bottom and here's why.

    AIG's latest visit to the trough of money we taxpayers are borrowing to fund this is a really, really bad sign. It exposes the lack of a coherent strategy on the part of Treasury and the Fed and, perhaps, the inability to develop one.

    1. AIG is the insurer of the credit default obligations that assisted in the disconnect between the provider of credit and scrutiny of the repayment likelihood on the debt obligations being sold. AIG didn't understand the risk involved in the contracts they were guaranteeing, priced them incorrectly, and now just simply don't have the money to fulfill their obligations. The scope of AIG's outstanding obligations makes Lehman look miniscule and even dwarfs the impact of Freddie and Fannie. Chris Whalen of Global Macro EconoMonitor conservatively estimated the likely default losses to be over $15 Trillion.

    2. This latest need for a cash infusion by AIG further solidifies the frozen credit markets because it reinforces the notion that no bank can be sure of the solvency of its neighbors and there is little predictability to the USGovernment's actions.

    3. The cost of more borrowing by the USG to fund a "stimulus" and these bailouts is increased borrowing costs in the form of higher interest rates to attract foreign investors. It seems that eventually investors look somewhere other than Treasuries for security as continued sizable borrowing by the USG calls into question our ability to repay. Where do they go? Precious metals, perhaps. Likely not Euros.

    4. If we follow this path we have higher interest rates at a time when credit markets are already tight and cheap money and too much of it is not the problem. That is not a recipe for recovery.

    5. So we wind up with the USGovt unable to borrow without increasingly unattractive rates, a resultant inability to "stimulate" the economy, the inability to cover AIG's losses, trillions of CDO insurance contracts going into default worldwide, and share valuations plummeting due to a near complete inability to generate earnings because of frozen credit markets, increased personal savings, and lack of government's ability to fund projects.

    The solution of liquidation of AIG (take your medicine now and all of it), is not well enough understood by me to be seen as a solution that does not trigger the very series of events discussed above. Perhaps we simply get through it more rapidly (2 years versus a decade) via liquidation.

    Am I wrong here? If not, "intrinsic" or "asset valuations" of shares become meaningless. The assets of companies have value because of their ability to generate earnings. If no one has the cash to fund earnings, then the assets aren't worth much. Given the sheer quantity of assets out there, there's not enough cash lying around to go through the creative destruction process that is largely funded by credit. Hence my inability to see the bottom.

    I'd appreciate some ideas on how we get out of this.

    Dmwardfool

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