How low can global markets go? (page 1 of 2)

At the same time, Jim Cramer of Street.com fame writes that we ought to 'quip moping about last year's market meltdown' and that since 'Greenspan has taken his foot off the break and begun to force interest rates down, you want exposure to the stock market. ...This is the lowest risk, highest reward environment possible. You have the Fed - and history totally on your side.'

The fact, however, is that the economy has just experienced one of the steepest decelerations on record. Yet economists dismiss this slowdown as an inventory correction and out of 54 economists recently surveyed, 52 are looking for a powerful rebound in the second half of 2001.

And despite the record inflows of more than $300 billion into equity mutual funds in 2000 and the concentration of this money into loss-making high tech funds, individual investors are more optimistic than ever, according to sentiment surveys.

Moreover, note that the $300 billion inflow into equity mutual funds in 2000 vastly exceeded total equity mutual fund assets in 1990, which were then less than $200 billion. People talk about the great US productivity miracle, but the enormous trade deficit suggests differently as does the record number of flight delays during the year 2000.

And finally, in Robert Mugabe's Zimbabwe, where the economy is falling apart and where the budget deficit is projected to rise to 29% of GDP this year, the stock market has recently soared to all time highs. So, what should an investor do in such a bizarre environment?

It may be that 'you have the Fed - and history totally on your side.' But is it 'the lowest risk, highest reward environment possible?' We have our doubts on both counts. It is true that in the past, Fed rate cuts led to rising stock prices most of the time, which averaged after the second or third rate cut between 15% and 17.5% for the subsequent twelve months period.

However, there are a few differences between past and present conditions. Just consider the two periods of previous rate cuts, 1973 to 1975, and 1981 to 1982. The great US bear market of 1973 to 1974 began for most stocks already by 1968, and for the 'nifty fifty' stocks in January 1973.

The first rate cut occurred on December 19, 1974, in the midst of a very serious recession and after stocks had been so badly devastated that they were 30% lower than they had been in 1964 - ten years earlier. The Dow Jones Industrial had a p/e of seven, was valued at less than book value and at a discount of 66% of replacement cost, and had a dividend yield of more than 6%.

In the 1981 to 1982 period, the situation was similar, except that prior to the first rate cut, Paul Volcker had increased the Fed Fund rate from less than 5% in 1977 to close to 20% in 1981. The subsequent three rate cuts took place between November 1981 and July 1982, when the economy was in one of its worst Post-War recessions (the unemployment rate touched 10.5% in 1982).

Also, over the previous 15 years, the Dow Jones Industrial had declined by 9% and was in real terms (inflation adjusted) down 70%! It sold for seven times depressed earnings and had a dividend yield of 6.3%. Equity mutual funds then had more than 11% of their assets in cash and their total assets ($40 billion) were no higher than they had been in 1970, because throughout the seventies mutual funds had been plagued by net redemptions.

Thus, in these two periods (1973/75 and 1981/82), there was a very depressed stock market and the economy was in the midst of a recession, when the rate cuts took place.