My Prediction Came True - Big Market Recovery in 2009

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Back in March 2009, I did a posting titled Prediction: Big Market Recovery This Year! That included the above graphic.

At the time of my prediction, the Dow was down at around 7,000. In the graphic, I showed what I thought the "true" value was (the green dots). and I wrote:

"The good news is that the market will probably recover nearly as fast as it dropped. I predict we will see it around 9,000 or more by year end and over 10,000 in a few years."

Well, the Market overachieved. It ended 2009 at 10,428.

Prediction: Big Market Recovery This Year!

[Double-click graphic for larger view]

My neighbor is not a racist. He is a Democrat who would vote for the proverbial "yellow dog" if it was a candidate of his party. Yet, back in May when Sen. Barack Obama appeared to be headed for the Democratic Party nomination, he told me "the country is not ready for a Black president." Of course, the country proved him wrong - we have a Black President, elected by a substantial majority of the population, including a near-majority of whites.

As I looked at the highlights of last year's presidential campaign and the precipitous fall of the Dow Jones Industrials (DJI) amid the current economic collapse led by the popping of the housing bubble, I began to wonder what contribution racism -and in particular the unjustified fear of racism- might have had.

My conclusion is that racism and what turned out to be unjustified fear of racism had a substantial effect on the market decline, along with what turned out to be an unjustifiably bloated valuation of the market and of real estate.


The good news is that the market will probably recover nearly as fast as it dropped. I predict we will see it around 9,000 or more by year end and over 10,000 in a few years. The bad news is that the high levels of the last decades, and in particular the peak of 14,000 in 2007, were unjustifiably optimistic and will not be seen again for many years.

LET'S LOOK AT THE GRAPHICAL RECORD



The base graph above shows the actual DJI from 1930 to the present (jagged blue line). It also shows my estimate of the "true" value of the corporations represented in the DJI (green dotted line), based upon the idea that the stock market, an imperfect instrument, seeks to find the "true value"as it oscillates above and below, overshooting and undershooting on its merry way. It is nearly impossible to project the future course of the "true" value, but, given the actuals from 1930 to the present it is possible to draw a smooth curve, called a "regression line", that approximates the "true" value.



As you can see, the period from about 1995 to last year saw the market 2000 to 4000 points above the "true" value. I believe it is now around 2000 to 3000 points below the "true" value. My projections for the future (the fan of red dashed lines) indicates the market will soon go up sharply, most probably matching the "true" value by 2012. Optimistically, it could overshoot the "true" value by 2012 or 2013 (upper dashed red line). Pessimistically, it could undershoot the "true" value for decades (lower red dashed line). But, even my most pessimistic prediction shows the DJI on a steep incline for the coming few years.





WHY WAS THE MARKET OVERVALUED?



Government policies, starting in the 1990's, overstimulated the housing market. Fannie and Freddie, quasi-government organizations, assumed increasing responsibility for mortgages. This created the government-backed "moral hazard" that allowed -even encouraged- local banks to hand out mortgages to marginal borrowers, knowing they could offload these mortgages to Fannie and Freddie. As these mortgages were sliced and diced and "securitized", the SEC failed to properly regulate the securities and companies like AIG that insured them.


Everybody believed (or pretended to believe) that real estate could not go down. Well, maybe it could go down in some local geographic area, but it could never go down all over the country at the same time. Thus, "securitizing", by creating "diversity", was a way to insure stability and growth of "affordable housing".


The constituents of both political parties loved these policies. Republican developers and housing material corporations saw their businesses boom. Democratic workers got good paying jobs in the factories and building trades and the lower middle-class got affordable housing. Home ownership was preferable to renting because it gave people a stake in the community and a path to the middle-class. OK so far, but then the banks started giving loans to people who could never pay them off -even in good times- and some lenders even helped borrowers phony up their applications to get them approved. ("Countrywide is on your side!")


WHAT ROLE DID FEAR OF RACISM HAVE IN THE MARKET CRASH?


Investors hate uncertainty. The inset graph above shows the actual DJI track from April 2008 through March 2009. (It is to the same vertical scale as the base chart for ease of comparison.) The DJI was around 13,000 when McCain became the presumptive nominee for the Republicans and a bit lower when Obama appeared to have a clear lead over Clinton in the Democratic race.


After McCain and Obama were nominated by their parties (end of August, beginning of September) the DJI was down to around 11,500. As it became clear that Obama was likely to win, the market dropped precipitously (777 points on September 29th), and by a month before the elections, with Obama 6 points ahead of McCain, it was in free fall, crossing below the 9,000 level.


From election day, with Obama's big win, to his taking office on Jan 20, 2009, the market tumbled down to around 8,000. Two months into his term it hit a low around 6,500.


I believe only a relatively small number of people (genuine racists) pulled their money out of the market or cut back on their workforce because they did not think a Black president could do a good job. On the other hand, I believe a much larger number pulled their money out because of their unjustified fear that the actions of the racists would cause the market to go down. That accellerated the fall.

OTHER REASONS FOR THE MARKET CRASH

As I mentioned above, the market was ripe for a "correction" down to 10,000 or so. There were fundamental problems in the housing market caused by government-backed "moral hazard" policies and lack of proper regulation.

There may have been some organized effort by some leftish-oriented members of the moneyed class to take advantage of these weaknesses and push the market down temporarily to guarantee an Obama victory. I have no proof of this allegation and only mention it in case further investigation shows that some hedge funds were manipulating the market in the September-October time frame last year.

Also, some rightish-oriented members of the moneyed class might have been worried that an Obama victory would bring about more "socialistic" policies that would hurt the economy and pulled their money out for that reason.

Finally, the major media, nearly all of which supported Obama, always like a crisis story. They jumped on the highlighted phrase when McCain said: "... Our economy is in crisis ... there's been tremendous turmoil in our financial markets and Wall Street ... people are frightened by these events. ... still the fundamentals of our economy are strong. But these are very, very difficult times. And I promise you, we will never put America in this position again. We will clean up Wall Street. We will reform government."

I believe the fundamentals -American workers and industry- are strong and will recover almost as fast as we went down. Markets tend to over-react in crisis -both on the way up and the way down- so, hold on to your hats for the ride up!




BOTTOM LINE


I believe President Obama is very smart and intellectually flexible and basically honest.

I hope he can overcome his work experience in an activist law firm, as a community organizer, and on the left in the Illinois legislature and the US Senate. His entire career has been based on pushing policies that take money from those who earned it and give it to those who (for whatever reason) did not. On the other hand, he has demonstrated that he, personally, is a very hard worker. At Harvard, the law firm, in Chicago communities, and the legislatures, he has demonstrated tremendous intellect and industry and work ethic.


I want President Obama to succeed because I want to see our country emerge from this economic crisis stronger and more "mean and lean" to compete better in the globalized marketplace. This "correction" in our economy was overdue but perhaps it has been overdone.


I see hope in the availability of more affordable housing (due to the foreclosures), the reduction in energy prices (due to the economic slowdown), the elimination of some unproductive factories and wasteful union work rules (due to bankruptcies and threats thereof) and people willing and anxious to work harder and smarter (due to the reduction in job availablity).


I do not want all of President Obama's stated policies to succeed. For example, I am worried that the printing of a few trillion (thousand-billion) "stimulus" dollars will inevitably lead to roaring inflation a couple years from now. Much of this money will go to politically-connected states and cities and companies and unions and will probably be wasted (think of Boston's "big dig" on steroids and spread over our entire Nation).

But, I remain optimistic.


My wife and I "hung on" during the stock market downturn and saw losses of about 50% in our stocks and 401K accounts, as well as a substantial drop in the value of our home. But, even counting these substantial declines, we are still above our cost basis in both stocks and our house, so all we have lost is some "paper profits". Let us all hope for a substantial recovery in the market this year and next.

Ira Glickstein