Our analysis at EWI goes beyond simply looking at price trends: we also observe trends in social mood, the collective feelings of optimism and pessimism that actually move markets. Fashion, politics, peace and war are a few such expressions of social mood, but stock markets are an especially sensitive indicator of shared mood because:
1) They are highly liquid,
2) People invest their money based on their hopes or fears, and
3) Market data is relatively accurate and extends back centuries.
These attributes allow us to compare the Elliott wave patterns in markets with social history generally. The result: an element of predictability.
Readers of Robert Prechter’s best-selling, 2002, book,
Conquer the Crash, are not surprised by today’s historic financial crisis. The book accurately described how a major change in social mood -- from optimism to pessimism -- would usher in a broad deflation. It also places the ongoing real estate collapse into a larger context, which includes the stock market, the economy, the credit crisis and yes, the coming banking crisis.
Deflation and its effects are visible in a variety of social symptoms. Just one example of the growing stress is evident in a recent Atlanta Journal Constitution headline: “Therapists helping builders cope during housing slump.” The article explained how “Every builder seems to know a colleague swamped in debt, and a few know friends in the business who have taken their lives.” A year ago, few imagined that smiling builders talking on cell phones in big trucks would soon be seeking emotional support on therapists’ couches.
Banks, investors and the financial system got therapy too: intensive bailout therapy. Some $30 billion for Bear Stearns, maybe $100 billion for Fannie and Freddie, $150 billion for the Economic Stimulus Act of 2008, two new loan programs that lent billions in “short term” loans to investment banks and a series of interest rate cuts.
But wait! Only a year ago, at the annual Kansas City Fed banking conference, Fed chairman Ben Bernanke said, "It is not the responsibility of the Federal Reserve - nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions." Yet the Fed and the Treasury gave unprecedented protection to lenders and investors, via a debt-financed bailout to avert an epidemic of bank failure.
The Beach Boys sang, “She’ll have fun fun fun til her daddy takes the t-bird away.” ‘Daddy’ Bernanke threatened “tough love” again this year at the same conference when he said: "If no countervailing actions are taken, what would be perceived as an implicit expansion of the safety net could exacerbate the problem of 'too big to fail,' possibly resulting in excessive risk-taking and yet greater systemic risk in the future."
Bummer, dude. It appears the therapist won’t write the banks a script for a mood-altering anti-depressant.
But that doesn’t keep the patients from yelling “HELP!” On September 4, Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. said, “If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury … The government needs to replace private investors … Treasury should support not only mortgage finance providers Fannie Mae and Freddie Mac, but also “Mom and Pop on Main Street U.S.A.” [emphasis added]
If the monetary authorities cave in and attempt another expensive rescue, you know who will get stuck with the tab. The Band sang, “Take a load off, Annie. Take a load for free. Take a load off, Annie. Aaaaaand, you put the load right on me.” Just change Annie to Fannie and you have a fitting anthem for the taxpayer, who invariably shoulders the boom-to-bust burden.
Meanwhile the headlines keep coming -- and not just in the U.S., but across the globe:
- L.A. seeing more people living out of their cars (June 23, AP)
- House price crash goes global (September 2, UK Guardian)
- House prices are falling at fastest rate since the Great Depression (September 5, UK Telegraph)
- Austerity Britain: crunch forces consumers to change habits (September 5, UK Guardian)
The last article pictures an austere plate of canned beans and cites data that shows consumers cutting back purchases across the board.
Major financial institutions actually invest in huge packages of these mortgages, an investment that they and their clients (which may include you) will surely regret. Money magazine (December 2001) reports that the CEO of Fannie Mae “may be the most confident CEO in America.” Certainly his stockholders, clients and mortgage-package investors had better share that feeling, because confidence is the only thing holding up this giant house of cards. When real estate prices begin to fall in a deflationary crash, lenders will experience a rising number of defaults on the mortgages they hold. My guess is that the Treasury will lose the $7 billion line of credit that it is required by law to extend to these quasi-government companies and even more if it attempts a bailout.
The investment bank J.P. Morgan is a good example of what timely risk avoidance can mean. A September 2 CNN Money article says the investment bank exited that business in 2006 by selling more than $12 billion in subprime mortgages, while their competitors “ignored the danger signs and piled into those products in a feeding frenzy.... In this market, losing less means winning big. Before the crisis J.P. Morgan was a middle-of-the-pack performer; today it leads in nearly every category, starting with its stock.”
Early recognition of a trend is critical to making profits and avoiding losses. The specific events that result from major social mood shifts are difficult to predict, but
Conquer the Crash proves that it’s possible, and that it’s possible to know the character of markets and society in advance. It is not too late to prepare. Many of the forecasts have yet to be fulfilled.