We are entering the New Year with a lot of pessimism about the stock market and the economy. While I have strong concerns I am optimistic for several reasons.
We have already had a strong move down with a nearly 40% drop in most indexes.
The conventional wisdom is that the worst is ahead. In such strong moves the conventional wisdom is often wrong. At times like this it pays to be a contrarian.
Unlike the Great Depression the Government is not taking a hands off approach. In fact they are bailing out everything in sight. While this may have serious inflationary consequences later I think it may not for several reasons. There are strong deflationary forces in lower fuel and commodity prices, an economic slump, rising unemployment, and the prospect of imports looking for a market in America. While our market is being battered, the rest of the world is having an even worse response.
There are also strong deflationary forces in the budget cuts in state governments who do not have inflation as a tool. Paul Krugman wrote an article called 50 Hoovers, lamenting the deflationary impact of state government budget cuts when the government should be spending to stimulate the economy. The state budget cuts may be counteracting the stimulus of much of the federal spending.
While the news is negative my eyes are telling me a different story. Malls are still crowded even though business is down. A friend travelling noted that all of the flights to Hawaii on a particularly day were overbooked. Restaurants are still crowded.
I will acknowledge that business is down. Car dealers, home builders and banking are getting hit exceptionally hard, but while homes were overpriced they are approaching a normal level where sales will eventually pick up. They may go further but they are closer to a bottom than a top.
Finally there is a ton of cash out there, and the fed is inflating strongly. This money has to go somewhere. When the fear abides and the cash enters the economy’s bloodstream we will see a bounce. Expect a higher Dow this year.
Will a one party government have the discipline to reign in the inflation when the recovery ensues? Will they be able to make the decisions to cut spending and make tough choices? That remains to be seen.