E-mail this article Printer-Friendly

Happy New Year! The stock market’s not getting any better

Some analysts see things brightening up part way through 2008. But not this one. He’s as bearish as ever, and he has several bones to pick.

The last time we visited with Mr. Irwin T. Yamamoto, he was wishing his readers happy holidays and telling them to stay out of the market.

In the latest issue of The Yamamoto Report we find this greeting: “First of all, we wish you a Happy New Year. As for the stock market and the economy, we unfortunately cannot say the same thing. At least, not for 2008. It’s going to be a rough twelve-month period.”

Writing from Hawaii, Mr. Yamamoto does not budge from the bearish stance he has maintained since well before the subprime crisis bubbled up in August.

This resolute negativity serves as a counterweight to the cautious optimism of a number of other market observers we follow. While some believe that the credit crisis and its attendant writedowns will work itself through the worst in the early quarters of 2008, Mr. Yamamoto is having none of it.

In his latest report, he buttresses his argument with a detailed look at interest rates — and a profile of the man who rides shotgun on those rates, U.S. Federal Reserve Board chairman Ben Bernanke.

Bulls on the horns of a dilemma

Lower interest rates have created something of a mirage, in Mr. Yamamoto’s opinion. The results look better than they actually are. What’s more, they could throw the bulls on the horns of a dilemma.

“Even the positive aspect of declining rates has been priced into the market to a large degree,” he says. “And in a strange way, the bulls won’t be able to hope for improvement in business activities. A pickup in the economy would decrease the chance for lower interest rates.”

When your bullish stance is based on the premise of ever-lowering interest rates, adds the editor, you are in a precarious position.

Furthermore, Mr. Ben Bernanke must “eventually stop destroying the value of the U.S. dollar with his loose monetary policy.”

The bears have an arsenal

In the meantime, says Mr. Yamamoto, “the bears have an arsenal to battle the bullish camp, namely the economic angle.”

The equity market will be dragging a heavy load throughout the year, he asserts: housing woes, record debt levels, recession concerns, lower corporate profit margins, a slowdown in global growth, hedge fund troubles, derivatives, the approaching China stock market sell-off, and unforeseen problems from an over-leveraged domestic economy.

About the only thing he leaves out is that the American Football Conference seems a virtual lock to win the Super Bowl this year, which usually means a lousy year for stocks. (Don’t ask — it doesn’t make any sense to us either.)

If indeed, a bull market or a new up cycle begins next year, “then our business model doesn’t add up,” admits the editor. But he doesn’t really think so. “At some point in time, the Pied Piper must be paid.”

Moreover, the worst is yet to come.

The bloodbath on Wall Street

“The troubles have just started,” says Mr. Yamamoto gloomily. He does not fail to point out that America’s largest banking houses required massive bailouts — the biggest being the $7.5 billion lifebuoy flung to Citigroup by the emirate of Abu Dhabi. Morgan Stanley and Merrill Lynch are among the other sufferers.

But how about E-Trade Financial? The value of its stock had fallen 83 per cent when this issue went to press. And fourth-quarter results for the big financial institutions have been predictably disastrous.

“The bloodbath on Wall Street won’t stop anytime soon,” predicts the editor. Financial corporations will continue to get hit by unrealized losses. Moreover, some are delaying the declaration of writedowns “in acts of complete denial.” Others have no idea how much exposure to bad debt they really have.

“The headlines will be no less brutal in 2008.”

At this point, Mr. Yamamoto admits to a mistake.

Alan, Ben and the Great Depression

In his last issue, Mr. Yamamoto referred to the current Fed chairman as Alan rather than Ben Bernanke, substituting the moniker of the previous chairman, Mr. Alan Greenspan, for the first name of the current chair. An interesting slip, if not quite a Freudian one.

As he points out, the name is less important than the policies. And the scary part, for Mr. Yamamoto, is that the current chairman’s “economic theories could be worse than Greenspan’s.” Here’s why.

Having done thorough background research on Mr. Bernanke, the editor finds that he is obsessed with the Great Depression. He has written about it in great detail. And Mr. Bernanke’s conclusion is that the Depression was the result of a mistake in monetary policy.

“In my opinion,” states Mr. Yamamoto, “the Fed chief privately blames Alan Greenspan for today’s mess. In order to avoid another depression, Bernanke appears to be convinced the only way out is to reflate the nation and the rest of the world out of the credit crunch. A depression on his ‘watch’ will be avoided at all costs.”

Making things worse, a country in crisis is in the hands of relative neophyte who took over the job less than a year ago. “He’s presently getting on-the-job training. The rookie now faces his first and biggest test.”

Worries about the next depression may be pushing Mr. Bernanke in the wrong direction. A little interest rate history indicates why.

Flooded with money

There is nothing inherently bad in low interest rates, says Mr. Yamamoto. It’s just that they’ve been forced down too often in this young century.

From early 2001 to 2003, the Fed decreased the federal funds rate no less than 13 times. It tumbled down the stairs from 6.25 to 1.00, the lowest nominal level since 1958, when the overnight rate was 0.68 per cent. “Essentially, the economy was flooded with money,” states the editor.

The Fed realized that monetary policy had to change. So off it went in the other direction, raising rates 17 times beginning in June 2004. That was necessary to keep inflation from the door.

But it wasn’t really enough. Rates had gone down too far, and been held down too long. Despite the slurry of rate hikes, interest rates remain at the lower end of the historical spectrum. The cost of borrowing is still too cheap. (Could that have had anything to do with the subprime mortgage crisis?)

“The recent action by Alan Bernanke, I mean… Ben, just compounds the problem,” adds Mr. Yamamoto. The rate cuts of recent months started at a level that was already too low.

The Federal Reserve Board was behind the curve on inflation, says the editor. Now, the situation is worse. Mr. Bernanke is seeking a temporary reprieve from an economic slowdown or the dreaded depression. “In return for a short-term fix, he will be rewarded with a longer and deeper recession.”

Mr. Yamamoto does not believe in happy endings — not this year at any rate. And there’s another interesting aspect to his bearish posture.

Some who take a dim view of today’s markets will nonetheless assert that there are good bargains to be picked up in a troubled stock market. Not Mr. Yamamoto.

His portfolio sits with 90 per cent cash and 10 per cent in the Rydex Ursa Fund (RYURX), which runs in the opposite direction of the S&P 500. And he recommends the fund only for aggressive investors. Conservative investors, he says, should be 100 per cent in bank money market accounts.

We were raised on accounts of the Great Depression. We are not anxious to see a rerun. But from time to time it doesn’t hurt to be reminded that those who take the wrong lessons from history may be heading straight into the problem they’re trying to avoid.