Bad News Bears take over Wall Street

The "bears" are here and it does not look like they are going anywhere soon.  The "bears" that I am referring to are the people who have a pessimistic outlook on the economy and the stock market. Anytime those people outnumber the "bulls" (those who have an optimistic outlook on stocks and the economy), the country is said to be in a bear market.

The major indicator that we are in a market where the bears outnumber the bulls is that the Dow Jones Industrial Average, or the Dow, closes down 20 percent from its previous high.  July brought with it the bears because on July 2, after losing 167 points for the day, the Dow closed 21 percent below its October 2007 peak of 14,198. And if the rest of the economy is an accurate indicator, the bears will be around for quite sometime. In some ways, it is remarkable that the bears took this long to coalesce and take control. 

The current economic crisis began in July 2007, almost one year ago with the credit crisis precipitated by the sub-prime mortgage meltdown and has been exacerbated by sharp increases in oil prices and subsequent inflationary pressure on the prices of staples such as food. The U.S. government has tried valiantly to stave off a bear market with dramatic cuts to interest rates, by brokering and backstopping bailouts in the financial securities industry, by opening up the Federal Reserve window to non-bank financial institutions and by providing tax rebates to citizens in the hopes of increasing economic spending.  Unfortunately, none of those measures has worked and here we are patiently waiting for a bad economic situation to get worse.

Consider that stocks have lost over $2 trillion of value this year. Almost $1.5 trillion of that loss came in June: The worst June loss on record since the Depression.  Oil prices have more than doubled in the past 12 months as per barrel crude prices have settled above $147, hitting record highs almost daily.  Rising oil prices have contributed directly to a rise in the prices of some of the basic consumer goods. For instance, gasoline prices are up almost 40 percent year over year to $4.10 per gallon.

However, increasing oil prices also indirectly affect the prices of consumer goods.  Increased transportation costs raise the prices of fruits, vegetables, meat, and dairy products trucked to cities from rural areas. An increased desire to use alternative fuels such as bio-diesel increases demand for agricultural crops such as wheat and corn, leading to an increase in the costs of everything from flour to animal feed. 

In the midst of all this, poor performance on Wall Street has resulted in a loss of more than 15,000 jobs in the financial sector, General Motors, Ford, and Chrysler recently announced major cutbacks and plant closings as consumer demand for large automobiles and SUVs wanes. Starbucks signalled the end of its expansion strategy by recently announcing that the company is going to close 600 stores and cut its workforce by as many as 12,000 fulltime employees.

These recent events do not portend well for the economy and the markets because rising prices will force consumers to reduce their spending.  Unemployment will have a similar effect on consumption as the unemployed decrease their budgets for discretionary items.  The decrease in consumption will lower profits for many corporations, and they will be forced reduce expenses; frequently labor expenses and shrinking corporate profits will reduce stock trading prices. 

Although it took nearly a year for an official bear market to arrive, the outlook is bleak for the rest of 2008 and into 2009.  The FED has cut interest rates to try to spur corporate investment and decrease the cost of consumer borrowing, but that coupled with the oil crisis has led to inflationary pressures.  The markets will probably remain in turmoil until the nation chooses a leader in November, at which point investors will decide if the glass is half empty or half full.  Unfortunately, regardless of November's outcome, it is likely to get worse before it starts getting better.