Depression or Not?

"Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic." ~ Charles Sanders Peirce

Are we headed for a Depression?  The media has certainly tossed around comparisons of the current financial crisis to the Great Depression but this type of sensationalism, which is used to steal our attention, is expected from a source of information whose primary objective is to sell advertising.

I would not give this subject any attention if I had not observed several traders and bloggers who are experienced and knowledgeable of market and economic history are also joining the media noise to draw serious parallels from this financial crisis to "the D-word."

Are we headed for a Depression or are we not headed for Depression?  Should a rational person be asking this question now?

Let's take a look at some opposing views from notable sources and draw our own conclusions... 

An economist and notable blogger, David Merkel, recently posted an article titled, "It's Called a Depression," where he draws several parallels from this current financial crisis to a depressionary environment, which is generally defined as a 10% decline in economic growth or Gross Domestic Product (GDP):

• Many go hat in hand to the government
• The spreads of the bond market are at record levels since the last depression, and maybe comparable.
• There is policy paralysis and confusion.  No one knows what to do (or leave alone), they act blindly or cower in fear.
• Ultra-safe investments have record low yields.
• Banks don't trust each other.
• GDP is shrinking, and unemployment is increasing at a rapid rate.
• Financial businesses are failing and shrinking at high rates.
• The government comes in to "help" the markets, and ends up replacing the markets.
• The security of banks and other financial entities is open to question.

Mr. Merkel's grim observations are based upon his view that the "gears of finance are jammed," which results from "financial systems that are in danger."

"To every action there is an equal and opposite reaction." ~ Newton's third law of motion

The counter-argument we will look at comes from fund manager, John P. Hussman, and his recent article titled, "The Stock Market is Not in Uncharted Territory:"

Meanwhile, it is notable that data that measure investor panic, such as risk-premiums and intra-day market volatility, already match historical extremes (1932, 1974, 1982, and 2002) – points where stock prices were not far from their lows even though negative economic news persisted for a longer period.

If we seriously need to talk about the Great Depression (I personally believe that it is an outrageously dire comparison), we should recognize that even during that prolonged decline, it rarely made sense to sell into a major break of a previous low, because investors invariably had a chance to sell on a later recovery to the prior level of support.

If one actually examines market data from the Great Depression, 1907, and other less extreme panics, one realizes how much the recent decline has already discounted potential economic negatives.

Veterans like Warren Buffett and Jeremy Grantham... know to ignore the paralyzing fear now, because they still understand that stocks are a claim on a very long-term stream of cash flows.

Mr. Hussman is essentially saying that today's stock prices have already (or nearly) factored in a worst case scenario, which is quite severe but significantly less severe than the Great Depression.  Furthermore, he implies that a prudent investor will not pay much attention to labels put forth by the news media but look for value opportunities that such an extreme environment has historically created.  

"All human situations have their inconveniences. We feel those of the present but neither see nor feel those of the future; and hence we make troublesome changes without amendment, and frequently for the worse." ~ Benjamin Franklin (1706-1790)

While Mr. Hussman's points come from a stock price and valuation perspective and Mr. Merkel's come from an economic and bond market perspective, both contrasting views show respect for history and illustrate the broad spectrum of opposing views prevalent today.

In my personal view, I believe conditions are certainly bad but likely not as bad as most people perceive them to be, especially the sectors outside of housing and financials.

Market cycle extremes, both on the upside and the downside, are accompanied by extreme emotions where our brain's limbic system will naturally seek patterns that make us believe that the current momentum will continue in the same direction... but the pendulum swings both ways...

Are fears of Depression justified or is it just more noise?  Or is there a human tendency to find the worst outcome that will make our current environment seem more tolerable?

What do you think?

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Related Post: "Know Thy Risk"

Comments

[ana]

I think the amount of fear one feels is equivalent to one's unconsciousness or unawareness of one's true self. I think we as a nation have been so identified with the labels of economy, money, power, comfort and so on. We forget these are just labels and we attach much energy to those labels. So we get instant Karma. Someone not dependent on those labels might not be suffering as much as someone who has placed great importance on them.

[Clint Stonebraker]

I am admittedly ignorant in regard to markets, trends, and other financial technicalities. However, my experience has been that we humans have a tendency to react to emotional situations rather than take the time to rationally and logically figure out the most appropriate way to respond.
I do not believe that it is all doom and gloom. I see the current financial situation as a collective confirmation that it is time for the system to change. As scary as change can be to some, it is inevitable. My responsibility to myself and my family is to remain calm, patient, and grateful. With these traits will come the willingness to stay appropriately informed rather than at the mercy of the hysterical mass media view.

[Kent @ The Financial Philosopher]

ana:

I could not agree more! One's level of concern with regard to economic conditions reveals, in kind, the measure of importance money and material status plays in one's life.

It is my hope that this revelation becomes one of those unforeseen, life-changing events for many people, much in the way that a near-death experience is reportedly such an enriching event.

Unfortunately, it takes a "shock" for people to see things as they should...

Cheers...

Kent

[Kent @ The Financial Philosopher]

Clint:

Thanks for the commet and yes, I agree with your inference that experience is quite a relative phenomena.

If one has not experienced a "depression," it is natural that the most extreme conditions they had experienced thus far in life would be attributable to the worst imaginable.

I wonder what someone who actually survived the Great Depression would say about today's crisis?

It is my guess that the comparison, to them, would be bordering on comical.

"Men are disturbed not by things, but by the view which they take of them." ~ Epictetus

[ana]

"Men are disturbed not by things, but by the view which they take of them." ~ Epictetus

That's a great quote. I think that being in touch with our feeling is important. Recently, becoming aware of my feelings, thoughts and sensations, has become part of my practice. I think sometimes the rational mind is quick to dismiss feeling as un-important. But feelings are a path to the Self and discovering the underlying apparent 'deficiencies' that one tries to cover up with consumerism. I think the current situation reflects how out of touch we, as a country, have been with our selves as Human-Beings.

[Leonardo Cecchini]

As humans, we abhor uncertainty (or randomness). Through the ages, we have fooled ourselves into believing that we could actually forecast future events. The fact that we have been more wrong than right (in many differing fields) as not dampened our efforts. Consequently and especially in moments of high emotional stress, we try to seek confort by trying to predict 'the next step'. If anything, the very act of trying to reduce uncertainty actually increases it. So, more often than not, our emotional bias (or confirmation bias) will stir us towards that information that confirms our view. That is why in any given moment you will always get one party arguing the bullish case whilst the other the bearish one, each with suitable evidence to suport their thesis. Who's right? Time will tell.

With regards to the current times, I personally try and see it as simple as possible. The fact that a huge pile of debt needs to be issued by the government (which will compete with the corporate sector that will also need to reset next year), coupled with the already existing pile of debt, one has to feel that at some point this will proove to be too heavy to carry... The trick woorked in 2001/2003 because the burden on the consumer was 'relatively' low. That is no longer the case

[Kent @ The Financial Philosopher]

Leonardo:

I agree with all of your points...

Humans are uncomfortable with things that are not concrete, such as space and time, which is why we have Science to define them for us!

In times of extreme emotion, however, I tend to rely more on qualitative (i.e. intuitive thought and judgment) measures rather than quantitive.

I, too, like to make thoughts on subjects such as this as simple as possible.

If I simplify this financial crisis, or any other market cycle, I expect it to begin and end by means of the same entity.

This entity is housing. Once inventories work their way down from record levels, the beginnings of a foundation strong enough to build upon will form.

In the mean time, the excesses will be removed.

The question that remains is how severe and how long will things be before we can build again...

Once again, we return to the question and discomfort over space and time...

[Ben]

Hi Kent.

A few weeks ago I saw a cover of Time magazine that had a Great Depression era photo with the tag line - "Depression 2.0" - this juxtaposition of old and new brought a smile to my face. IMHO it's too early to say the "D" word. The fundamental difference between now and seven decades ago is the global intertwining of economies.

Where I live, Australia, a common joke is that when the USA sneezes we catch a cold. The Australian economy is more reliant on the Chinese economy these days due to the natural resources that are exported to fuel the Chinese building boom.

History has many invaluable lessons to teach us, but there will always be fundamental differences between the past and the present. The future is an unexplored country.

In my lifetime I have seen the news media go from two daily newspapers, nightly news bulletins on television and hourly news bulletins on radio to a relentless 24 hour news cycle. I still marvel at the fact that on a brisk Saturday afternoon I can easily find stock prices from pretty much every stock market.

If one has the belief that human nature is fundamentally geared towards fear and catastrophe then the 24 hour news cycle will feed that fear - "if it bleeds, it leads".

What might come out of the current situation is a questioning of the nature of relentless consumerism. There might be a shift to looking inward for a "well lived life" and not relying on external "shiny objects" for life satisfaction.

I also bear in mind that the steps that governments take in these times may very well have unintended consequences - that's just the nature of the market.

My country and yours, Kent, will know it's a depression when the majority of the population will be foraging and bartering for food. This is fair way off at this point in time.

To finish up I think that Steven Covey's Circle of Concern and Circle of Influence need to be considered. I may be very concerned about the measures that governments take, but I can only influence the way I utilize my resources - mental, physical and fiscal.

Cheers.

[Kent @ The Financial Philosopher]

Ben,

You make several great points!

The depression call is certainly premature, even in the face of a financial "perfect storm." The combination of 24-hour media access, freedom and tremendous advances in technology have enabled this financial crisis but can also enable its recovery.

The greater perspective, as you mention, is that many people will take a much closer look at what brings meaning and purpose to their lives.

Most of them, hopefully, will find that money, material wealth and stocial status are not anywhere near the highest of priorities.

Thanks for sharing your thoughts...

Kent

[Ben]

Hi Kent,

Thanks for your kind words. There are very interesting times ahead.

Cheers