Stock markets fall worldwide

January 21, 2008   2:45 pm


The world wide slump in stock markets of upward of 6 % comes as no surprise. Markets because they are based on human nature and therefore can exhibit all the instincts of fear, greed and the tendency for many to panic in a crisis are inevitablely prone to such falls. They are repetitive occurences in market behaviour.
Irrationality abounds when panic strikes.

Unfortunately a whole new generation of investors will have to learn the same lesson learned by previous ones that investment in the markets takes place under conditions of uncertainty and risk. There is no such thing as a 100 %sure bet in the market, ever.

Rather , there are probabilistic outcomes some greater than others but all subject to the ultimately unknowable posibility of a surprise.Because the contemporary market is strongly influenced by professional program traders who regularly buy and sell options on margin whenever bearish tendencies emerge the swings can be quite violent.

Current investor sentiment is quite pessimistic and irrationally so.

Once the stimulus package is implemented and the Federal reserve and other central banks lower rates to more realistic levels which actually reflect the real risks of core inflation rising above 3 % which are diminishing rapidly and approaching 0, the economies will eventually recover.

A typical recession lasts than a year and the loss in GDP is usually under 1.0%
According to data collected by the NBER in the US there have been 17 recessions since 1918(excluding the one now underway).The longest in duration was the famous Great Depression which began in August of 1929 and lasted 43 months until March of 1933.

Every other recession was 16 months or shorter. Ten of them lasted 12 months or less. Since 1945 the recessions have averaged 11 months. If we exclude the 16 month recessions of 1973 and 1981 the average length of the remaining 8 recessions is 8 months.

Once the recovery clicks in stock markets revive and stock prices regain their previous levels. There are exceptions to this including the great crash of 1929 and the long bear market of the 1970s. But on the whole they are exceptions to the rule.

A deficit stimulated recovery has in almost all cases led to a rise in stock prices within 18 months. (See the work of Robert Eisner on this) Unless this is a collapse of 1929 proportions which I personally doubt although one can never tell with certainty the markets will recover.People who believe in the long run Kondratieff cycle should know that we are still in the positive phase of that cycle.Technological innovation continues to be robust and India, China and Asia generally are growing markets with enormous potential. Properly regulated with a proper balance between the private and public sectors the global economy can still produce unprecedented environmentally sound prosperity.

But in the period of uncertainty that now prevails it is essential that the central banks ensure a supply of liquidity at very low rates of interest and recognize that inflation is not   now nor has been for some time our immediate threat.

Governments, journalists and the general public should also understand , as the American Government clearly does that public sector deficits have a legitimate role to play in countering cyclical downturns. They are most effective when combined with an accomodating monetary policy.I have taught this to my students for the past 25 years. I hope wherever they are now(and some of them are in positions of considerable influence) that they remember.

Jan. 22 2:00 am

The sell off continues in Asia with markets losing a further 7 %in some cases on top of their losses yesterday. So it is wise to expect a major sell off when the New York market opens. If the Bank of Canada has any sense which I sometimes wonder about it will cut its rates by 50 basis points or more tomorrow. This kind of financial market panic bordering on hysteria can do very real damage to the economy in short order if is not checked by appropriate decisive action by central banks and governments. Those in Ottawa   and on Bay street who believe that Canada will be unaffected are simply profoundly disconnected from reality.