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The Worst Is Behind UsBy
Tuesday, January 25, 2011
"It's unprecedented," you'll hear people say.
"It's the worst since the Great Depression," you'll also hear. "We've never experienced such bad times."
Actually, we have experienced such bad times.
Not in America, maybe. But since World War II, we've seen 18 significant financial crises like ours today. These include Japan starting in the early 1990s... the Asian crisis starting in 1997... Spain in 1977... Argentina in 2001... and the list goes on.
The question is... What do those crises tell us about ours? A lot actually, as I'll show today.
How long did they last? How far did home and stock prices fall? How bad did unemployment get? And what about government debt?
I have the answers.
To spare you the suspense, the U.S. experience is right in line with the averages of those 18 other crises. That surprised me, but it's true, as I'll show.
If the outcome in the U.S. is anything like the outcome in these other 18 instances, the worst is behind us.
This isn't my work... This is the work of Carmen Reinhart and Kenneth Rogoff in their book This Time is Different, Eight Centuries of Financial Folly. Let's take a look at the answers to those specific questions above...
Rogoff and Reinhart found that, in these 18 post-war financial crises, home prices fall an average 35% over an average of six years. So far, house prices in the U.S. are down roughly 31%... And it's been nearly four years since house prices peaked. In short, the worst appears to be over. (Note: Rogoff and Reinhart use inflation-adjusted prices, and I'm using actual prices today. But the inflation rate has been low in the U.S. over this time.)
They found stock prices fall an average 56% over an average of 3.5 years. Our stock market fell 57%, but it only took 18 months. Stocks have nearly doubled since bottoming in March 2009. After such an enormous rally off the bottom, the worst seems to be behind us here.
They found the unemployment rate usually rises by seven percentage points and peaks just over four years in... In our crisis, we're at the four-year mark now, and unemployment is up 5.2 percentage points – a little better than average.
Lastly, Reinhart and Rogoff found that government debt "tends to explode." It rose an average of 86% in crisis. So far, our government debt has "exploded" 62% since the end of 2006. (They give an interesting description for why government debt explodes... It's not the cost of bailouts, they explain. "The biggest driver of debt increases is the inevitable collapse in tax revenues.")
Everyone believes we're in uncharted territory... and we've never seen this before. That might be true for America in recent decades... But it's not true when you consider the rest of the world. We've had plenty of crises.
Based on Reinhart and Rogoff's work, the current financial crisis in the U.S. is about as close to "average" as you can get, based on the 18 other major post-war financial crises.
Could things get worse? Absolutely.
But as I've shown above, Reinhart and Rogoff suggest the worst is behind us. I sure hope they're right...
Good investing,
Steve
Further Reading:
"Where do I think the market goes next? The very worst case would be like what we just went through from July 2007 to March 2009," Steve says. But "I don't expect we'll see that." Find out what Steve does expect to see here: Where the Market Goes Next.
Market NotesA HUGE DAY FOR AMERICAN FINANCIAL HEALTH COULD BE COMING Day by day, XLF marches closer to a huge breakout...
For much of the past year, we've highlighted the action in the big financial fund, XLF. With large weightings in Goldman Sachs, JPMorgan, Bank of America, and Citigroup, this fund consists of the "who's who" of American finance. Its price action is a picture of America's banking health.
XLF enjoyed a monster "from bad to less bad" move in 2009... and screamed more than 100% off its credit-crisis low. It then spent a year in a giant sideways trading pattern. During this big sideways pattern, bulls and bears constantly argued on which way XLF would break.
As you can see from our updated chart on the situation, the financial bulls are winning. XLF is steadily marching higher... and is a whisker away from a multiyear upside breakout. If this breakout occurs, it's a further sign that at least for now, America's banking system is getting stronger, driving profits higher, and in a confirmed uptrend.
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