According to one on-line dictionary of current urban language usage, the word “epic” now means: awesome, legendary, failure, amazing, stupid, cool, sweet, great, lol, sick, funny, crazy. Oddly, all of these seemingly unrelated words could be used in some context to descript global markets this week.
The week also saw blood draining from people’s faces as memories of 2008 came flooding back. It was almost exactly three years ago this month when markets started to rumble and gyrate—the start of the “epic” market meltdown and Great Recession of 2008-09.
While there are similarities, 2011 is not 2008. And it’s unlikely that we’re in for the same sort of market collapse we saw three years ago.
First of all, the fuel of the 2008 meltdown was an overleveraged US economy, and the match that started the fire was the collapse of the investment bank Lehman Brothers. The financial institutions were full of the now-famous “toxic assets”—basically, rotten debt. And because of the interconnectedness of the global financial system, no one wanted to lend anyone any cash. Credit dried up for almost everyone, including the Mom-and-Pop businesses on Main street. Soon, even perfectly solvent businesses couldn’t access credit... or pay their bills and the recession was born.
But the trigger that started this week’s market mayhem was a downgrade of US government debt. Lehman had no money to pay its bills, while the US government does. The debt-ceiling story in July and early August was not a financial problem, it was a political one. The US economy is perfectly able to pay its debtors, either through cuts to spending, or through raising taxes. There are options on the table, but US politicians can’t agree on which bad medicine it wants to swallow. Lehman Brothers, on the other hand, had no options, and no medicine. It was bankrupt.
Secondly, leading up to 2008, enormous bubbles in both the US housing market and global equity markets were building. No one wanted to spoil the party, especially in the housing market where everyone was getting rich! But looking back it’s plain to see that problems were brewing. Typical for market bubbles, the bigger the bubble the more painful and spectacular is the bust. In 2011, however, there aren’t really any bubbles to burst. The US housing market is still DOA from the collapse it suffered three years ago. Stock and commodity prices, while having recovered significantly from the lows in 2009, are less out of line with reality than they were in the summer of 2008. Today, only gold is showing classic signs of a price bubble.
Third, company stocks in 2008 were crashing because investors feared US corporations were insolvent—or if they weren’t, they would be soon. The lack of business credit, combined with a massive contraction of consumer spending between 2007 and 2009, painted a very dire picture indeed. Investors were probably doing the right thing, especially since price-to-earnings (P/E) ratios were too high for a lot of corporate stocks three years ago. But in 2011, the situation is entirely different. Corporate America is stuffed to the gills with cash. At one point during the US debt ceiling crisis, it was reported that Apple Corp. had access to more cash than did Washington. And P/E ratios are much more balanced; indeed, many stocks are still undervalued. Investors will wake up to that fact, and as a result stock markets are far less likely to crash like they did in 2008.
This isn’t to say that 2011 is great. In fact, some factors suggest the situation is even worse. The European sovereign debt problem is very serious, and a Greek government default could still lead to a run on European banks. The euro could fly apart. China is dealing with inflation and fears of inflated asset prices, particularly in real estate, and is trying to actually calm growth by tightening credit.
Worse yet, the prospect of a US double-dip recession has re-emerged as a distinct possibility. Revisions to the data show that the last recession was much deeper—and the recovery much weaker—than previously thought. Moving into the second half of 2011, growth is stalling out. It’s impossible to predict with certainty what will happen next, but with unemployment stuck above 9%, growth in the US will be slow at best.
This week has tested the resolve of investors and market watchers, and has stirred up the ghosts of 2008. There is no way to candy-coat the volatility in the markets—the global economic situation is not fantastic. Markets may continue to wobble and shake over the next few weeks. Greece may default. It won’t be pretty, but it also won’t be the credit-induced collapse witnessed in 2008.
It will be, plain and simply, epic.