Random Market Thoughts: When does the downward spiral stop?

There's a lot of fear out there that we're going into a depression, or that we're going to suffer deflation, which seems to be everyone's worst nightmare. I'm not an economist and don't really understand why deflation is such a Horrible Thing or why inflation is somehow less worse. I read somewhere recently that deflation represents an "inverse bubble" in which people keep hoarding cash and don't buy goods or make investments even at attractive prices. I don't see how this vicious circle (positive feedback) is necessarily what's to be expected. Instead, I expect a usual stock cycle (negative feedback) in which stock prices decreases till they reach a floor and then rebound as economic growth resumes. So what factors will create a floor under stock prices at their bottoms?

Right now, those with little cash:

financial companies

Those with more cash:

many non-financial companies

Those with a lot of cash:

few non-financial companies, either with cash saved up, or with strong, regular, predictable cash flow

As stock prices continue to slide, those non-financial institutions with lots of cash will see value in non-financial institutions with less cash. Consolidation will be the name of the game. Many public companies will be bought by private owners. Expectation of being bought can provide a floor for stock prices.

As stock prices continue to slide, dividends will continue to rise. Right now, GE has a yield of 6.1%. Merck's is almost 8%. These are approaching very compelling valuations. As they continue to rise, investors will choose to own stock rather than buy fixed-income investments or Treasury securities which pay a lower yield and don't have the potential to provide additional returns from price increases like stocks.

As stock prices continue to slide, PEs will continue to shrink. Right now, AMAT has a price/sales ratio of 2. As I've told Brandon in the past, I've been waiting to buy AMAT for over a decade. My standard for "great value" is when AMAT's P/S ratio is 1. Unfortunately, I missed the 1995 massive capital expenditure chip cyle, so I've been waiting for the last decade. The industry has matured and is no longer cyclical, but if and when AMAT's P/S ratio becomes 1, I will buy far out of the money 2011 LEAPS. More generally, when prices go low enough, there will be people who will realize that stock XYZ hasn't been this poorly valued in the last 5 years, 10 years, 20 years, etc and will step in to buy.

So that's my answer as to why a usual negative feedback stock price cycle will happen rather than a positive feedback vicious circle: consolidation and expectations of consolidation, dividend increases, and attractive valuation.

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Banks do not have "little cash"

Bank reserves at the Fed are off the charts.

The problem is precisely that banks are hoarding that cash and not loaning it, especially to each other. But that's simply not the same as saying they don't have the cash.

P.S. Merck is weak because its patent expiration timeline is a wreck. GE is weak because it's a financial company as much as an industrial company (they just announced the suspension of stock buybacks because the money is needed at GE Capital).

Stocks trade where they trade for a reason. Always.


GE has on average doubled its dividend every 6 years for nearly 40 years now, and the dividend has never decreased. With a yield today of 6.1%, that is approaching compelling valuation for the conservative investor. As the price continues to drop, the yield will continue to grow.

Bank Reserves Up?

"Bank reserves at the Fed are off the charts."

Why's that? They were negative in January. Did the Fed just pump them full of cash somehow?

You make it sound like this is all due to banks hoarding cash when it appears the opposite. The reserves can go up by the mechanism in that link, which isn't about people saving money and banks hoarding it.

One reason reserves at the Fed might be at an all time high is that the Fed has made some beneficial deal this or last week (which I don't remember) for them holding their reserves with the Fed.


Seems to me part of the problem is the evolution of the meaning of "money." 90% of the "money" in circulation is electronic book keeping entry. Less than 5% is paper or metallic markers, "cash." the rest is checks, money orders, and other commercial paper.

"On the books" has taken new meaning, "cash" and "money" now mean "credit." We sell something and use the credit to "buy" something else, a hard asset like land or the use of another person's time, say a dentist. We sell our labor for credit on the books.

The best explanation of international finance is that the value national currencies is determined by a sort of averaging the commodities market. For example, a person who owns a tanker load of oil doesn't care where it is sold because he will get the same value of credit in each port. The money traders (unintentionally) work to insure that the oil owner receives the same value if he is paid in dollars or pounds. In other words, on any given day, the same value in dollars or pounds will buy about the same quantity of of oil in London or NYC.

The problem would be simpler if there was only one brand (unit) of credit in existence. The existing world financial system is like building a car out of half metric and half SAE fasteners. The only guy who comes out ahead is the guy who sells wrenches.

I propose a new unit of credit, the work-hour, the economic value of one person using a shovel for an hour. This is an almost universal quantity. Everything else would be measured in multiples and fractions of a m-h. This would at least take the money traders out of the system.