June sharemarket gloom has some black precedents: Kohler

Unless there is a powerful recovery tonight, Wall Street is about to record its worst June since 1930. The Dow Jones Average closed on 31 May at 12,638.2 and last Friday at 11,346.5, a fall of just over 10%.

This is not the Great Crash all over again, although we may be seeing the Great Housing and Credit Crash. But gloom has returned to the markets and the brief optimism of March and April has evaporated.

The March lows are likely to be breached, if not today then in early July. A bounce will follow, as it usually does, but the great risk now overhanging the market is of more credit write-offs and defaults.

The fact is that the credit market has not recovered, the mortgage securitisation market remains closed, US house prices are continuing to fall and foreclosures are still rising.

Gloom in June has a certain resonance. In June 1930, the Dow fell 18%. It was an especially shattering month for US investors because at that point it looked like the crash was over.

The Dow had peaked at 381 on 3 September 1929 before falling 17% over the rest of that month and then recovering more than half of what had been lost in early October in one of the all time great “dead cat bounces”.

Then in late October there was a series of “black” days: Black Thursday (24 October) when a record number of shares were traded, prompting a group of Wall Street bankers to buy on Friday to try to ease the panic; then Black Monday (28 October) when the Dow fell 13%; and Black Tuesday, when it fell another 12% and the number of shares traded was not exceeded until 1969.

The market recovered steadily over the next few months until a secondary peak of 294 occurred in April 1930. The market fell again in May, and then recovered again before the end of the month – beginning the legend of “sell in May and go away”.

It was the fall in June 1930 that really destroyed the confidence of investors – the slide that resumed that month did not end until 8 July 1932, with the Dow at 41.22 – 89% below the 1929 peak.

The big difference between 1929-1930 and 2007-2008 is that we are not seeing the huge volatility normally associated with bear markets, and the sort of bull capitulation that arose at the beginning of the Great Depression. Specifically there have been no really black days of 10% plus losses, and even though the fall in June so far is 10% there has not been an air of capitulation about it or any very big drops.

There were some spikes in volatility around the lows of August, January and March but investors and analysts have, on the whole, been in denial about recession risk and risk of a second phase of credit crisis, especially after the Bear Stearns bailout showed the Federal Reserve coming to the rescue and prepared to do what it takes.

In fact this June has been quite orderly – an advancing darkness has just steadily eclipsed the market.

In fact over the whole eight months of this bear market so far we have not seen any of the 20% advances and declines normally associated with bear markets, such as in 2000-2002 when there were three separate rallies of more than 20% before the bear market low was reached. The Dow Jones is still not even down more than 20% overall and the rallies have all been around half that percentage.

Albert Edwards, the legendary strategist for Societe Generale and one of the world’s great bears, says the Dow will finish 70% below last year’s peak, which implies a level of 4500.

He was quoted in The Financial Times over the weekend as saying: “America is leading the way, diving into deep recession as a collapse in consumer confidence induces the great unwind,” he says. He compares the economy with a pyramid scheme that is poised to crash to earth, and interest rate changes can do nothing to avert it.

Edwards has also said: “Investing on the basis of forecasts is a waste of time” – except his, presumably.

Nouriel Roubini, the great bear on the other side of the Atlantic, wrote in his blog on the weekend: “The delusional complacency following the Bear Stearns bailout is now rapidly collapsing as financial markets are back to panic mode.”

There is, however, one fear that will evaporate quite soon – interest rate increases. Futures markets have been pricing in rate hikes around the globe because of rising oil prices that are resulting in rising inflation expectations, but a new wave of credit losses is likely to put paid to this idea.

An interesting sidelight is that we seem to have seen the advent of “negative window dressing” – that is, where fund managers sells stocks to get the price down before year end, instead of up as they normally do.

The ASX sent out a warning last week to brokers about year-end window dressing, but this post on short selling in Business Spectator this morning highlights what one broker did at 4.10pm last Friday – sold a whole basket of small cap stocks and smashed the Small Ords index by more than 3% in a few minutes.

John Abernethy of Clime, who wrote the post and whose unit price suffered as a result of what happened, is demanding an explanation from the ASX.

This first appeared in Business Spectator

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