Retail update, Volume and Volatility, amazing photos, and a heartwarming Holiday story

Sunday Morsels

Each Sunday (well...Monday this week), I toss out a few ideas that I have been thinking about during the week which don't quite make it into full-blown Posts. If I receive enough feedback on any given topic, I'll expand on it in the future. Let the commenting begin!

First - Retail update on the last shopping weekend before Christmas: J. Crew, Gap, and other midpriced clothing stores were just as busy as in previous years -- as predicted by moi 6 weeks ago, retail sales will be somewhat lower than the recent past but not a total disaster. However, high-end retail is a total disaster. Paul Stuart and Michael C. Fina were empty, and Tiffany's good floor traffic could be somewhat misleading as it is a magnet for tourists who can't afford the jewelry but want to tell their friends in Dubuque that they went to the famous Store on 5th Avenue.

Second - There has been a noticeable decline in stock volatility and trading volume over the past few weeks...far more than can be explained by the traditional Holiday vacation slowdown. What's going on? Are we setting up for the new Bull Market, as an endless string of pundits have predicted? Hardly. We are seeing the Beginning of the End of the 25-year mania for stock investing as a long-term guarantee of compounding wealth...the mistrust of Wall Street (AIG/Bear Stearns bailouts, Citigroup $300 Billion guarantee to stave off collapse, WaMu/Wachovia failures, Madoff/hedge fund lack of due diligence, excessive Executive/banker/trader compensation, annuities potential defaults, and so on) is starting to build. There's going to be mass apathy and anger (not necessarily in that order) towards stock investing over the next several years, and it is possible that we are witnessing the first stage of a total breakdown in the presumed pattern of comfortable retirement after 30 years in the workforce. I'll have much more to say on this topic in the weeks ahead.

Third - stunning photography from all over the world. Enjoy!

Last, but certainly not least, a great story about generosity in the face of difficult times.

Madoff, Malls, and Misery

Sunday Morsels

Each Sunday, I toss out a few ideas that I have been thinking about during the week which don't quite make it into full-blown Posts. If I receive enough feedback on any given topic, I'll expand on it in the future. Let the commenting begin!

First off - Dozens of well-off New Yorkers and Floridians lost millions in the Madoff ponzi scheme, and some of them are crying over money as if their child had just died. Whilst I fully agree that the SEC was asleep at the switch and Madoff himself is a crook who deserves not one iota of empathy, these adults who dumped practically ALL of their liquid assets in one investment should look in the mirror and ask themselves who is ultimately to blame. Give 10 or 15% of your assets to a trusted friend....Sure. Concentrate your entire financial existence in one basket (regardless of how confident you are in that advisor's abilities) and you are your own worst enemy. It's the Airplane Yellow Oxygen Mask theory - make the right decisions for yourself first, or risk becoming useless to everyone around you.

Second - I was shopping the stores this weekend, and Lo and Behold my prediction from over a month ago appears to be coming true -- the stores were packed. Bloomie's, J. Crew, Williams-Sonoma and sundry other stores were all doing brisk business. Look for Media news stories to start appearing in about 10 days' time which corroborate what my Blog readers already know: Holiday 2008 will certainly be down from recent years, but far from a disaster.

Third - Everyone on the Equities side of the financial services industry, and to an extent millions of investors, currently suffers from a case of "Volatility Fatigue". The daily swings in the market, which have been relentless for nearly three straight months, have put people into a state of acceptance. The zeitgeist now is "OK, I am down 35-40% on my 401K...I have made peace with that fact". I sense a blanket of calm resignation and a collective mental writeoff of 2008 as a year to forget. The hope is for a partial (real estate/stock market) recovery in '09....let's see how the populace handles the situation 6 to 9 months from now when credit is still tight, hundreds of thousands are losing their jobs, and government bickering (as witnessed over a paltry $15 Billion to assist the auto industry) yields a continued "no confidence" vote in the marketplace.

Where are we right now on the Fear/Greed meter?

If there was a scale that calibrated Maximum greed as a +10 (internet stocks in late 1999, real estate in late 2006, commodities in spring 2008) and Maximum fear as a -10 (depths of the Great Depression in 1933), where would we be today in the midst of the Global financial crisis and economic meltdown? In my opinion, we are roughly at a +2. Yes, a +2. There seems to be an inordinate amount of attention focused on not missing the next Bull market (some actually called a bottom in JUNE of this year), and near-zero apprehension of a possible Decade-long malaise in the majority of Industrialized western nations. While we are currently enjoying a respite from the relentless downward stock action of Sept/Oct/Nov, the chances of seeing any signs of economic recovery in the next several months is near-zero. In fact, my readers were the first to see the case for a huge retrenchment in National consumption and production that will make all recessions of the past three decades look like a walk in Central Park on a balmy Spring day.

I am herewith reprising excerpts from a recent email exchange with a friend of mine, which I believe is typical of the mindset of the average investor with 6 or low-7 figures in assets. My responses to his queries are in bold italics.

Q. When do we realize this economic deflation, and how long do you expect that to last?

Economy's been deflating radically for months -- stocks are down 40%, real estate 20-40% depending on where you live, and have you shopped for clothes lately? Unprecedented sales. Circuit City, Linens 'N' Things, and many more stores (or dozens of locations of larger chains such as Ann Taylor/Talbots) will be closing over the next 12 months. Commodities also down huge....this is Deflation. Everything drops in value due to lack of demand from consumers. Expect this to continue for at least another year, at which time the equity markets will be seriously lower than where we are now. Be aware that we are in the middle of a mini-rally in stocks which may last another month or two. The consensus is that we are close to the end of this recession and by the fall of 2009 the economy will be back on the upswing. In my opinion, this is the single most dangerous presumption that an investor can make. No one under the age of 85 has lived through a collapse of the world financial system such as we are seeing today, and the damage will last for several years.

Q. When do you think we will bottom? What will be the cause of the halt? At some point, (the hoarding/saving will cease) and we can't purchase any less as a society? Using your knowledge and experience, build a two likely scenario for the next 5 to 8 years.

We will see the deleveraging of the individual - much in the same way that the institutions in the financial sector have shrunk/become insolvent. The mistake everyone seems to be making is that there will be tons of bargains in stocks and real estate to be had. That will only be true for a relative minority of people who didn't get wiped out/lose their jobs along the way to the bottom. Believe me, when your neighbor's house sells for 60% off its peak value and your retirement savings has dwindled by 70-80% from its peak, and your job can only pay you the yearly income you were making in the late 90s - you won't exactly be hunting for investment bargains at that point in time. Millions of people will be in the same boat. We are going to unwind all the gains that were built on excessive credit (home equity, credit cards, stock investments, etc) that have been falsely presumed as a birthright for living in the U.S. of A. in modern times. Given the dissonance between people's naive presumption that we can't get much worse than the current economic environment - and the reality of the ongoing unwinding of leverage and credit, it would not surprise me to see the Dow trading at 4000 within two years (not withstanding the mini-rally up to around dow 10000 in the next few months). I suggest readers look at FDR's spending programs as an example of how ineffectual government can be. The depression rolled right along for 8 Years after FDR's first progams started, and despite all of govt's best efforts we did not get out of the economic morass until we got involved in World War II.

Q. Do you see the unwinding going to realistic values or will they descend beyond because of loss of faith in the economy after peoples expectations for a rapid recovery to pre-existing values are dashed? I have heard some people speak of P/E ratios they see as favorable in many stocks at this point in time. Are they wildly mistaken? As for history, I think it gives structure and meaning to the present. Does current communication technology alter the parallels to history? Does it sufficiently alter population awareness and reaction time to a point where we can no longer anticipate timelines for events such as these (as if we really ever could before)? Is the relatively blunted population response (ie, overall panic) reflect naïveté or a better collective understanding of the situation?

With near-certainty, I would say that a total loss of faith in our economic system is coming. Such a radical shift in mass psychology doesn't occur overnight. people have been conditioned to think the natural state of economic matters is always better in the 'long run'. Guess it depends how you define 'the long run'...life in the early 1950's was better than in 1928, but we had a disastrous 16 years in between. "I have heard some people speak of pe ratios they see as favorable in many stocks at this point. Are they wildly mistaken?" 'Wildly' is a severe understatement, and ties in with the general naivete about the severity of our current worldwide situation. Do you understand what the E in P/E stands for? It's already sinking rapidly. I started this Blog specifically to provide some insight other than twaddle from so-called 'professionals' who have zero standing to discuss the future, since they were completely clueless in warning anyone a year or two ago about the financial tsunami currently upon us. "And as for history,..." The history of economic man is encumbered by two fundamental forces: Fear and Greed. You've seen the heights that Greed can take us to...and now you are going to witness the other side of the coin firsthand. The fact that investors as a whole are still concerned about 'missing out' about bargains in the next up-cycle which is surely to be right around the corner is an indicator of where we are in December 2008 on the fear/greed meter....which is to say "nowhere near Fear". Human beings are no different in their Base emotions than they were 50, 500, or 5000 years ago - only the technology changes. When we get to real Fear, when unemployment is at 10% and everyone finally realizes that government intervention can't solve a crisis of world proportions, we'll be much closer to a buying opportunity in the stock market - call it late 2010 for an estimate.

This conversation is crucially important for people to understand just where we are in the down-cycle, which is to say "very early". Remember, no one who works in the industry is coming on TV or writing anything negative in a major media publication because they CAN'T. You think you are going to hear "investment professionals" publicly tell you to run for the Hills? Their livelihoods depend on YOUR assets being fully invested in stocks, mutual funds, real estate, emerging markets, etc. so they can take management fees and commissions off you. Don't be so foolish as to equate "professionalism" on Wall Street with expertise in other professions. They are all SALESPEOPLE, nothing more. This should have been obvious to all my readers a long time ago.

The four stages of a complete Cycle in a Consumer-based economy

Analyzing the mass psychology of consumerism is becoming a cottage industry these days. Rather than refer you to other ponderous sources, let me explain the Cycle in simple prose:

First, we spend money we have. With few exceptions, the United States spent the first 100+ years of its existence with relatively little in the way of burdensome debt. If one couldn't pay cash/barter with labor for a particular item, then it would not be acquired. A reasonable amount of borrowing came into vogue in Post-World War II society (the GI Bill and whatnot), but I would tend to include that kind of debt here and not in the next phase below simply because the debt made complete sense in relation to current collective income and growth prospects. This is the foundation of a capitalist economy and, although there may be mini-booms and small recessions, it mostly works out well.

Second, we start spending money we don't have. This phase actually started in the 1960's with the Johnson administration's "Guns and Butter" policies. Later, in the 1980s/90s and most clearly in the Housing bubble of 2003-2007, society got more and more comfortable with a lifestyle that was detached from current income. It's not enough, as is the wont of human desire, to be content. We have to get the SUV, the bigger house, the granite/stainless steel kitchen upgrade, and so forth.

Third, as we reach the outer limits of borrowed money against future earnings and our credit lines from item #2 start dwindling, we stop spending money we don't have. This is where we currently are in the cycle, and the denouement is vicious. All the economic gains from item #2 are exposed as an illusion, built on the shifting surface of loose lending standards.

Fourth, as the populace is slowly but surely panicked into mass-saving after having seen the end long-term results of item #2 and #3, we stop spending money we do have. This has been the situation in Japan for at least the past 10 years, where the savings rate until recently has been something on the order of 12% (for comparison, the savings rate in the U.S. is very close to Zero percent). Could it take a decade of fearful nut-gathering before the U.S. Consumer Squirrel comes out of hiding again? Stay tuned.

Obama's upcoming infrastructure stimulus...is it the Answer?

Sunday Morsels

Each Sunday, I toss out a few ideas that I have been thinking about during the week which don't quite make it into full-blown Posts. If I receive enough feedback on any given topic, I'll expand on it in the future. Let the commenting begin!

First off - the Obama plan to create 2.5 Million new jobs over the next 2 to 3 years. A few observations:

1. The economy has lost roughly 1.2 million jobs thus far in 2008...Obama's economic team finds it necessary to pull out all the stops and create Double that amount of jobs. What does that tell you about the depth of the coming unemployment problem, in the opinion of the President-elect's economic team? Guess all those genius analyst talking heads on Bloomberg TV and other financial media who keep screaming about a quick V-shaped recovery are going to be begging for a job riveting bolts on bridges next year.
2. Didn't Congress just approve a $700 Billion rescue package designed to halt the downtrend in home prices and simultaneously boost the capital and lending capabilities of major Banks and Investment dealers? How's that looking right about now? Point is, who's to say what the REAL infrastructure package will look like a year hence, and to what degree it will be effective in accomplishing the original goals set forth by our all-knowing leaders?
3. The cost of creating 2.5 million jobs (figure $100K per, all-in with benefits/taxes/organizing costs) is a somewhat reasonable $250 Billion. The problem is that we are so far overextended, what with the Fed's balance sheet a mess, the tax revenue base dropping at the Fed/State/Local level, and the never-ending cost of rescuing the Banking system, that our Government is starting to look like the American consumer - tapped out with little or no rainy-day savings. We'll see how this plays out.

Secondly - am I the only one who thinks Jason Zweig's recurring column entitled "The Intelligent Investor" is so incredibly naive as to be outright dangerous as a piece of financial guidance? Take a read of some recent sample articles and let me know what you think.

Finally - Happy Turkey Day everyone...special shout-out to my Nephews in Malibu!

Holiday Retail sales analysis: a 3-part process

I spent all day yesterday shopping the stores here in Midtown Manhattan -- Gap, Banana, Williams-Sonoma, Pottery Barn, J. Crew, and Bloomie's. It dawned on me that there are 3 separate events happening, and any one of them can make or break the Christmas shopping season.

1. People have to actually show up in the stores and browse the merchandise with intent to buy. Bloomie's and J. Crew had reasonably good floor traffic; Gap/Banana and Williams/Pottery less so.
2. Consumers in the store must take goods to the register and pay for them, not just 'consider' an item and then put it back on the shelf. This bullet point sounds self-evident, but believe me it is not. I saw a heck of a lot of shoppers doing 'Touch and Feel' without actually getting into a checkout line and whipping out the credit card. Gap and Williams-Sonoma seemed to have a fair percentage of actual spenders, which may partially offset the lower floor traffic. Pottery Barn and Banana, in this observer's opinion, were noticeably weak in both points 1 and 2.
3. The most important aspect from a Retailer's perspective this year: what kind of incentives are to be given as an inducement for consumers? On this score, we have a huge problem for retailers (and a big Home Run for those of us with a steady job). I have never, in 17 years of shopping the stores, seen this depth and breadth of markdowns on the floor pre-Thanksgiving. Bloomie's was 30-40% off names that are NEVER on sale - Armani, Boss, and so forth. I'm sure there were equivalent discounts in the women's sections. My sister reports in from the West coast that Saks has tons of stuff at deep discounts as well. Don't bother logging on to their website, she's rigged it to lock out any potential competitors until she's finished buying what she wants. Try back in a week, she'll be done by then. I think.

Conclusion: Holiday traffic, though certainly not at the levels of previous years, will be pretty good vis a vis the dismal expectations of most analysts - but Gross Margins for retailers will be seriously compromised. Expect 4th quarter reports to show reasonable top-line sales, but a serious year-over-decline in net income due to GM compression. You heard it here first.

GM borrows from Citi, Wells, B of A, Morgan....

Sunday Morsels (New Feature!)

Each Sunday, I'll toss out a few ideas that I have been thinking about during the week which don't quite make it into full-blown Posts. If I receive enough feedback on any given topic, I'll expand on it in the future. Let the commenting begin!

First off - the GM/Chrysler government loan debate. Why are the auto companies running to the government for a Lending Hand, when the government just gave $125 Billion to the major banks with the express intent to LEND IT OUT to corporate and retail customers? Why aren't 5 or 6 major banks not getting together and syndicating out $25-$30 Billion in guarantees to the auto manufacturers (with covenants that may involve Union/management concessions)? This is hardly Rocket Science, yet I hear no one in the Mainstream media tossing such an idea out there for discussion.

Secondly - some ground-level observations on the retail trade here in NYC...Tourist traffic is decidedly lower than the same time last year; hotel vacancies are up; Broadway is down; retailers (including cheap shopping such as H&M) are definitely suffering; and you can get a table on short notice at most restaurants. All in all, my ground-level observation stands at odds with the previous controversial post about a less-than-horrible Christmas shopping season. Let's see how it plays out over the next 4 weeks.

Third - a WSJ article that should be required reading for anyone who thinks we are in a mild or moderate recession. Wake up, people.

Annuity (Mis)Management is destroying well-known Insurers

In literally 6 months (or less), we may see a "run on the bank" in the Insurance industry -- specifically a withdrawal of Variable annuity and possibly Fixed annuity assets from weaker players such as Genworth, Hartford, and Lincoln (Symbols GNW, HIG, and LNC). Once annuityholders and/or their financial advisors get the belief that their policies are in any danger of nonpayment, advisors will switch clients out of perceived weak institutions within weeks if not days. The fact that these three companies are now buying captive banks in order to qualify for TARP assistance does not solve the intermediate-to-long term problems of deteriorating investments.

As the bulk of the recent market correction occurred beyond the conclusion of the third quarter, surely additional losses have occurred in the past 6 weeks. Capital levels are severely impaired and the prospect of raising new capital is limited in this environment.

Balance sheets of the major insurers can't simply be 'fixed'. The Hartford, for example, has any number of asset deterioration issues, including $10 Billion of CMBS bonds, $2 Billion of Subprime, and $5 Billion in formerly safe Financial Services industry bonds (GE, Citi, AXP, and so forth). $11 Billion in DAC (Deferred Acquisition Costs), sitting there as an asset -- a significant portion of that is related to VA business written in the past few years which will never be profitable. Life division only: $46 Billion in bonds and real estate, 'pick a number' as to what that is worth. Liabilities for future unpaid benefits: $16 Billion. the $16 Billion in future benefits is a lowball number based on some kind of prior 'normalized level' VA utilization rate on the guaranteed payouts....so the REAL liability could be multi-billions higher. On the income side, revenues are no doubt grinding to a halt the past two months.

Principal Financial Group $60 Billion of investable assets, $20B rated Baa or lower, $400 Million in impairments aka writedowns for the first 9 months of 2008, $86M of which was Lehman. Principal carries $4 Billion of net Unrealized losses on its fixed income assets (1.8 B on securities maturing in 12 months or less) - compare to 12/31/07, a small net unrealized gain. Potential commercial mortgages listed as a potential problem": just under 1%. Principal holds almost $10 Billion of res/commercial MBS and other ABS. What's worse - top-line revenue is stagnating in conjunction with the funding issue...what a deadly combo. Analogy: it's like an individual who has to take a huge pay cut to keep his/her job, while at the same time their credit card lines are closed off and they have a limited amount of liquid assets to tap in order to meet the monthly expenses, which are mostly of a fixed nature.

The real drivers of financial volatility in this sector are DAC writedowns, hedging losses associated with insuring benefits within VA, and profitability models that will not be realized. DAC represents the cost of the commission (approximately 7% of the total contract) that is fronted by an insurer to the salesperson/agent. Hedging losses are linked with investments designed to cover the cost of future payments (‘living benefits’) to policy holders if the equity markets fail to perform. This leaves a significant portion of an insurer’s portfolio unprotected against loss. What will be the future utilization rate of the lifetime living benefits feature? Insurers are now on the hook to pay income to their client base for an indefinite period of time -- conceivably 20-30 years if clients begin to exercise this option en masse in the near future. Does an insurance company have sufficient cash reserves to pay claims or surrenders in an environment where underlying investments have fallen apart? When you calculate the bond/real estate losses backing the FA, the VA DAC write-downs, breakage of hedging strategies, and mispricing of living benefits that are certain to have much higher utilization rates than expected, the all-in writedowns/losses easily climb into the Multi-billions.

Holiday retail sales: not the horror show presented in mainstream media

Ever since October's retail sales figures were released, there has been a growing chorus of Grinches declaring the yet-to-arrive 2008 Christmas season a total washout. Respected (?) professional investors are yelping about the "Worst Holiday season in 25 years" and such. Here's a thought: Instead of extrapolating October's awful numbers in a three-month straight line to a December mass-markdown, how about we inject a little Behavioral psychology into the thought process?

• Consumers aren't oblivious to the fact that the Holiday season is right around the corner -- they stopped spending money in October, at least partially, because they don't want to disappoint their kids/families come Christmas. What is happening to some extent is a 'substitution effect' whereby October sales were sacrificed into the future and will manifest as late-November and December spending.
• Analysts have taken expectations down so low that we have plenty of room for an 'upside' surprise. Even though sales will certainly be less than recent years, they will exceed the now-developing horrendous consensus. Retail stock rally in late November, anyone?
• Concomitant with the development of this post, I did a search in the New York Times to see if any previous Holiday seasons had surpassed lowered expectations in a weak economic environment. Lo and Behold, it happened in one of the worst years since WWII -- December of 1974. Don't be surprised to see the same kind of headline in about six weeks.

Don't get me wrong - I am quite Bearish on the economic picture for 2009, starting literally right after the New Year's Ball drops (great metaphor). Forget about small fry like Circuit City, we are going to see some Major-league store closings next spring. More on this topic to come in December...stay tuned.

Triple-levered equity indexed ETFs are now trading

Three times the return of a market index, easily accessible to any retail investor? No problem! Within the complete prospectus filed at the SEC , take a gander at the subsection entitled "Principal Risks". Notice all those capitalized X's in the chart? Yeah...me too. Oh...and I believe these exchange-traded instruments are fully Marginable at 50%, so your theoretical leverage could be SIX to one. Perfect for the 401K !

There are a few other blogs/sites that have questioned the wisdom of listing such securities as we fall headfirst into the biggest credit crisis and deleveraging of all time -- but I'd like to take it a step further, back to the Source. ETFs don't just magically appear for trading, they are allegedly put through a stringent review process. Exactly what was the conversation at the SEC a week or so ago, when these funds were given a government stamp of approval? I doubt that discussion is a matter of public record, but let's look at a few realities:

1. This is an even more egregious circumvention of Federal Reserve margin requirements than the current Ultra ETFs with 2x leverage;

2. Retail or institutional investors who need exposure to equity index movements can already get substantial leverage in the super-liquid Futures and Listed Options markets;

3. To sanction these ETFs at this particular time, in the face of a systemic DE-leveraging currently traversing worldwide financial markets (not to mention a credit crunch that has prompted in excess of a Trillion $ of emergency funds from the Fed), is just incredibly tone-deaf. It's as if the SEC's investment management division has no experience in either the structure of equity markets or judicious public relations.

Equity provision for residential real estate lenders

Following is an unpublished letter to the Editor of the New York Times submitted on Sunday, October 26, 2008. The impetus for this particular letter is a total absence of discussion in the financial media of what I believe to be an obvious solution to the competing interests of institutional lenders and retail borrowers stuck in nonpaying Subprime/Alt-A mortgages.

Editors:

We now have hundreds of billions in mortgage relief authorized at the Federal level ('TARP'). Here's a simple and logical implementation, which helps those who have bought a home in good faith while simultaneously protecting both lenders and the banking system.

• Keep people in their homes via a reduction of monthly payments to something "equitable". Establish a 'going rate' at a given household income level, and a principal reduction concomitant with a particular neighborhood. For example, borrower pays 25% of after-tax monthly household income based on a principal reduction of 20% of the outstanding mortgage balance.
• This is the key provision: Lender takes anywhere from 20 to 80% of the equity appreciation going forward (with a buyout/paydown proviso if borrower finds him/herself in a better financial position in the future). The exact percentage would depend on the particular level of relief applied to each original mortgage/monthly payment. Why is this essential? It serves two important purposes. 1. It avoids mass-foreclosure -- entire communities with boarded-up houses and its attendant negative social consequences; and 2. Borrowers who carry a bit too much of an outstanding mortgage do NOT get to participate in the eventual recovery of property values several years hence. This is an essential component for political expediency (deflects anger from the 'my taxes should not fund someone's grab at a high lifestyle/outsized home' crowd), and it simultaneously protects lending institutions/federal government from locking themselves solely into low-rate returns into the future by giving them an equity kicker.
• There will be a bunch of people (probably in the low hundreds of thousands) who DO deserve to face foreclosure proceedings because they either lied about their income or took on WAY more (not a little more) than they could handle. All of those people will have to suffer the consequences of their greed/poor decision making, excepting the case of Lender fraud or deception.

More typically, we are talking about a family with household income of maybe $100K who got a 500K mortgage when they really should have a 375K mortgage. They would clearly fall under my 'plan'.

I believe that such a framework will serve all three constituents (borrowers, lenders, and taxpayers footing the rescue plan) fairly.

Editorial on deleveraging and linkage to the depth of recession‏

Following is an outline for an editorial submitted on Sunday, October 26, 2008 to two major national financial publications. The impetus for this particular discussion is the total dismissal by the financial media (Print, TV, Internet) of the possibility of a modern-day depression.

No one is making this connection, and I think it is both intuitively obvious as well as vital for an understanding of why a modern depression scenario (definition: 10% peak to trough reduction in annual GDP) isn't out of the question.

1. Everyone agrees there is massive worldwide deleveraging in all financial organizations (notably banks, dealers, HFs) across the entire investment spectrum: commodities, equities, CDOs, CDS, and all manner of securitized Real Estate/consumer lending vehicles. As many pundits have already noted, US Equity markets (and to a large extent, most major Foreign marts) have already unwound every single dollar of gain since Spring of 2003.

2. Everyone further agrees that GDP over the past five years, at the margin, has benefitted from a not-seen-in-decades upsurge in real property origination, construction, and sales - with its attendant trickledown into the materials/industrial sectors, as well as home improvement/furnishings sectors via aggregate lending of multi-trillion $ worth of HELOCs/second mortgages. Government statistics indicate, conservatively speaking, a 29% cumulative increase in Nominal GDP from FY03 to FY08 (depends where Q4 comes in).

3. Everyone agrees that profits from (2) as well as consumer funds borrowed against the real estate bubble and (in the case of NY, CT, Chicago, and Calif) massively outsized financial services/HF compensation (I'll cuff that at a conservative figure of an incremental $150 Billion per year) has goosed GDP numbers over the past 5 years vis a vis previous 'normalized' patterns of personal income and spending.

4. If (1), (2) and (3) are essentially true, can there can be any other conclusion but that some significant portion of GDP growth over the past five years has been a one-off illusion? Since the entire economy is now in serious spending-retrenchment mode, and increasing unemployment is a given for the next 3 or 4 quarters, is it so far-fetched to believe that this recession could rewind the economic clock back to something close to 2003's figures?

And, just to put the icing on the cake -- unlike the deflation of the internet bubble in 2000-2002, we will not be subsequently pumping up the economic base artificially via a new bubble due to the fact that Leverage in all capacities is soon to be subject to stringent regulation. Hence, the runup from 8,000 to 14,000 on the Dow was, at its core, pretty much a Fake rally achieved on the back of systemic leverage throughout the investment chain.

Investors tend to psychologically 'anchor' themselves to the most recent results in any tradeable market and make a presumption that said recent highs (Dow 14K a year ago) or lows (Dow 8K at the last bear low in 2003) are reflective of a 'normal' level. Unfortunately, an anchor mentality only serves to obscure those future equity returns which may be realistically achieveable - to say nothing of the potential level of the low point of the Dow/SPX in this particular cycle.