An Experiment in Scotch

As any gar­dener will tell you, healthy lawns hardly ever have weeds in them. This is because when a lawn is healthy, it is lush and thick and weeds don’t have a chance to grow. Weeds only show up in a lawn when there is some­thing wrong with the under­ly­ing soil or lawn. If the lawn is unhealthy or the soil isn’t pro­vid­ing the right nutri­ents, weeds have a bet­ter chance of ger­mi­nat­ing and prop­a­gat­ing through­out the lawn.

There has been some talk of green shoots in the econ­omy lately and the stock mar­ket has cer­tainly been doing its part with the S&P up over 30% from its March lows. There seems to be some opti­mism out there and peo­ple are start­ing to talk like the worst reces­sion since 1930 might end in a V rebound to pros­per­ity. The ques­tion is, are the green shoots really a healthy lawn rebound­ing after a cold win­ter or is the lawn dead, the soil use­less and thus what we’re see­ing are essen­tially weeds?

I’d argue we’re get­ting awfully excited about a bunch of dan­de­lions. All of this excite­ment is almost cer­tainly wish­ful think­ing and the peo­ple pour­ing money back into the mar­ket right now are likely to be very dis­ap­pointed come sum­mer when it gets hot and the weeds shrivel up and die. The data over the past 3 months has been over­whelm­ingly neg­a­tive yet because the “stress tests” our esteemed gov­ern­ment ran on the banks came out pos­i­tive (ignor­ing the fact that there was no neg­a­tive option, it was set up as win-win), the mar­ket has acted as though noth­ing bad was going on. S&P earn­ings are down an unheard of 90% over the past 20 months, unem­ploy­ment con­tin­ues to rise and we’re about to go through the bank­ruptcy of two large automak­ers in the US. There is a pend­ing dis­as­ter wait­ing in the wings of com­mer­cial real estate and fore­clo­sures are increas­ing while home prices con­tinue to fall. The state of Cal­i­for­nia may go bank­rupt or our fed­eral gov­ern­ment will be forced to bail them out, either out­come lead­ing to a rip­ple effect through­out the economy.

Every bear mar­ket has runs of 20–30% that trick peo­ple into putting money back in at the highs before crush­ing their hopes of a recov­ery by test­ing new lows. We may not see the lows in the S&P that we saw back in March but I have seri­ous doubts that the run up we have recently seen is sus­tain­able given the over­all sever­ity of the reces­sion we are in.