If my emotional barometer is any indication of where people’s minds are at the moment then I can only label it as coming down or recovering from a major hangover. It is the Sunday afternoon after a big night out sipping on your bloody mary to ease the pain.

We have been living on credit and tons of it.  At some point it becomes unsustainable and the house of cards tumbles down.  

Getting back to my analogy, think of drinking a ton of alcohol or coffee.  You keep wanting more and more when you finally get to a point where your body is completely dependent.  Any reduction in the drug will cause mild to severe withdrawal symptoms, any increase doesn’t do anything. 

This is what happens with credit expansion.  Too much and everyone goes on a spending spree with all the cheap money.  Take away the cheap money and people stop spending, jobs vanish, incomes decrease, and the previously incurred debt can’t be paid off.

So, instead of going through withdrawal you decide to take a lesser amount of the drug to make your hangover go away or slightly abate. However, you are still hungover. This pattern will continue until either you are completely free of the drug or your tolerance is now much lower enabling you to start increasing the amount as it now has a new profound effect as it did when you first started.  

It seems to me that we are in the post-crash hangover stage, but we aren’t completely free from the addiction.  We have taken a bit of the drug to ease the suffering.  The more of the drug we took the more likely we are to repeat the cycle.  We still need the drug to continue, otherwise we are going to feel like crap.  Hence, we still have a ways to go before we can recover.

If all goes as planned we will have a new President tomorrow and no longer will have to listen to the political banter at least for a while.  One piece of the uncertainty puzzle will be put into place, and we can focus on other issues.

In a NY Times article:

“We don’t know if it’s the end of the bear market yet, but it looks as though the bear has taken a nap,” said Sam Stovall, chief investment strategist at Standard & Poor’s equity research. “So investors are thinking, let’s enjoy a bit of a relief, both from the market’s lows and from the endless pre-election rhetoric.”

Other factors seemed to be playing into the rally as well, including a continuing round of coordinated interest rate cuts worldwide, the ongoing thaw in the credit markets, and the increasing resiliency of the markets to the daily drumbeat of bad economic news. The extreme volatility of recent weeks has calmed in recent days, though trading volume remained light.

Yes, the bear is taking a nap, but we are still very hungover and have taken a bit of the drug to help relieve the pain.  People haven’t completely capitulated and given up on equities.  They are hesitant yes, but still hopeful that things will turn around.

There is a major bear lurking around the corner and it isn’t just in the US.  They are giving birth around the world and China is no exception.  In a Financial Times article:

Wen Jiabao, China’s prime minister, warned that high growth was needed to maintain social stability as fresh evidence emerged on Monday that China’s economy was slowing quickly.

…

“We must be crystal-clear that without a certain pace of economic growth, there will be difficulties with employment, fiscal revenues and social development . . . and factors damaging social stability will grow,” he wrote in the magazine, Seeking Truth.

So, while equity markets recover mildly on noticeably low volume, bears are growling from afar.  Manufacturing is way down, consumer’s aren’t spending, banks still are reluctant to loan, major exporters are slowing.  I’d call this a worldwide slowdown of massive proportion.  We still have credit cards right?

What lies ahead…?

Recession, higher interest rates, massive inflation, higher commodity prices, continued decrease in housing, rising unemployment, and eventual devaluation of the United States dollar.  When will all of these things play out?  

My crystal ball has a few cracks, but for inflation to take hold we have to complete the current phase of de-leveraging and disinflation (which is bringing down prices).  Once this phase is complete all the newly created money will directly cause inflated prices.