Is this it? Is this the beginning of the end?

In the beginning there was the word. And the word was ‘sub-prime’. When investors spoke the word in 2007, markets quaked. By the autumn of 2008, Lehman Brothers had gone broke and stocks were falling all over the globe.

The end of the beginning came on 9 March, 2009. Stocks had lost about half of their value... a loss of about $25 trillion, worldwide. The first stage was over.

The next stage was the rebound... the bounce. It boosted stock prices everywhere – particularly in the emerging markets. Worldwide, stocks recovered about half of what they had lost in the first stage.

Now, we are either near the end of the middle stage or at the beginning of the final stage. Last week, it looked like the final stage had begun. The Dow fell in four out of five sessions... with a big drop on Friday of 216 points.

Fear is back. Oil is trading under $75. Gold dropped $13 on Friday. Proportionally, gold lost less than stocks. At least a few smart investors see gold as a refuge rather than a threat.
Commentators are providing plenty of ‘reasons’ for the wobbles on Wall Street. The Chinese are tightening credit. Obama is getting tough on the banks. Take your pick.

But the noise coming from the financial media merely provides a way for investors to understand what is going on without really understanding at all. On the surface, markets react to the news. But their primary direction is determined by deeper currents.

Obama is losing the confidence of the nation. His health care reform plan is a rat’s nest of corruption and confusion. His handling of the wars against the Iraqis and the Afghans is a disgraceful mixture of claptrap and cupidity. And his treatment of the banks is one half publicity stunt and the other half relatively unimportant…

He just didn’t realise that he came into the presidency on the downside of the credit cycle. Fish gotta swim. Birds gotta fly. And credit cycles gotta correct. That’s why the stock market – at present – is unfinished business. It is a work in progress.

A bear market began at the beginning of the ‘00s. It was held off by a final, reckless increase in cash and credit from the feds, following the pseudo recession of 2001.

Then, after a spectacular bubble in the financial industry and in residential real estate, the bear market resumed in 2007. In 2009, stock prices reached a temporary bottom and bounced. And now the end stage for the bear market may be beginning.

None of this is Obama’s fault. He didn’t create the credit bubble. And he can’t be faulted for not fixing it. It’s not a fixable thing; at least, not by politicians.

Markets have to do their work. They have to take prices down to levels where it makes sense – considering the risk of loss – to buy assets again.

They have to get rid of the mistakes. They need to punish stupid... arrogant... and imprudent investors.

They need to move money from weak hands to strong ones. All of that takes time. Offering the market more phony money only blurs the picture... making the decisions more difficult.

You can’t really fault Mr Obama for doing the silly things he has done, either. He’s been too busy to think deeply about how an economy works. That’s why he has advisers.

Unfortunately, his financial team is made up of mostly jackasses, fools and opportunists, such as Larry Summers, Ben Bernanke and Tim Geithner – not necessarily in that order.

Only “Tall Paul” Volcker has any clue what is going on. To his credit, he’s made some brave critiques of the banking industry. He’s probably giving Mr Obama some decent advice, here and there.

But what can he say?

Obama is president of all the Americans. He needs to ‘do something’ to make the pain go away. His party is counting on it. The voters demand it.

Mr Volcker knows you can’t really make the pain of a correction go away. It has to run its course. It has to do its job. All you can do is to try to control the banks so it doesn’t cost so much to bail them out.

Mr Volcker may also realise that feds are only making things worse – with their bailouts, deficits, subsidies and boondoggle spending.

But so what? Fish gotta swim, remember. Democratic governments gotta play to the voters. And the voters want solutions! They want leadership! They’d rather have a bunkum, harmful solution than no solution at all.

And that’s what they’ve got.

Maybe this is the next leg down. Maybe it isn’t. In either case, we don’t want to be holding a lot of stocks and real estate when we find out.

If we’re right about the depression/deleveraging…

And if we’re right about the bear market...

You’re probably going to see stocks lose another half of their value. Remember, a correction is equal and opposite to the deception that preceded it. That deception is almost a hundred years old... and has added trillions of (largely fictitious) dollars to the nation’s wealth.

An Everest of mistakes has been made. Can all this deception be corrected in two years... with the feds fighting every inch of the way? Can problems caused by too much credit be cured by more credit? Can a generation’s worth of mistakes be hidden under a carpet of bailouts? Can the boondoggles be washed away by more boondoggles?

“They do one dumb thing,” said our gardener, speaking of the feds, “then they do two dumb things so they don’t have to admit they did something dumb in the first place”.

“The whole idea that you can cure financial problems by offering people money that doesn’t exist is preposterous,” adds colleague Simone Wapler.

Governments have been up to this trick for a long time – but especially since the world went on the paper money standard in 1971. Where Americans had a dollar worth a dollar in 1913, today they have a dollar worth three cents. What happened to the other 97 cents? Where did it go?

We don’t know. But we’ll take a guess – it went to the place where the feds keep all that money they don’t have.

Hey, we’re not the only ones who think Japanese stocks may be a good buy. Bloomberg reports:

Not even the slowest economic growth in the industrialized world or deflation can keep Byron Wien, David Herro and John Alkire away from Japanese equities.

Wien, the Blackstone Group LP adviser who predicted last year’s rallies in stocks and oil, says Japan shares are his favorites.

Harris Associates LP’s Herro, Morningstar Inc’s international manager of the decade, says stocks at the cheapest ever relative to assets will gain even if the economy stagnates. Alkire of Morgan Stanley Asset & Investment Management is betting low debt levels will spur an advance that beats the US.

Japan, the world’s second-biggest equity market, is up 3.7% this year as measured by the Topix index – the most among the world’s ten largest economies.

Overseas investors pumped almost $13 billion into Japan during the two weeks ended January 15 – the most since 2004. Companies trade for an average 1.2 times book value, almost half the valuation for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.

My best investment idea is Japan,’ said Wien, 76, a former market strategist at Morgan Stanley and at hedge fund Pequot Capital Management Inc, who predicted the end of the technology bubble in 2000. ‘The Japanese market looks relatively attractive assuming the earnings come through, which I think they will.’

“Wien, Herro and Alkire’s predictions are based on valuations instead of economic prospects. Wien favors export-related companies, technology makers and drug and cosmetics suppliers.

“Gauges of automakers and electronics companies in the Topix have climbed 11% and 6.2%, respectively, in the past three months – more than the broader index’s 4.3% advance.

“‘ Japan is extremely cheap on fundamentals,’ said Herro, the chief investment officer for international equities at Harris, with $55 billion in assets.

“‘When you combine the two concepts of low price and high quality to get a value proposition, especially if we see a movement towards more sustainable operating profitability by corporate Japan, this could be one of the best-performing markets over the next couple of years.’”