"...For the first time in 35 years, I have gotten frightened. ... I think the legislation that has been passed is going to allow everybody to take a very deep breadth and say, ok, we'll get through this. Are we going to be fine in a year from now? Oh of course; but getting through it til next Tuesday, whole 'nother question."

—Dennis Gartman, CNBC interview; 10/3/08

I. Recent Events

• The recent turmoil in the financial markets has made many investors—both professional and nonprofessional alike—frightened. And who can blame one for having the feeling of despair with the S&P 500 skidding to a fresh four-year low, economic data contracting, previous stalwart institutions dropping like flies, and credit conditions remaining extremely tight. Uncertainty breeds fear, and there remain plenty of unknowns facing the economy.
• Moreover, the passage of the rescue bill on Friday was greeted with an unenthusiastic reversal in the stock market. (From the day's high the S&P 500 retreated 4.7%.) Our sense was and continues to be that this plan—which calls for the Treasury to use up to $700 billion to purchase toxic debt from financial institutions—was a necessary step, but certainly not a cure-all. SunTrust Economist Gregory Miller recently articulated his view through the following statement: "The truth is the TARP is an awesomely awful policy. I know no economist who doesn't hate this bill. But, under contemporary circumstances there is only one thing worse than passage, and that is doing nothing."
• Although there remain questions about the mechanics of the program, the hoped-for outcome of this plan is it will allow banks that participate to sell their worst assets (which currently don't have a market) to the government, which in turn would provide much needed cash flow to the banking system, which subsequently would allow banks to start lending more freely. Most reports speculate it will be at least a few weeks before the government starts buying assets, and then it will take time to judge the effectiveness of the plan. Added attention should be paid to the credit markets, to see if spreads/lending rates start to loosen. In the meantime, investor attention will start to focus back on a weakening economy and earnings outlook.

II. Economy

• In our view, part of the reason the market did not have a more positive reaction to the passage of the rescue package is investor attention is already shifting to the deteriorating economic landscape: Last week, initial jobless claims jumped to 497K, the monthly payroll report showed a loss of 159K jobs (the ninth consecutive monthly decline), and the ISM manufacturing report dropped over six points to 43.5.

With that said, the word depression, unfortunately, is coming back into vogue (as shown in Figure 1).

Figure 1. Google Key Word Search And News Reference For 'Depression'

Source: Google

• For most of the past year, SunTrust's Economist Gregory Miller has believed the U.S. economy is in a recession that started sometime late last year and will probably end in April or May of next year; a view he continues to hold. It is evident that the economy is deteriorating, but it is important to distinguish some important differences between now and the Great Depression. While there remains some debate about the cause of the Great Depression, many experts blame it partially on Fed policy mistakes, such as raising interest rates and contraction in money supply, which is not occurring today.
• Also, in remarks made during a speech to Washington and Lee University in 2004, then Fed Governor Ben Bernanke pointed out that, "In particular, the experience of the Depression helped forge a consensus that the government bears the important responsibility of trying to stabilize the economy and the financial system, as well as of assisting people affected by economic downturns. Dozens of our most important government agencies and programs, ranging from social security (to assist the elderly and disabled) to federal deposit insurance (to eliminate banking panics) to the Securities and Exchange Commission (to regulate financial activities) were created in the 1930s, each a legacy of the Depression." Unemployment insurance is another important automatic stabilizer, which was not around during the Depression.
• Moreover, Briefing.com's Patrick O'Hare helps to place the current situation in context: "Clearly, the economic situation isn't great, but keep these statistics in mind: during the Great Depression, GDP fell 30%, unemployment exceeded 20%, wholesale prices declined 33% and industrial production plummeted close to 50%. The latest complete information available showed real GDP up 2.8% on an annualized basis in the second quarter, the unemployment rate at 6.1%, wholesale prices up 9.6% from 12 months ago, and industrial production down just 1.5% from 12 months ago."

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