Wednesday, May 19, 2010

5/19 Daily Commentary

The I1 is now in a sell signal from 4/29 for longer-term trades, but it is in a portion of it's movement that is normally associated with a sideways market.  I undertook a longer-term trade because of the broader bear picture.  Nonetheless, severe market moves do not occur in the current phase of I1.  The phase shifts back to the downside after 5/24:



The stock market decline since the EU plan announcement is a reflection of a debt transfer from private banks holding suspect sovereign debt to the European public balance sheet.  In other words, now every euro spent on buying bad debt or lending to bad creditors puts handcuffs upon any future actions by EU and ECB.  The U.S. treasury and the Fed have already blown their wad, making this environment unique in the last 500 years.  The occult knowledge of the power of government deficit spending has permeated into the fabric of government existence.  Asked to produce a price forecast the most essential point is that what happened in the Seventies will not happen again.   


The above graph shows why the bond market will stop the government dead in it's tracks within 2 years if the government does not establish a credible plan to reduce the debt load on the U.S. economy. In contrast the Sixties and Seventies offered relatively fertile fields for the fiat plungers (politicians) to expand spending because of the low debt burden. 
Being long the bond market is a reflection of being bearish on global stock markets.  My bullishness on bonds will give way to bearishness on bonds in another year.  So the initial forecast is that whatever decline in stocks occurs will not be exacerbated by inflation, as in the Seventies.  This decline will provide more real dollars, not less. The decline will be more severe than the 70-74 period because of the lack of an inflationary element. 
The forecast with this in mind is stunning, a 75% decline in this 5 year period from current levels.  Forecast low below 2500 DJI.  The decade of the Seventies was a lesser-degree decline and still cut nominal stock indices in half.  Factor inflation and real stock prices fell 75%.  Without inflation there will be no money desperate to chase return.  Sitting back will be not only safe, but profitable because the money will be worth more, not less.  There will be few strong bids, only intermittent purchases that wind up at a loss.  This behavior will stop after a succession of losses and prices will fall of their own weight (it will not take much selling pressure).  Such is the world where nations and individuals are up to their necks in debt.  The governments around the world deperately tried to inflate their way out of the debt crisis.  They failed.  Lenders no longer lend because they are risk averse and can borrow 0% money and leverage treasury bond purchases, borrowers no longer borrow because they are scrambling to reduce their own debt loads and monthly payments. 
I find it more profitable to forecast time windows for action than absolute price levels.  Normal cycles will no longer operate.  The 4-year cycle will not show much of a rebound from the 4-year low.  This year is supposed to be the 4-year low, yet after a rebound through April, 2011 there will be a crash into October.  That should not happen in the context of a 4-year cycle.  However, cycles only operate in normal environments.
Hope this helps.

3 comments:

  1. Steve,
    Thanks for the forecast. That is even more dire than I would have imagined. I had kinda pegged it at 500 ish on S&P, but I certainly realized we need to reset the P/E valuations down to single digits like 6 or so and get the dividend yield up to 6%. I wonder what the people without access to inverse funds and options can do to protect their portfolios.I would worry for the country if it comes to pass as you predict.

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  2. Charles,
    I think before this is over the P/E valuations will go as low as in the 3 to 4 percent range.
    I'm thinking S&P 250ish. Before this is over it will go down as the great, great depression.
    We will probably move to a new monetary system, maybe back to the gold standard who knows.

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  3. Believe me I am not a doom-and-gloomer. This is a debt issue, a monetary issue, the toughest in our country's history including the Civil War. Lincoln issued greenbacks to finance the northern effort and the flood of them distorted the monetary system until 1873 when they were retired. This problem is worse in that apart from the flood of debt for past spending we are committed to unrealistic future liabilities, primarily to our elderly. This means that cutting spending will fall primarily on other government programs and the amount of cuts will not be sufficient to impact the debt burden. Volcker has just warned the government that they have 2 years to drastically reduce spending and future liabilities or the bond market will ration their credit for them. Rationing credit means 10+% interest rates.

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