Itâ€™s Not Just Me
By Bob Wood
Any Bear will tell you itâ€™s tough making a living on the short side of the markets, risking your hard-earned capital on the idea that markets are heading lower. And itâ€™s just as hard for the Bear writing weekly columns about the marketsâ€™ shaky footing. Since, in both cases, â€œwrongâ€ can be costly, never assume that a Bear takes his position just to be contrarian or different.
You can be sure of one thing about the Bears whose work I follow. Neither are they pessimistic or negative by nature. But to me, it seems only the Bears are doing any real analytical work, though few people prefer listening to or believing Bears over Bulls, so strong cases must be made for their side.
Several better-known Bears tend to agree about the near- and long-term future of stock and bond markets and now add information relating to real estate. To me, their analyses are much more compelling than those offered by TVâ€™s Bulls. And to assure you that not only the guy writing on page 6 of TMO is bearish, Iâ€™m sharing thoughts from other financial writers, whose thinking I respect and follow.
On the stock market, I can hit two birds with one rock by citing a quote from one guy whom I wouldnâ€™t have known except for the other. In his most recent work, the Mogambo Guru quotes Robert Prechter from the â€œElliot Wave.â€
And in talking about Newtonian physics and â€œbig moves,â€ Robert Prechter, of Elliott Wave fame, says that the recent huge (>40%) losses in Middle-Eastern stock markets is just prolog. â€œThis year the U.S. stock market is shaping up to drop at least as fast. Generally when stocks levitate into a market cycle, they make up for it by crashing.
In 1929, stocks rose for 2.5 years into the 2.7-year cycle. Then they lost 50 percent of their value in 2 months. In 1987, stocks rose for 3.1 years into the 3.3-year cycle. Then they lost 40 percent of their value in 7 weeks.â€ If you think you got the guts to weather a 40% drop in your portfolio, maybe you ought to re-think that optimistic assessment when he goes on to say â€œBut given that the bear market is of Grand Supercycle degree, the largest in nearly 300 years, the coming drop should dwarf both of those crashes.â€
And not only these two voice their concerns about todayâ€™s stock market. Richard Russell also chimed in this past week.
â€œBut with the massive amount of debt built into the US economy, I donâ€™t see how the Fed could tolerate a path of contracting liquidityâ€”it would be too dangerous. The more probable path would be the Fed raising rates too high and setting off trouble in the housing marketâ€” remember, the effects of rate changes donâ€™t usually appear until six months to even a year after the last rate change.
In the meantime, stock market action is erratic and suspect. While the Dow holds and even creeps higher, the majority of stocks are failing to follow. How about this surprising statisticâ€”only 50% of the stocks in the S&P 500 are now holding above their 50-day exponential moving average (statistics from the great DecisionPoint site). In other words, weâ€™re seeing persistent internal deterioration in the stock market, despite the better performance of the Dow.
What are the markets waiting for or looking at? One thing theyâ€™re looking at is the oil situation, and theyâ€™re wondering if thereâ€™s any way that it can be resolvedâ€”Nigeria, Iraq, Venezuela, Iran? Has the US lost control of the worldâ€™s oil markets? Well, thereâ€™s always Canada.
In response to all the uncertainty, the stock market seems to have adopted a â€œwhat, me worry?â€ attitude. Here we have an â€œIran problem,â€ an expensive mess in Iraq, huge negative trade balances, China taking away our manufacturing base, rising interest rates, record high oil pricesâ€”and lots, lots more. And does Wall Street worry? Not at all. The only thing the boys on Wall Street are worried about is the size of next yearâ€™s bonus.
Jim Stack of Investech Research now allocates 39% of his model portfolio to cash. While his reading of technical tools like charts leads him to think that bull market trends will continue, his concerns center on the real estate market. Of particular concern: more than $2 trillion in mortgages are the adjustable rate variety. And with rates now rising, those debts will see rates â€œthat will be reset at much higher levels in 2006-07.â€™â€™
Since the middle class seems to save little, the pain could be most intense there. And speaking of real estate, Bill Fleckenstein noticed this Wall Street Journal item.
â€œIt is indeed the financial institutions that are most at risk in the real-estate market (which is not to say that consumers and speculators wonâ€™t get hurt). They will bear the brunt of the pain, because in many cases, they loaned the entire purchase price. As I have said often, the housing bubble has been more a lending bubble. It will be the impairment of the financial institutions that will stop the flow of credit to the real-estate market.
In turn, that will accelerate the collapse in house prices somewhere along the way.
The story closes with a description of how slow the market has recently become in Florida, demonstrated by an email sent last week by real-estate broker Mike Morgan read as follows: â€œWe went three days this week with not a single showing.
Thatâ€™s incredible. I have 35 listings. We usually get 2-6 showings a day. . . . I received more desperate calls from sellers than ever. One lady broke down into tears. Her husband bought two investment properties, and they are now going to lose their â€˜life savingsâ€™ if they sell the homes in todayâ€™s market.â€
Ladies and gentlemen, that is going to happen to a lot of people around the country.
And, after they have lost their life savings, the financial institutions that were the engine behind this folly will take their own hit. Easy Al tried to bail out one bubble with another bubble. While it bought some time, it will end in far-worse pain.â€™â€™
But the overall economy looks pretty good, doesnâ€™t it? How many times have you heard that the economy is â€˜â€™strong and getting strongerâ€™â€™ and unemployment and inflation rates are nearly at record lows? But hereâ€™s another problem: whom do you believe when smart arguments come from both sides of an economics issue? Weâ€™ve all seen glorious statistics issued by government agencies and touted by those making fiscal policy!
I tend to listen to people who work for meâ€”those whom I pay for access to their work, including some cited in this article. I donâ€™t see much conflict in their thinking. One such source, Kurt Richebacher, notes in his latest letter how government statistics have changed over the past 40 years.
â€œWe have pursued these and other changes in the U.S. statistics for years with great misgivings. There has been an unusual, concerted drive to produce better looking statistics. Obviously, these contributions have been decisive in creating the perception of the U.S. economyâ€™s superior performance. The particular importance of the inflation rate arises from the fact that it has a large effect on real GDP and productivity growth, two aggregates of highest economic and political assessmentâ€™â€™.
So, if you understate inflation enough, the economy looks like itâ€™s growing smartly when it is actually in recessionâ€”the thinking of some right now. John Williams of â€œShadowstats.comâ€ shows how using methodology of the 1980s to calculate todayâ€™s rate of inflation produces a result of 6.6%, while using a method from the 1970s yields a 7.4% inflation rate. And that would take GDP growth to about a negative 4%.
Speaking of government accountability and the veracity of its reports, Williams offers more interesting items this week. It seems that some have misgivings about reporting our countryâ€™s financial position, such as material weaknesses and â€œproblems with fundamental record keeping and financial reporting, incomplete documentation and weak internal control.â€™â€™
He adds that auditors will not apply their signatures to attest accuracy of the nationâ€™s financial accounting, with three reasons cited: â€œserious financial management problems at the Dept. of Defense, the federal governmentâ€™s inability to account for billions of dollars of transactions between federal government entities, and the federal governmentâ€™s ineffective process for preparing the consolidated financial statements.â€™â€™
Comforting? Hereâ€™s more. Deeper in his report is the writerâ€™s opinion of the National Debt, â€œonly $7 trillion,â€™â€™ at the time, which does not account for the federal governmentâ€™s true liability total. Left out are items for projected Social Security and Medicare benefits at about four times that amount. And â€œthe new prescription drug benefit, which is one of the largest unfunded commitments ever undertaken by the federal government, will serve to increase this financial and fiscal challenge.â€
It seems the President has pushed through his prescription drug plan with no apparent thought about how to pay for it. This information comes from David Walker, Comptroller General of the United States, who should know! And since we borrow to pay our deficits â€” and more every year to pay interest costs on that debt, rapid money printing as seen during the Greenspan era seems like the easiest thing for government leaders to do. And so they continue the printing.
Williams concludes that â€œrisks of the current circumstance evolving into a hyperinflationary depression remain extraordinarily high. An unfolding inflationary recession is the worst of all worlds for financial markets. Particularly hard hit will be the U.S. dollar, with downside implications for both equity and bond prices.â€™â€™ But the story does get better. He adds that â€œwhen the system re-stabilizes, post-crisis, there will be exceptional investment opportunities for those who have been able to preserve their wealth, capital and liquidity.â€™â€™ And Russell agrees.
So what do we do about this now? If youâ€™ve been reading this column regularly, youâ€™ve heard it all before. In his latest â€œGloom, Boom and Doom Reportâ€ (wish Iâ€™d thought of that!), Marc Faber says, â€œIn my opinion, the dollar will depreciate mostly against gold. In the long run, what you will see is the standard of living in America decline very significantly compared to the standard of living in Asia.
And the stock market capitalization of the U.S., which is now 52% of the worldâ€™s stock market capitalization, which will decline to somewhere between 20 and 30% and the Asian stock market capitalization will rise to between 20% and 30%, possibly 50% of the worldâ€™â€™.
And you thought I was gloomy, eh? To me, these sources make perfect sense. Remember, it is hard being the Bear when investors would much rather be hopeful. But there is hope! In economics, we always find winners and losers, just as in the markets. The outlook for gold, energy and Asian markets offer hope for positive returns. And of course, hedging with bear market mutual funds makes any bear market a lot less worrisome.
Have a great week…I mean it!
Itâ€™s Not Just Me