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Five Things: Just When You Thought It Was Over...


Don't make a career out of bearishness, bizarre outbursts explained, putting the pieces together and much more.

1) Just When We Thought It Was Over...

Just when we thought it was over, it was really only beginning. Someone once said that about the Great Depression. And it was true; the awful tragedy of it wasn't the flat reality of economic depression, but the bitter discovery over a period of 10 long years that whenever things seemed as if they couldn't possibly get any worse, they did.

Today I ran across a well respected strategist calling an end to the credit crisis. It's not an arbitrary market call, it's rooted in what the credit market itself is saying; namely, after reaching deeply depressed levels, credit buyers are returning to the market even as debt continues to be destroyed, replaced by equity issuance in a massive ongoing balance sheet restructuring.

I agree. But, as I've maintained all along, this is a debt crisis, not a credit crisis. And even as debt is being destroyed on a massive scale, the root of the crisis - several decades spent over-leveraging our households, businesses and government - must be fully unwound.

What we are seeing is the cyclical recognition that the market will survive. The structural point of recognition and adjustment lies ahead. Just when we thought it was over, it was really only beginning.

2) Don't Make a Career Out of It

I am not interested in a making career out of bearishness. On the one hand, bursting bubbles can be entertaining... for a while. But only bloated sad sacks and misanthropic fools make a career out of it. And in the end, they're left with... what? Nevermind. It's a rhetorical question.

Our more pressing disastrous concerns are, in order: Under the guise of recovery - bust the government - blame the capitalists for the failure - junk the Constitution and declare a dictatorship. It's a time-honored prescriptive course, and one I stole outright from here:

Chicago Tribune, 1934

Indeed. Like it says on the sign, Plan of Action for U.S.: Spend! Spend! Spend! Under the guise of recovery - bust the government - blame the capitalists for the failure - junk the Constitution and declare a dictatorship.

The point is:either take your doomsday with a grain of salt, or simply take your salt with a grain of doomsday. In the end, the salt will be worth more. Which partly explains yesterday's bizarre outburst about "buying stocks."

3) Bizarre Outburst Explained

Yes, the economy will turn horrific before improving. But the economy and financial markets are not the same thing.

Yesterday I took some heat from people who demanded to know how I could claim we are in the middle of a deflationary debt unwind while at the same time saying I want to add exposure to stocks just below 800, if given a 10-plus year time horizon.

Let's pause for a moment and consider where we are: The S&P 500 closed below 900 on a weekly basis just 56 times over the past decade. That's 520 weekly closes. Fifty-six below 900. All told there were 28 closes below 900 in the 2001-2002 period, and 28 recently. There have only been five weekly closes below 800 over the past decade, each one occurring this year.

Here's the thing. I agree there is a some probability we trade below 600, a lesser probability we overshoot and trade in a range of 400-500. But going down, and staying down, are not the same thing.

Ask yourself this: How long do you believe we'll stay at 400 if we decline to that level. Two weeks? Two months? Two years? Those time frames can be evaluated probabilistically. My contention is that if someone with a time frame beyond 10 years does some work on those probabilities, they'll reach very interesting conclusions about when to recommit some portion of their cash back to equities.

I guess what it comes down to is that the time to be bearish was in 2007 at 1500. And in Minyanville we were. That's not the same thing as saying now is the time to be bullish. But just as we spent time in the run-up to 1500 explaining why that move was bearish, not bullish, now is the time to prepare for the rundown to 700, 600, maybe even 400, considering why that move will ultimately be bullish, not bearish.

4) Putting the Pieces Together

But again, how does this fit with the deflationary debt unwind scenario? I am working with the following long-term investment thesis:

Step One: Asset Deflation Accelerates - Point of Recognition Reached
At this point I expect stocks to decline along with other asset classes as the deflationary debt unwind everyone thought was over reasserts itself with renewed intensity, perhaps by the fourth quarter of this year.

I expect this to take stocks down below 800.

Step Two: Embrace the Difficult
I have no idea what fundamental events will be blamed for this acceleration in asset deflation. What I do know is that it will seem foolish to recommit capital to stocks as we cross 800 to the downside. It will seem just plain dumb to do so when/if we cross 700 to the downside. And if we cross 600 to the downside then The Dumb will seem like geniuses compared to the Fools that bought 200 S&P 500 points higher. But I'll ask myself again, what is my time horizon? If it's longer than 10 years, then I can withstand 10 months of being Dumb and Foolish.

Step Four: Real Assets
Following upon Step One for a moment, I think we get one more major turn of asset deflation, hence a move for stocks below 800, and that deflation I believe will spill over into gold and commodities too. At that point I want to be able to start adding exposure to real assets, commodities, particularly foodstuffs and softs.

What about the dollar in all of this? Short-term, I am looking for a respite here in the next week or so, followed by a potential qualified break (DeMark indicator terms) of 77.92, which will mean a low next year ~71 or so, possibly below 70 briefly. But, I think that is the bottom.

Again, I don't know why or how, and see the same fundamental issues everyone else does, but the technicals simply do not support a (further) collapse of the dollar. There is a non-trivial probability that we see a major currency readjustment in our lifetime, but I think it is years away. Meanwhile, silver, more than gold, seems to project some type of either currency attachment or at least some kind of industrial usage that makes it far more attractive than gold to me. I just do not believe gold will become the currency alternative people believe it to be.

Step Five: Priorities
I currently have exposure to Emerging Markets that I initiated several months ago through the Emerging Markets ETF (EEM) and a number of other funds. I want to be overweight this group versus U.S. stocks, but with no exposure to U.S. markets currently, I will be looking to begin increasing it at 800 and below.

While some Minyanville professors, such as Ryan Krueger, have been a long time ahead of the curve with respect to commodities and Real Assets, that is a priority for me after the:

1) Emerging Markets;
2) Real Assets;
3) U.S. Stocks.

So viewed in that context, discussing adding exposure to U.S. stocks is not exactly bullish, at least not in a relative sense.

5) News & Weirdness

Pending U.S. Home Resales Jump Most Since 2001 as Lower Prices Lure Buyers - Bloomberg
Lower Prices = Asset Deflation. This is the readjustment process in action.

Dollar Declines Versus Euro as Nations Mull Reserve Currency Alternatives - Bloomberg
Good luck "mulling." I've done some mulling myself. Right now there are now good alternatives. Let's get together and mull again in 2013.

Northwestern Mutual Makes First Gold Buy in 152 Years - Bloomberg
"The downside risk is limited, but the upside is large," Chief Executive Officer Edward Zore said. "We have stocks in our portfolio that lost 95 percent." Gold "is not going down to $90." So let me see if I understand this: you were so bad at timing your stock purchases that you lost 95% in some cases, yet we are to believe that somehow your timing has improved with respect to your gold purchases? Ok.

Emerging Markets Most Expensive Since 2007 as Funds Flooded by $12 Billion - Bloomberg
It's true. But I will be a buyer in the unwind as Emerging Markets make a higher low.

Saying Goodbye to Your Stuff - WSJ
This is a hard point to make to people when talking about structural shifts in consumption patterns: Just because people who make $50,000 a year stop buying $500 handbags and shoes doesn't mean they are going to stop buying everything. The shift will be a revaluation in of priorities - away from material goods, toward intangible expenses - with reduced discretionary income directed toward, say, time spent with family on a vacation that is not Disney World. There will be an economic benefit to a different sectors of the economy.

Frugality Turns Fashionable as Recession Hits the Wealthy - LA Times
"[S]ome customers who have money despite the stock market dive seem too embarrassed to spend it. They just don't want to throw it in their friends' faces," he said. "Corporate is the same way, afraid to do anything that looks extravagant." Related: I just ate a can of dog food for breakfast.
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