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Five Things You Need to Know: Only One Way Out

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"There is only one way out of the crisis: Forgo every attempt to prevent the impact of market prices on production."

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Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

Getting "Lucky"... Only One Way Out... The New Frugality... The Psychology of Deflation...

Getting "Lucky"

All Gamblers Die Broke. Damon Runyon pointed this awful nugget out nearly a century ago, but sometimes it takes a full-on beating to catch the drift of it. This was what I was mulling over at breakfast this past weekend for reasons I'd rather not think about right now when suddenly I was gripped with the urge to blurt it out it to Lila.

"You know, all gamblers die broke," I sputtered without warning.

She looked up from the newspaper, "What are you talking about?"

"It's true," I said. "All gamblers die broke."

She gave me a quizzical look. "All gamblers die broke? Well, you gamble."

"That's true," I said. "But I really enjoy it."

"Wait a minute," she said, her voice rising, "How can you enjoy it if you know you're going to die broke!?"

"That's easy, I don't do it for the money."

Right. Sadly, that kind of pure, unfiltered wisdom is lost on those without the gambling gene. To them, it floats by like a non-sequitur. Only, like it or not, we are all gamblers now. And being gamblers, it's only natural to come to the place where we begin to interpret and sort nearly all random events into one of two piles - Lucky, or Unlucky. This is The Gambler's Curse.

Even "data services" such as Bloomberg have succumbed to The Gambler's Curse:

"The world may be heading for its worst recession in a quarter of a century -- if it's lucky."

- Bloomberg News, 10/13/2008, World May Be Lucky to Get Worst Recession Since 1983


Only One Way Out

"All attempts to emerge from the crisis by new interventionist measures are completely misguided. There is only one way out of the crisis: Forgo every attempt to prevent the impact of market prices on production.
- Ludwig von Mises, The Causes of the Economic Crisis

Indeed. But with the market, as I write, up more than 8%, that would certainly seem to be a contradictory viewpoint, or at the very least an unpopular one. And that may be why in that same paragraph Mises then wrote, "This may contradict the prevailing view. It certainly is not popular."

Mises certainly found out there is no popularity to be gained from being right about economic doom. Being "right" is the quickest way to lose all of your friends and create more enemies than you can shake a stick at.

That is really the only way to explain why the very people in charge of driving the global economy over the cliff - global central banks - are now charged with rescuing it from the death dive.


The New Age of Frugality

Meanwhile, regardless of what stocks are doing, Main Street is beginning to embrace what BusinessWeek is now calling "The New Age of Frugality."

"People who overconsumed during the past decade are now rejecting extravagant lifestyles. They're spending less, and more wisely. Some are getting their finances in order. Others are fearful of losing their jobs, shocked by investment losses, or hunkering down amid the general uncertainty."

These are people no longer concerned with "getting lucky." They've had about as much "luck" as they can endure and are now ready for, or being forced to accept, a new reality related to credit and spending.

Despite the increased usage of the word "frugality" - the New York Times also ran a story over the weekend discussing teen spending and using the word "frugal" in the headline - If anything, Main Street's debt revulsion is being underestimated by the mainstream media.


The Psychology of Deflation

In the early 1980s, warning about excessive use of credit were everywhere. The Finance section of bookstores was chock full of books, such as "After the Crash," detailing what one should do to prepare for the coming debt crash. How is this time any different? Well, for starters, social mood was transitioning from dark to positive in the early 1980s. And along with that transition came a renewed appetite for risk, for credit, for debt, but most important, rooted in a positive outlook and social mood, an expanding perception of how much debt could be safely carried.

Indeed, this time is most certainly different.

"For instance, he switched from shaving cream to a bar of shaving soap. He figures he saves $6 a year that way. "It's not much, but there's a psychological benefit," he says."
- BusinessWeek, "The New Age of Frugality"

Saving $6 a year is not going to improve anyone's bottom line. But that is unimportant. What is important is that once the psychology of deflation sets in, it is nearly impossible to kickstart the guns of credit.

But it isn't just individuals, it's also businesses. Take this separate article from Bloomberg this morning:

"While copper prices plunged 30 percent in the past two weeks, copper-tube mills haven't reduced what they charge and plumbers are putting off purchases until they do, said wholesale supplier Jay Richman."
- Bloomberg News, Oct. 13, 2008, "Copper Mills Aren't Passing On Price Cuts; Plumbers Wait to Buy"

Central banks can supply theoretically unlimited quantities of ammunition, but the guns have stopped working... and the targets have disappeared.


What Does Oversold Look Like?

But what does any of this have to do with stocks? Based on a - good Lord, I just checked the screens again and we're now up more than 10% - based on a day like this, apparently not much. But keep in mind, nothing goes down in a straight line. And with credit markets closed today, we really have no idea whether the government interventions in the markets are going to have a temporary effect.

Below is the U.S. Industry Bell Curve from Investor's Intelligence. This measures the percent of stocks in each industry on point and figure buy signals. The last time it looked like this was 1987.


Click to enlarge

With bond markets closed today it is still too early to tell how much impact the forthcoming "comprehensive plan" will have in unlocking them. Tomorrow should provide a better look, though keep in mind that even as credit was improving in late 2002 and throughout 2003, stocks eventually "re-tested" the October 2002 low.

Because stocks were, until last week, lagging behind the historic decimation in credit markets, there may again be a decoupling in stocks as the impact of the credit lock down manifests more severely on Main Street in 2009. We may have a low in place for this year, but I still believe stocks will hit a new low next year. It remains important to take cues from credit markets in evaluating the process of bottoming for equities.

This is a difficult environment for investors - as it has been since 2000. If this secular bear market continues in duration relative to the last one in 1965-81, 16 years, then we are least halfway through it at this point, with many more peaks and valleys ahead. From that standpoint, investors with time frames exceeding 10 years can consider returning to stocks, but with the understanding that they are investing during a low, not during the bottom. I certainly have no idea how long this bear market will last, but I do know that investing money during these periods, longer-term, will be more rewarding than investing money when it "seems right" to do so.

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No positions in stocks mentioned.

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