Dredd Market Analysis: Our View of the World

This blog was originally intended for people that feel a bit lost in this economic mess and are hearing everything from "things are getting better" to "Obama and world leaders are going to fix this" to "it's the end of the world" and "the dollar's going to crash and be replaced by a global currency." The purpose is to shed some light on where are are, how we got here, where we're probably going, and ultimately, what to do about it. That last part includes everything from investing to keeping your money out of prying hands to, ultimately, how to save yourself and your family--it if gets that bad.

Unfortunately, that's a lot of ground to cover. Just understanding the economic fundamentals and the interactions of politics and government is multiple years of study and observation. It's simply not possible to try and distill hundreds of years of history, theories of major past and present economic thinkers, detailed quantitative analysis, and mass psychology into a daily blog. By the time we finish the education process, the world will have significantly changed.

Our only hope is to try, piece by piece, to paint enough of the picture and hope that, as readers, you take an interest in expanding your own knowledge base. The next few years, in a global sense, will be extremely trying for most. You must gather enough independent knowledge to guide you through what's ahead.

Are we proclaiming the end of the world? Not exactly. Let's talk a bit about how we go about putting together the big picture--the filter through which we view the world.

We use a combination of fundamental analysis, economic theory, behavioral economics, cyclical behavior, historical precedent, and traditional technical analysis to give us a view of what's going on. The future is made of up infinite possibilities, but not infinite probabilities. The above mentioned tools are used to attempt to determine the probabilities of different paths. While nothing is certain, once we have a sense of the probabilities of various things occurring in a given timeframe, then that leads us to the next possible series of events. From an investing perspective, we bet on the likelihood of the most probable event happening.

The Big Picture From 50,000 Feet - Economic Theory
"An economist is a surgeon with an excellent scalpel and a rough-edged lancet, who operates beautifully on the dead and tortures the living."
- Nicholas Chamfort, French writer (1741 - 1794)

"Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it."
- Ronald Reagan, former US President (1911 - 2004)

In the big picture, we rely on economic theory. That is, there are many economic schools of thought (note we touched on a few last week) that define both, in our opinion, how the world would work when left to its own devices, and how the world is manipulated by "tinkering" of governments and central banks. The Austrian school of economics, which readers can delve into more deeply at the Ludwig von Mises Institute, is, in our opinion, the best measure of how the world functions in absence of meddling by external sources. People seek their own self interest, they trade their labor for money which has a real store of value, creating money (inflation) leads to rises in prices, for every boom there will be a bust--all of these concepts are Austrian in nature.

Then there are the Keynesian, monetarist and Marxian schools (that's right, Karl Marx, father of communism, was an economist) which seek to alter the natural flow of events for "the greater good." As a result of these schools of thought, we have global central bankers that work to control short term interest rates, fiat money that is created through debt, floating exchange rates for fiat currency, the concept of quantitative easing, etc. In theory, these courses of economic direction help ease recessions, prevent depressions, maximize growth, and have lots of other benefits. [Side note: Some people believe that the real purpose of these policies is to ensure that the banks can control everyone and everything. This may or may not be true, but we prefer to not get hung up on why we are where we are because it distracts from determining what is likely to come next.]

Thrown in the mix are the policies of politicians, theories like supply side economics, and other details that we'll get into more later on.

The bottom line is that there is a natural way of doing things, and there is how many seeks to control nature. It is not at all unlike the idea of the natural sciences versus engineering. In the natural sciences, which include things like chemistry, physics, and biology, man seeks to understand the world around him. He recognizes a natural order to things and attempts to explain what occurs by using tools like mathematics to study the world. Let us make the analogy that the Austrian school of economics is most like "the natural science of the economic world" in that it really only reviews how economics arrives as a natural product of man's and society's evolution.

Let's contrast this idea with the other schools of economic thought, regardless of which they are. They are most analogous to engineering instead of natural science. Engineers seek to understand only enough of the natural world so that they can manipulate nature to do the will of man. Engineers design and build planes, bridges, roads, buildings, computers, etc by observing the laws of nature as described by physics, chemistry, materials sciences, and other disciplines.

If we take a broad stroke and look at economics from these points of view, it is hard to argue that the goal of most economic schools of thought is to improve and control the economy. But as the Austrian school dictates, these controls are not sustainable.

Man cannot build a plane that will fly forever without fuel, maintenance, and the occasional crash caused by natural factors out of his control. Bridges erode. Homes decay. The point is, any manipulated economy, no matter how good the intent, cannot be manipulated indefinitely. The world will revert to its mean at one point or another. This is, in rough terms, the difference between the Austrian school and the other economic schools.

Thus, if we take the view that nature will do one thing (Austrian view) and that governments, central banks, and people will try to make it do another, then the questions that we seek to answer are "how sustainable is plan of the government/central bank, what is the effect on the natural economy, and what is likely to happen as a result of said policies?"

In short, to live in nature, is the government building a house of straw or of bricks? Obviously, it makes all of the difference in the world when the first big storm hits.

From 30,000 Feet - The Fundamentals
"The long run is a misleading guide to current affairs. In the long run we are all dead."
- John Maynard Keynes, English economist (1883 - 1946)

Once we have a framework from which to view the world, we have to determine where we are within it. (We are expanding more on this in our "Where?" series. Note that you can click the "Education" link on the right side of the blog and get all of our educational essays.) The fundamentals are key to understanding this.

What do we mean by fundamentals?

Is the economy really growing or shrinking? What is the cause of the bad economy? What are nations around the world focusing on? What are the dynamics at play between various nations?

Much like a fundamental analysis of a stock purchase would include researching the company to understand issues like its cash flow, strategy, and growth prospects, there are fundamentals at play in the economies of the world that require investigation and scrutiny. This, of course, requires understanding what questions to ask. That is the difficult part and is, in all honesty, an evolving situation that requires staying on top of global current events in politics and economics. After all, if you think you can determine what is going to happen economically without understanding the role of politicians in tinkering with the economy, you're fooling yourself.

It is the role of the fundamentals within the context of economic theory that gives us a sense of how predictable the future may be. That brings us to the next level of detail.

From 10,000 Feet - Historical Precedent
"What has been will be again,
what has been done will be done again;
there is nothing new under the sun. "
- Ecclesiastes 1:9

Using fundamentals, we can look back into history and look for similar periods of time in which similar events were occurring. Historical precendent gives us context. Often, it pays to look at past examples of history to determine what may occur next. Assuming we understand the fundamentals within the context of economic theory, we are likely to end up with a few different scenarios from which to gauge our present situation.

For example, fundamentally, we know that the western countries of the world, notably the US and Europe, have massive debt levels. They are producing more than they consume. All countries use fiat currencies, which tend to die over time because they are abused by politicians and central banks. We understand the effects of deficits (and implications of using floating currencies and how that distorts the realities), debts, and what happens when governments take certain actions. We know of similar periods of time in which we've had similar stock market crashes. The end game is clear, but the path to the end game is cloudy.

Historical precedent is the first phase we use to being to make a physical model of where we are based on similar situations in the past. It is our first guide to making reasonable timing decisions on when future events, formed by a combination of understanding fundamentals, economic theory, and historical events may play out.

From 5,000 Feet - Cyclical Influences
"History doesn't repeat itself, but it does rhyme."
- Mark Twain, American writer (1835 - 1910)

The big problem with historical precedent alone is that there is no exact period in the past that can describe the future. Often, we see characteristics of multiple times in the past, so no model fits 100%. For example, the current crash in stock markets is, historically, much like the 1930s. It is caused by the crashing of debt. However, in the 1930s, the world was tied to a gold standard. Money could not be created out of thin air. The 1970s markets were similar in that they were caused by the creation of too much money in the prior decades which caused massive inflation.

We have elements of both markets at play today. There is no historical precedent for what we're seeing that fits 100%.

There may not be anything new under the sun, but no two events are exactly alike. Twain's quote above is a cardinal rule.

To adjust the model, we rely on cyclical patterns and technical analysis (next section).

Humans tend to repeat their mistakes, especially over the generations. This tends to manifest itself in cyclical trends. Fashions repeat. Generations make the same mistakes year apart. There is a discernible stock market cycle around US Presidential elections, in transfer of capital around the world, in debt destruction (Kondratiev Wave), a business cycle, and hundreds of others covering very short term to very long term periods.

These cyclical behaviors refine historical precedent models, improving our ability to determine likely outcomes.

From 2,000 Feet - Technical Analysis
"The market can stay irrational longer than you can stay solvent."
- John Maynard Keynes (1883 - 1946)

The issue, as always, is one of timing. As an extreme example, we can say sadly, but definitively, that you will die, dear reader. It is unquestionable. It will happen. However, there's a really good chance that if I bet everything that you'll die tomorrow, I'll lose everything. Although we know an outcome is virtually guaranteed, we must evolve WITH the markets and not stand in defiance of them, lest we end up in poverty and squalor.

At this stage, we have a model formulated with fundamentals in mind, forged by an understanding of economic theory, patterned after historical events of the past and refined with cyclical perspective. Based on this model, we know what to expect over time. We know what to buy and what to avoid. But we do not know when exactly. We may have some ideas, but we cannot afford to step in front of a moving freight train.

Technical analysis is the key to improving our timing. It tells us when an event based on historical precedent, and within a window of opportunity, is probably about to occur. There will be signs in the buying and selling patterns of select assets. There will be fundamental indicators of stress. This is what we watch and report on for short term moves.


Hopefully this provides you with an outline on how we approach markets, investing, and market analysis. We will cover more of these topics in greater detail over time.