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We're Back....With Market Forecasts and Scenarios
It's been a busy couple of weeks with little time to comment on the markets. To get caught up, we'll probably have multiple topics that we'll hit in the next few days.
First on tap is a recent review of our performance. When last we left, we were looking at gold rising, but expecting a throwback to the 960 level (outside of the triangle). The best we got was a pull back to 990, and since then it's been on a tear. Given that we're not big fans of chasing momentum, we'll take a look at gold today in greater detail, particularly after this evening's NYMEX close. To give away the punch line, it looks like the dollar will probably fall all the way to 76 before catching a bid again and having a rally. At that point, gold will likely sell off again--to what level is the primary question. At this stage, 990 looks like it is the low end of the sell-off range. Tonight's analysis will tell us more. If, for some reason, the dollar does not catch a bid at 76, gold may shoot to 1300 or so quickly as the dollar moves down to 72. That will happen, but we do anticipate a buying opportunity coming up soon before that run occurs.
Natural gas finally found some support. It has been very volatile, but looks like it may be base building. This will be an important one to watch develop.
The crude oil market and related stocks were, as we forecast, great buys this week.
In other news, it appears that retail investors (that is, individual, non-professional investors) are getting into the stock market. We hate to sound cynical, but that usually marks the beginning of the end. Bernanke is calling an end to the recession (which will be true only technically, but not in the real world). Any recovery will be short lived--you can bet on that. There has been no structural fix to the economy. The secular bear market continues, and while this cyclical bull market may have further to run, it's much closer to being over than it is to beginning. Caution is warranted. We expect that a stock market sell-off could begin as early as Q1/2010 (not a correction, a sell-off to at least retest the March 2009 lows). The likely catalyst will be a poor holiday retail season, which will reinforce the fact that in the US, the consumer is over 70% of the GDP. No consumer sales implies lower GDP. That will send most of the major stock indices lower because most of those stocks are consumer-oriented in one form or fashion. A reality check in Q1/2010 makes good rational sense as a point for a sell-off.
It is important to keep in mind the various scenarios which may unfold. There are three obvious possibilities that we are watching:
1. Return of the Credit Crisis
The next leg down in the stock market may be a repeat of the 2008 credit crisis that really began once Lehman went under last September. There's good reason to believe that event could return. For one, the 1929 crash was a similar, debt-related event. The DJIA crashed from a high of 381.17 on September 3, 1929 to a low of 41.22 on July 8, 1932--a crash of 89%. Once the initial crash into 1932 was over, there was a brief but powerful bear market rally from the 41.22 low to 79.93 on September 7, 1932--a 94% rally from the lows. Then it proceeded to crash again to 50.16 on February 27, 1033. The repeat crash was caused by continual credit stress.
It is entirely possible that we may see another crash to at least retest the March 2008 lows. We have more ARM resets, major issues in commercial real estate, more credit derivatives being created, and increasing government debt levels. All of these contribute to the possibility of a return of the credit crisis that would make asset markets retest the lows, and possibly exceed them to the downside. However, if we see a repeat of the credit crisis, then we should also see credit stress appear in the markets just beforehand along with a sell off in corporate and junk bonds and a stabilization of the dollar. We would then expect to see most assets, notably stocks and commodities, crash. Gold may sell off initially, but would then start moving higher quickly as confidence in government ability to manage the crisis waned.
Governments and central banks would react by printing more money to save the banking system and attempt to stimulate the economies of the world. The fact is that people have become ever more dependent on their governments, especially in the westernized countries, to the extent that politicians will have to do something to help the masses or face serious, perhaps fatal, consequences from their starving populations.
2. Reality Sinks In
If the credit crisis fails to resume, we may see simple reality finally catch up to overly frothy, overpriced assets, especially stocks. Globally, stock markets are pricing in a recovery. Given that consumers will take many years to fix their balance sheets, unemployment remains high and is rising, and export-driven economies have greatly reduced purchasing from their primary customers, reality may just catch up to the markets and cause a sell-off. The fact that the retail investor is now entering the market when it is deeply overbought is a contrarian sign of a nearing top since retail investors are, by definition, uninformed and uneducated in market events. The market will simply stop going up when we run out of buyers. The professionals are about done. The retail investors will make the market rise until there is buyer exhaustion. Then the only option is for the market to go down. News of a poor holiday season may be the catalyst that forces the professionals to sell. Then the retail investor is left trying to find the next biggest sucker to buy his overpriced stock assets.
Central to this issue is the health of export-driven economies like China. The major question for China becomes whether or not they can make up for the lack of big western consumer country customers with their own population buying more consumer goods. Given than most western countries don't produce as many goods for domestic consumption as the Chinese do for western countries, it is likely that even greatly reduced westernized consumption will still benefit China for the foreseeable future. After all, consumer spending cannot go to zero. People still need goods to go on living, and those goods are primarily coming from countries like China. With those funds from sales to western countries, the Chinese are likely to continue to buy resources to fund their modernization and expansion. That will, in turn, support commodity prices, commodity companies, and countries whose primary exports are commodities.
In this case, we should see stocks do well that have good fundamentals. Most of those stocks are not part of the S&P or DJIA. Some tech companies, commodity producers, and commodities themselves should do well even in the face of a greater stock market crash.
3. A Bubble Recovery
This is, we believe, what the Fed wants to see--another bubble. To understand this scenario, we need to recap how we got where we are.
Leaving behind the events like the creation of the Fed, Keynesian policies and Bretton Woods, the ending of the gold standard, and the introduction of floating exchange rates--all of which contributed to where we are--we can take a look at Fed policy from the latter 1990s to present as the catalyst for our current problem. The events such as the Asian currency crisis of 1997, Long Term Capital Management in 1998, the dot com bubble crash of 2000, and the 9/11/2001 events all prompted the Fed to make more cheap money available. Since the dot com crash in particular, the real US economy has never gotten back on its feet, and no new "real" jobs have been created. The cheap money and credit fueled one bubble after another. Most recently, the cheap money and credit that resulted in the malinvestment that resulted in the dot com crash simply ran over and fueled the housing and real estate bubble. All of the domestic job creation from that point forward was related in some way to housing and commercial real estate, whether it was increased retail near new housing additions, construction jobs, local service businesses, etc. Meanwhile, in the real economy, more real jobs were exported (a topic we'll delve into more another time). The net result is what we see now--the total number of real, sustainable jobs since 2000 has been declining. As the real estate bubble unwinds, we see the real effects of this problem resulting in higher unemployment than would be expected in a typical recession.
The Fed and the government would like to see a new bubble. The alternative is a real, structural fix to the western economies of the world that would result in more local manufacturing and sustainability. That will take years, maybe decades, to put into place. Because the economy is necessarily competitive on a global scale, the created jobs would have to be cost competitive with other countries (or governments will try to "fix" the game and become insular, resulting in a destruction of their local economies). That would require a more honest monetary system, massive reductions in the size of government and government spending, and a decreased (but stable) standard of living for most of the western countries. Thus, instead of a real, structural repair, we believe that the governments of the world will try for a bubble again. It may or may not happen. In fact, it may instead create a new carry trade--but that's a subject for another day and a very important thesis to consider for investing as we move forward.
Before this is all over, we may see all three scenarios in one form or another.
That's a lot of commentary for one posting, but since we've been gone a while, we needed to give you something to chew on. In closing, this video from Michael Pento seems very relevant to our topic for the day.
