Nothing has Changed… and now the Markets know that too.


What seems to be happening in the markets, with stock indexes, toggling aimlessly around their respective numbers, is the formation of a rationale setting in to the mind of investors.

On Thursday the Dow almost landed 0.0 points higher than the day prior at a pace that would make any doctor panic in the operating room.

I would speculate that when the realization of a housing slowdown became eminent, in late 2005, a sentiment set in of a weaker and slower economy, i.e. a “Wall of Worry”. Stock investors used this to their advantage loading up on high quality issues and buying hard assets such as gold and commodities. In May we saw speculators jump aboard sending the Dow into a decline as well as a strong meltdown in Metals and eventually in Energy.

Once this became common ground investors then saw a great opportunity to once again trounce on these issues. The Dow is since up over 2,400 points and Gold has recovered from its 550 lows to over 650 in the past week.

In my opinion, what we are seeing now is once again indecision, stronger than before, as to what the economy will do next and what the Federal Reserve will do to counter that reaction.

However, the general sentiment of the people is what is getting distorted, not the fundamentals behind the macroeconomic picture.

Bear in mind that between 1966 and 1980 the Dow made an total annual appreciation of 0.4%. Then too the Dow ran up almost 15%, but then fell by over 40% on slower growth in the economy at large as well as in corporate profits, due to inflation and higher oil and commodity prices.

Strangely enough, the rise in stocks has almost been in replicated tandem with falling commodity and oil prices and the media knows this…

“Falling Oil Prices May Help Spell Relief for Consumers.” – Wall Street Journal, September 13, 2006.

“Stocks Rise as Oil Prices Keep Falling” – Seattle Times, September 13, 2006.

“Falling Oil Prices Fuel Blue Chips to Jump 101.25.” – Wall Street Journal, September 13, 2006.

“Buying Frenzy! Dow up 101 on Sinking Oil, Strong Earnings.”

“The notion that lower oil prices are bad for the equity market is ‘rubbish’…the decline in commodity prices is bullish for stocks.” Dick Green, president of Briefing.com.

“Yesterday I heard on television that anyone who thinks commodities are going to lead stocks lower is ‘stupid.’ Well, I guess I’m with stupid. So is Australia. And much of the Asia-Pacific region.”Pepe Depew in yesterday’s Five Things

“The rub, for lack of a better word, is that the long-held and universally accepted notion that lower energy prices would bode well for the consumer and, as an extension, the stock market is entirely misplaced. If the commodity complex begins to spin lower, the odds on bet is that equities will follow their lead.” Todd Harrison , August 23, 2006 and as stated on CNBC on August 30th.

 

Thus one may reason that the people, those with no investing education and see only that which is most obvious, were indeed correct in their original assumptions but have been trumped by the Media and their emotional conscious.

Many analysts claim that Energy and Metals are the most speculative of industries to be in due to their large run ups. But when looking at these two sectors we see, dominantly, oil – the life source of this economy – in the energies has gone virtually nowhere over the past 12 months after falling almost 40% off its May 2006 highs. Gold as well has fallen substantially from 710 to 650 and is still well below its 1980 high of $800 not adjusted for inflation.

All that seems possible and thus probable is that the shake up we’ve seen recently in lenders, primarily sub-prime, the ones we’ve been writing about, will continue and most probably worsen as the sentiment and the Media begin covering it in more detail.

Once that does happen then it would be a matter of decision for the Fed to either allow the markets to stabilize themselves or to speculate with interest rates and risk leveraging the economy either towards hyperinflation with money creation, lower rates and credit expansion or towards a strong depression with higher rates and tightening of money supplies.

Only Time will tell. Risk is dominant, Credit and Money is flowing through the streets and complacency and tolerance is at all-time highs, all significantly undervalued. We think of sentiments too as commodities that may be used in or against our favor.

When bulls begin to panic, when the homeowners loaded with unsettled debts sitting on homes – with tied ARMs – dreaming of better returns realize that they’ve been had, the risk-free assets will rule as an industry. Hard assets will be favored once again, the fiat-dollar bills shunned and gold restored to its historic abode of monetary dominance.

This will happen because it must and it has worked this way since the laws of supply and demand economics were first discovered.

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