It’s Time to Revisit The Markets

It’s time to reflect on the predicament of the markets. We ran two editorials in late December entitled “Are You Ready for The “Blue” Year?” and “Some Thoughts on the Markets“. We defined a general outlook for the economy for the year of 2008.

We are constantly reminded that “The more things change, the more they stay the same”, it is far easier to predict what we may see in the future. With that I would like to offer clarity to the confused investor.

Dow/Gold Ratio
The ratio currently stands at 15, with a low of 12.5. Our immediate term goal is 7 with an eventual decline to 3 before the economy pulls itself out of recession.

During the brutal 1973 downturn the Dow Jones Industrial Average fell from 1050 to 570, a decline of 45%! Yet this wrecking fall was cushioned by a counter-rally from 800 to 1000, within 5% of its all-time high. Interestingly gold, during this same period, rose throughout the downturn, from 70 to 195 over the 2 years period. Over 178%!

If I were to rewrite that paragraph but multiplying all 1973-75 dates respectively, it would read as follows:


During the brutal 2007 downturn the Dow Jones Industrial Average fell from 14,000 to 7600, a decline of 45%! Yet this wrecking fall was cushioned by a counter-rally from 10,650 to 13,300, within 5% of its all-time high. Interestingly gold, during this same period, rose throughout the downturn, from 700 to 1950 over the 2 years period. Over 178%!

Obviously, history will not repeat itself, but it sure as hell does rhyme. I believe that the DJIA will push above 13,000 temporarily and then resume its decline to 7600 vicinity. While gold will trend ultimately to the $2000 level by late 2009.

[One may ask based on these calculations, that Dow 7600 / Gold 2000 = 3.8, well above our factor of 3. Nevertheless, it is most probable that gold won’t peak at the exact time that the Dow bottoms].

Thus the prudent investor will seek refuge in some words from our December article.

“The truth is, however inverted it may seem, bad is good, bear is better than bull, bust beats boom”.

This simply means the investor can do phenomenally well by simply paying little attention to the media and markets and instead focus on the short yet profitable buying opportunities that present themselves.

With that we move on to some predictions we made back in December of 2007, results since then and what we can expect going into 2009.

The Economy

“When demand is high and supply is low prices must rise, and if by any means they are manipulated or capped they will rise further in no different a logic than the what lead to most of the current problems in housing

This sums up what we’ve been seeing over the last few months, and it can be expected to continue into 2009. The media will keep calling bottoms while credit and leveraged conditions deteriorate.

“There isn’t much we can be sure of in the next year other than the fact that more volatility and election jargon will be stuffed down our throats

This in my eyes was a no-brainer. Tension was all too high and much of the markets movements were based on speculation rather than solid fundamentals.

“Corporate profits will fall causing either p/e’s to rise or prices to fall as well. Don’t be surprise to see us approaching single-digit ratios for the Dow”

This may have been too short an outlook, however it is expected before markets bottom. It’s not if, but when.

“Expect to see more and more consumers turn to their retirement accounts and credit cards to keep them afloat”

This has been seen slightly and is significantly increasing. Foreclosures have doubled year-to-date and increasing amounts of home-owners are just walking away.

Inflation

Whether or not [we have a Recession]… expect some sort of ‘flation.

So far GDP has been positive so there is no “official” recession. But ‘flation indeed! Stocks have fallen and since found some relief, while commodities have boomed and since corrected. Yet the investor should not be fooled by this.

Interest Rates

“He [Bernanke] really has no choice… right now he sees fear of recession and it’s his job to cater to it”

With rates lowered from 6.25% to 2%, all Fed Discount Windows were opened and inflows have been supplied to the market, not to mention the bailing out of Bear Sterns.

Currencies

“The Yen and Yuan seem to be holding up fairly well… As for Switzerland? Yeah, I think the Franc should hold up just fine… for the Loony, Real, Ruble and Aussie Dollar the future never looked so bright”

This was mostly due to a declining Dollar. The Dollar may have now found a bottom and this will be sustained when the Fed turns to raising short term rates. Yet if markets follow any similarity to the 1970s, this rally will be short-lived, with the Dollar testing new lows come 2010.

Housing

Interest rates are a major part of the equation. The lower rates go the higher the floor for housing prices”

Any economist would agree that the potential damage has been avoided. Yet we are faced with the worst housing recession since the Great Depression and the results will be felt. Low interest rates cannot makeup for decades of careless credit policy.

“Prices fell a record amount for this year. Buffett says it will continue into late 2008. Others say into 2009. Jeff Saut says prices have to either fall 25% tomorrow or streamline for 5 years in order to reevaluate on an price/income basis.

According to the Schiller Index prices are down 12% in many U.S. cities.

Oil and Gas

“Oil at $150? …I think oil has more to run… many others say $150 or even $200 before the year is out… Expect higher prices at the pump”.

Right on the money! Oil has risen as high as $120 recently. (with gas prices expected to possibly reach $8 a gallon before the year is out). This may be due to the fact that many airline fuel storages, were running low. Acting as a catalyst this replenishing pushed up prices.

“Recessions do decrease demand, but with a decrease in demand comes a decrease in productivity… Wall Street’s assumption of $50 oil… may be way off target”

This can be seen with regard to possible production decreases in Nigeria, and with regard to metals production from South Africa.

The Stock Market

“It’s all in the earnings… there will be surprises… there will be opportunities but I doubt there will be any significant bottoms at least until the recession officially begins”.

Earnings have yet to plummet as stocks are currently down a mere 8% from their highs. Yet while we find ourselves amidst a speculative, yet predictive, short-term rally, we remain within a well defined long-term downtrend. (Is the Dow really selling for 64x earnings?)

Small Banks and Homebuilders

“I say not yet. Will I be wrong? Possibly, but at least I’ll be empty handed on the downside risk, and there is some. I still don’t believe Wall Street has revisited pure unadulterated pessimism. A P/E of 8 doesn’t seem that bad until you recognize its all in the denominator.”

This call is still up in the air. Average bottoms have been presented with indexes selling below book value. They currently sell for 1.3x book.

Commodities and Precious Metals

“When people want food, prices rise”

If I say “Rice, Wheat, Soybeans”, need I say more?

“This will benefit all commodities, as well as gold (The Street gives a $1000 projection). Of course Silver has much further to rise as it regains some historical ratio.”

Talk about psychological resistance! Commodities benefited greatly and Gold went straight to $1000 before correcting strongly. In the case of the Gold/Silver ratio now major advancement was seen. The ratio hovered around 48 before heading as high as 53.5

“In the event that commodities… decline in the short-term this should be seen as a buying opportunity”

We have since been offered this buying opportunity.

China

“China’s bubble will blow over, but not before the Olympics… After that I suggest you get out, especially if USA Today is announcing record high stock prices.”

China has corrected together with the world markets, but has since regained much losses.

Another great quote from the last article

“The perma-bulls tell you to remain 100% invested in the ‘long run’ as stocks are the highest returning asset class over very long periods, like 100 years… But I have yet to meet an investor that either has a 100 year time horizon or can actually sit through all of the bear markets that occur during 100 years.”
Bennet Sedacca

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