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Thursday, August 04, 2011


Why Prices are Cascading

As expected the debt limit increase passed, with belly aching by both Tea Partiers and Liberals, but with healthy margins. Congress never refuses to write itself an increase in its line of credit, even when it makes a pretense of self-discipline.

An interesting reaction to the denouement has been that the financial markets have voted thumbs down. In my view, I would interpret the market slumps (everything but metals and certain foreign currencies) as a protest against the softness of the savings so far identified. In fact, the markets interpret the deal as another instance of our leaders kicking the can down the road, the Tea Party's success at changing the nature of the conversation notwithstanding.

Of course, one problem with market reactions is that the market doesn't speak specifically or definitively, so anyone can make the interpretation they like. Progressives think the market is upset because "austerity" exacerbates the double dip recession possibility. So one must accept that people of different world views will have extreme difficulty in having a civil and enlightening conversation about these issues. To me, reviewing the liberal blogs is like visiting fantasy land. They revile the Tea Party and consider THEM the crazies. In fact, the Tea Partiers are the only people facing the reality of our crippling fiscal situation. Hence the rise of Cantor and especially DeMint.

After a technical bounce yesterday, the market is resuming its devastating slide today. We opened down a hundred points today and as this is written, trail by about 220. That means we are down about a thousand Dow points in the last ten sessions. This is reflective of a concern about the health and ability of corporations to deal with a significant double dip recession experience. Frankly, the bottom today could be quite a bit lower.

In fact, corporations have largely enhanced their balance sheets since 2008, though I have detected some weakening in the second quarter reports. Though scary, this probably represents a nominal buying opportunity; nominal because I expect the inflation that we will soon experience to offset the price gains when they come in. In fact, it will be inflation that drives stock prices higher once equilibrium is restored.

This is a very difficult time to be on the Federal Reserve Board, though they brought much of this mess on themselves. The fact is that we NEED higher interest rates, and we need to reduce the Fed's balance sheet, not increase it again as they seem to be tempted to do now via QE3. How does the Fed take these actions on the precipice of another downturn? This is yet another reason why the Fed needs Congress and the Administration to cooperate by reducing spending.

Why do we need higher interest rates? Right now, corporations and banks are hoarding cash, as they have since 2008. Would you invest in any venture involving risk at a yield of near zero? How many of you are buying CD's, and providing capital for accumulation purposes, at such low rates? That is what the Fed seems to be asking business and consumers to do. Not going to happen, and the economy will remain dead in the water until a normal risk/reward ratio is restored.

Meanwhile, the Fed continues to prop up banks by paying them much more on their reserve deposits than they have to pay what consumer deposits they can drum up.

Furthering the problem is the regulatory madhouse unleashed by the Obama Administration, and the one they have promised by enacting PPACA and Dodd Frank. That just raises business costs and risk. Other frictions include the failure to submit the trade agreements for approval, a nod to the administration's union buddies.

If all this sounds like a rerun of the Carter Administration, that's because it is. Luckily, we reversed course in 1980 after four years of this kind of nonsense. Let's hope the electorate in 2012 has some of the same common sense.

Back at my computer, and the markets have finally closed, as I expected, down much more, over 500 Dow points and even worse on the NASDAQ - over a 5% loss. This was a day that resembled the bad days of 2008 in that every time the market tried to poke its head up, the big players came in and squashed it. Paul Kangas might call it "mindless selling." Nice earnings reports were greeted with double digit losses. Dividend increases were ignored. It was really a day to lay low.

Maybe now, readers will understand why we have been moving money gradually into preferred's, gold and TIPS. Even there, only TIPS thrived in today's rout, indicating there is more fear about inflation than deflation. More on that in a second.

This was a day that only Bob Prechter and his followers could love. As the Eliot Waves came crashing down around us, one wonders whether Prechter will ultimately be vindicated after all. I would say that he already has, at least economically if not in terms of his stock price predictions. We are certainly well into a decade or two of flat to no growth.

On the other hand, Fed actions to inflate the dollar seem to have thwarted Bob's expected deflation and the attendant slump for gold and commodity prices. In fact, I think there is a good chance the Prechter scenario might have occurred if not for the irresponsible fiscal and monetary policy of the country since 2005 or so. Instead we face an inflationary, no growth period, something like what we experienced during the Carter years. It will be different though; I'm just not yet sure how.

So where does the market go next? We don't know and we don't forecast. We do react to market developments, methodically, unemotionally, and in accordance with our investing formula. I will say that what happened today just doesn't feel as much like a bear market as it does the end (or very near the end) of a short but very sharp correction. There was capitulation today, and that is necessary to go through before we start back up. I just don't see how a bear market starts when all these companies are raising earnings guidance and dividends. That doesn't add up for me.

We did take a beating today along with most other players, one of the worst ever. I suppose we might be down for the year now, or even at best. We have been buying, at what seemed like good prices at the time, but not now. On Monday, we bought 200 shares of American Dental Partners (ADPI) at 11.67. On Wednesday, we bought 400 shares of Pulte Homes (what, again? PHM) at 6.24. We do what the formula says, but these are both speculative stocks that most folks should avoid, particularly in such volatile markets. We'll fish in the preferred pond tomorrow and reassess over the weekend.

Good time for our periodic disclaimer. Neither Redwavemusings, nor its author are investment advisors, and the comments and securities mentioned here do not represent advice nor recommendations. The securities and our investing strategy are likely to be unsuitable for readers (and everyone else, including moi).

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