A Broken Down Stock Market

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Before this correction is over, the Dow will trade below 5,000. That has been our prediction for the last 10 years. Maybe we were a little early. But we’re sticking with it.

Besides, stocks have been a bad bet for the last 12 years. They’re now back to ’97 levels…meaning, investors have made nothing for a dozen years. Stocks for the long run? How long do you have to wait?

And now, the stock market is breaking down…again. Dow Theory has given a Bear Market Signal. What that means, exactly, we don’t know. Stocks will go down until they stop going down, we guess.

Citigroup is moving “closer to toast,” the New York Times reports. The market cap of Citigroup has fallen by more than 50% since Monday. “I think it is going down,” writes old friend Jim Davidson. “My best guess, it will be nationalized…on a ‘temporary’ basis.”

Many are the economists urging the government to nationalize the big banks. People need confidence in the banking system, they say, or we’ll all be toast.

Among the big names in favor of nationalization is Nouriel Roubini, one of the few economists who seemed to know what was going on. He saw the crisis coming and said so. Now, he’s practically a media star.

Of course, we saw the crisis coming too…here at The Daily Reckoning. We said something too… But we’re still waiting for the press to call…just so we can hang up on them. The worst thing that can happen in this trade is success. It makes you think you know what you’re talking about. The next thing you know, you’re giving advice to central bankers and major corporations. Then, the gods get their backs up. Everyone starts believing what you say…even you.

If we were in charge, we’d get out the toaster. But nobody asks our opinion. And it’s probably a good thing. Because when people come to think what you think, what you all think is probably wrong. At least, that’s the way it tends to work in the financial markets. As soon as everyone gets on to a trend, it is soon over. Back when the going was good, for example, everyone thought it would be good forever. Naturally, it stopped being so good soon after.

Now, what does everyone think? Hard to say. We read the headlines and try to figure it out.

“In Gold We Trust,” says a headline at the Wall Street Journal. Gold fell back below $1,000 yesterday. The yellow metal seems very popular. Maybe too popular. But does everyone think gold is going up? We hope not; if they did, we’d have to sell.

Still, most people still think gold is a little kooky…the kind of stuff that grumpy old men bury in their back yards. And most professionals, too, still think gold is weird — an investment for grandpas. “Worried about inflation?” they ask. Then, solving their own problem: “Just buy TIPS. You know, government bonds indexed for inflation. You’ll collect some interest…and you’ll be protected against inflation. These bonds are indexed to the CPI.”

TIPS are cheap. That is, you don’t give up much yield to get the inflation protection. But if investors can get protection from inflation for only, say, 1% of yield…what does that tell us? Well, it tells us that investors think the rate of inflation over the next 10 years — TIPS are equivalent to 10-year notes — will be only about 1% per year.

People don’t call an exterminator when they have no pests. Gold is protection against inflation. They don’t usually buy gold when they don’t fear inflation. The TIPS premium — the extra that investors pay (or the yield that the give up) — is so low, it tells us that investors aren’t afraid of inflation.

What are they afraid of then? Why is gold going up? What is it that everyone thinks?

Our guess is that people don’t know what to think. Some — and only some — are hedging their bets by buying gold. Something funny is going on, they must think. They don’t know exactly what it is, but they’re sure it won’t end well. They buy gold…just in case.

So, the major trends continue. Stocks go down. Gold goes up.

The S&P 500 took quite a beating last week. After breaking through near-term support at in the 804 area — the bottom of the market’s intermediate trading range — stocks are now poised to test November lows at 741 on the S&P. But Easy Money Options’ Wayne Burritt thinks, if history is any guide, that the market may be poised for a bull run.

“The recent technical action is shaping up much like the market’s recovery after the dot-com fiasco. Back then, the S&P tested the 769 to 789 level three times in the eight-month period between July 2002 and March 2003. Each time the levels held and after the third was over, the market commenced a spectacular bull run.

“In fact, from its jump-off point of 783 in March 2003, the market didn’t stop until it reached 1576 in October 2007. That’s a staggering 101% gain in just over four years.

“Today, the markets are wrestling with similar lows in the 741 area. It made its first test in November and succeeded. It’s now in the midst of a second test. If my thinking is right, it will test that low, recover and then test it once again. After the third, a new bull run could be in the cards.”

Wayne does admit that the fundamental pressures of today are much worse than following the dotcom bust…and that means the market bias going forward is certainly to the downside.

However, Wayne has his sights set on a handful of companies that are prepared to move up — no matter what the broader market does.

Looks like Paul Volcker is channeling Gloria Gaynor…

Volcker, former head of the Fed and hero of the inflation fight of the ’80s, says of capitalism: “I will survive, I will survive.”

We did not read Mr. Volcker’s speech. But we can imagine it. Capitalism, in its various forms, has been around for a long, long time. It is unlikely to go away, simply because everything else is a fraud and a scam.

What a delight to see Mr. Volcker rise to defend capitalism. The old creed needs a lift. Every crackpot and malcontent on the planet is gunning for it — including Danny Ortega, here in Nicaragua.

What is capitalism, after all? It is not a system…not a plan…not a program. It was not decreed by any half-wit tyrant…nor written into law by any earnest assembly. It has no constitution…and no boundaries. It is merely a recognition of basic principles. “Thou shalt not steal,” it says in the Bible. Capitalism recognizes other peoples’ property. The baker has a right to his oven. The farmer has a right to his land. The capitalist has a right to his money. What they do with these things is up to them.

Will they make mistakes? Of course they will. Will they do evil and obnoxious things? No doubt about it. Will they occasionally lose their heads and overprice their assets…or run the whole economy into too much debt…or blow themselves up in a bubble? You bet.

As Adam Smith described, they will also bumble along to create the wealth of nations.

But larceny wasn’t invented in the 21st century either. Naturally, people want what the capitalists have. Everywhere and always, the thieves will find reasons why they should be able to take it from them. They will respect the environment better, they say. They will invest in “socially responsible” projects, they claim. They will heal the lame and make the blind see. If only they get their hands on your money!

We don’t particularly like capitalism or capitalists. We just don’t like anyone telling us what to do. So, doing unto others as we would have them do unto us, we make no effort to tell others what to do with their money. If they want to give it to Bernie Madoff or to Barack Obama, so be it — just count us out. If they want to invest in CDOs and MBDs…well, good luck to them; but don’t look to us to bail them out.

“Danny Ortega is not really the person making the decisions down here,” explained a Nicaraguan friend. “It’s his wife. And she’s a witch.”

We thought she was expressing an opinion. Instead, she was merely stating a fact.

“No, she’s a real witch. She even organized an international witch convention here in Nicaragua. Witches from all over the world came to participate. You should see her. She wears rings on all her fingers. Each one is supposed to be a talisman of some sort. You have to watch out, or she’ll put a curse on you.

“Naturally, the whole country is a mess. These people have no idea what they are doing. But they are convinced that capitalism is bad. So they try to stop it. What that means in practice is that they make it very hard to invest in Nicaragua. Just look around. Do you see any new factories? Any new roads? Any new developments of any sort?

“Well, maybe out here at the beach, where rich foreigners are building houses. But the rest of the country has come to a standstill. Of course it has, because who wants to invest in a country run by a witch?”

“It’s the same down here as everywhere else,” explained a developer in Nicaragua. “During the boom, people were creating new developments everywhere. Most of them got to the advanced design stage. Lots were laid out and sold. But the infrastructure was never completed. Now, a lot of those places are just closing down. It’s not a good time for us.

“But I just think it is a lull. Over the long haul, Americans will still want a nice place to retire. And Danny Ortega should be gone — I hope — in a few years. There’s no prettier or nicer place in the Northern Hemisphere. The coast is beautiful. The beaches are nearly perfect. And the prices are still very low compared to other beach areas. When the economy picks up, this place will come back to life and people will begin building again. It’s not like Detroit. That city will probably never come back to life.”

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007).

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