October 22, 2007: Very short term -- as of Friday's close, the Dow had been down seven out of the last eight days, This left the Dow "straining" on the downside. Today the Dow closed higher, which relieved the strain.
However, the technical picture is clearing up at last. And again, it's incredible in this multi-trillion-dollar industry that so few investors, traders, analysts, professionals, have learned to read the story that is being told by the market. It's comparable to an auto mechanic who hasn't learned to drive.
At any rate, we're now dealing with a classic Dow Theory situation, and it's all laid out in the two daily charts shown below.
Here's the story. The two D-J Averages, Industrials and Transports, plunged to secondary lows on August 16, Industrials at 12845.78 and Transports at 4672.35.
From the August 16 lows, the Averages rallied with Industrials reaching a record high of 14163.80 on October 9. As you see on the lower chart, the Transports failed by a wide margin to confirm. This set up the potential for a classic Dow Theory bear signal.
The signal for a primary bear market would be given under the following conditions. Both Averages, and I emphasize BOTH, must now decline and break below their August 16 lows. The authority of the signal would be heightened if the two Averages were to break below their August 16 marks simultaneously, and an increase in volume.
A violation of one Average, unconfirmed by the other, would not constitute a bear market signal. In fact, a violation of one Average, while the other Average stubbornly refuses to follow, could represent a bullish non-confirmation.
We are at a dramatic juncture, and the picture is quite clear. It's now a matter of whether the Industrials and the Transports, one or both, hold above their August 16 lows. If BOTH Averages, Industrials and Transports violate their August 16 lows, then the tide of the market will have turned and we will be dealing with a primary bear market.
I will add that if a bear market is signaled, and there is no guarantee that it will be, but IF a primary bear market is signaled, it would be best to be out of all common stocks.
Again I'll repeat, the critical August 16 lows were 12845.78 for the Industrials and 4672.35 for the Transports. The horizontal blue lines on each chart identifies the all-important August 16 lows.
Question -- Russell, if a primary bear market is signaled, do you think it would be a reflection of declining corporate earnings or could it be a forecast of further trouble in real estate?
Answer -- There's absolutely no way of knowing. It could be either, it could be both, or it could be something else that is not now receiving any recognition. I've used this simile before, and I'll use it again. When you're standing on the railroad tracks, and the train is hurtling toward you at 110 miles an hour, it doesn't make a bit of difference whether that train is the Midnight Special or the Wabash Canon Ball, you had just better get the hell off the track.
Remember, I'm not predicting that a primary bear market will be signaled. I'm just telling you, my subscribers, what the situation is and what to look for IF those August 16 lows are violated.
Question -- Russell, if we do receive a bear signal, would there be any special reasons to take the signal seriously?
Answer -- Primary bear market signals are rare, and I always take them seriously. But I would take a bear signal ahead particularly seriously. This is why --
First -- Nobody seems to have noticed that the current structure in the Averages sets the market up for a potential bear market signal. I haven't read anything about the structure -- nothing! Therefore, if we do receive a bear signal, it will be totally unexpected. And that's NOT good.
Second -- Lowry's Buying Power is now at a six month low. And even more important, Lowry's Selling Pressure as of Friday was a big 145 points above the Buying Power Index. This is both a negative position and a negative spread in the two indices.
Third -- New lows on the NYSE have been rising. Here are the new lows for the last six days -- 56, 80, 103, 122, 152, and today 176.
Fourth -- As of today's close, my PTI was only 18 points above its moving average. Thus, my PTI was only three days away from a potential bear signal.
Question -- Russell, I see that gold has been whacked today. If gold is real money, why are frightened investors turning to T-bills and short notes instead of real money, gold?
Answer -- Gold is an asset like a diamond or a section of coastal land or a Matisse painting. Over time, gold will appreciate against fiat paper. But T-bills or cash is what everything is denominated in. If the dollar turns really weak, it may drop 1% or 2% in terms of purchasing power. But unless there is a total panic out of dollars, dollars are probably the safest place to be in a deflationary collapse.
Gold is denominated in dollars and is treated today as more of a commodity than as money. Thus, in a weak market with deflationary overtones, gold will be hit. But gold is a timeless asset or pure wealth. Ten years from now gold will still be an asset while who knows whether the dollar will still be around.
Conclusion -- In these times, you need both -- gold and dollars -- but for different reasons.
Question -- If, and I say IF, we do get a bear market signal, do you think it will have deflationary implications?
Answer -- Yes, absolutely. If a bear market is signaled, all assets will be hit, and particularly US and European housing. If we receive a bear market signal, it will then be up to the central banks of the world to start an enormous reflation campaign. I've said all along that we're moving into a situation that can be best described as "Inflate or die." If a bear market is signaled, the central banks and the various governments will have to start spending and inflating as never before! Otherwise, the world will sink into deflation.
Question -- If the government has to increase spending, what's the easiest area for the government to up its spending..
Answer -- Do you even have to ask? It's the military. But remember, we're in a war on terror and on nuclear weapons and on weapons of mass destruction and on poverty and on narcotics and on crime and on -- well, you fill in the rest.
TODAY'S MARKET ACTION -- My PTI was up 7 to 5955. Moving average was 5937, so my PTI remains bullish by 18 points.
The Dow was up 45.12 to 13567.14. No movers in the Dow today.
Nov. crude was down 1.04 to 87.56.
Transports were up 43.91 to 4845.27.
Utilities were up 3.20 to 591.86.
There were 1799 advances on the NYSE and 1473 new lows. UP volume was 59.3% of up + down volume.
There were 25 new highs on the NYSE and 176 new lows. My 5-day high-low diffentials turned negative today -- from plus 106 yesterday to minus 147 today.
Total NYSE volume was 3.07 billion shares.
S&P was up 5.70 to 150 6.33.
NASDAQ was up 28.77 to 2753.95.
My Big Money Breadth Index was up 4 to 838.
Dollar Index was up .59 to 78.00. Euro was down 1.39 to 141.56. Yen was up .52 to 87.64.
Bonds were mixed. Yield on the 10 year T-note was 4.39%. Yield on the long T-bond was 4.67%. Yield on the 91 day T-bill was 3.86%. CRB Commodity Index was down 3.02 to 447.54.
Dec. gold was down 8.40 to 760.00. Dec. silver 13.55. Platinum was down 8.80 to 1439.80.
GDX was down 1.27 to 45.53. HUI was down 10.27 to 394.55.
ABX down 1.27, AU down .48, ASA down 1.93, NEM down .89, PAAS down 1.36.
Gold was down along with cotton, oil, copper, and they're still treating gold as a commodity.
STOCKS -- My Most Active Stocks Index was up 3 to 567.
The five most active stocks on the NYSE were SGP down 4.37, C up .25, F down .03, PFE down .05, EMC up .21.
The VIX was down 1.82 to 21.84.
CONCLUSION -- Dow rallied after seven out of eight days down. Nothing proved today either for the bulls or the bears. We did get 176 new lows today, the most since mid-August. breadth was sluggish, up by a plurality of only 298. I have to see more before I can draw any intelligent conclusions. The Lowry's figures will give the market a grade today, but with such poor breadth I have to think that the Lowry's statistics won't be particularly bullish.
Looking forward to tomorrow, I am --
R. Russell
............................................................................................... I just received this e-mail from my friend, the brilliant Richard Duncan. He wrote the book, "The Dollar Crisis," which I recommended strongly when it came out a few years ago.
Dear Mr. Russell,
I hope you are well. I have moved to Singapore after a year and a half in London where I was the Global Head of the investment strategy department at ABN AMRO Asset Management. I am now a partner at Blackhorse Asset Management, an Asian equities hedge fund.
Please find attached an article I wrote for the cover story of FinanceAsia's September edition.
I hope you find it interesting.
With best regards,
Richard Duncan ......................................................... Richard's e-mail is too long for me to include here, but I am including the first few pages. Suffice it to say that Richard Duncan sees the possibility of an international deflation, and he believes the US will have to create and spend a massive amount of money in order to counteract the coming deflation as the massive bubble that has been built -- finally contracts.
BLAME THE DOLLAR STANDARD By Richard Duncan September 2007
Introduction
Global credit markets are caught up in the worst systemic crisis in living memory. A meaningful portion of all outstanding financial instruments are significantly impaired. The solvency of some of the largest financial institutions in the world is in question and trust in the interbank market has evaporated. Central banks have been forced to inject hundreds of billions of dollars into money markets to prevent a world-wide financial sector meltdown. It is imperative to understand this credit crisis is only one part of a much more far reaching crisis within the global economy. A world-wide credit bubble has arisen as a result of the United States’ $800 billion a year current account deficit. Flaws in the post-Bretton Woods international monetary system are to blame.
The chances of a global recession are high. The severity and length of the downturn will be determined by how policy makers respond now that the global credit bubble has begun to deflate. A wise policy response could result in some good emerging from this disaster. A foolish policy response could have catastrophic consequences. This article will consider the origins of this crisis. It will also offer advice to policy makers, who need to act quickly to prevent the Great Credit Crisis of 2007 from becoming an economic depression.
Flaws in The Dollar Standard
The Dollar Standard is the most appropriate name for the international monetary system that evolved following the collapse of the Bretton Woods System in the early 1970s. The principal flaw in The Dollar Standard is that it has no mechanism to prevent large and persistent trade imbalances between countries. Consequently, the deterioration in the United States’ current account deficit has gone unchecked, recently reaching nearly 7% of US GDP. The countries with a trade surplus with the United States have been blown into economic bubbles. Japan in the 1980s, the Asia Crisis countries in the 1990s, and China today are examples. Moreover, as the central banks of the United States’ trading partners have reinvested their dollar surpluses back into US dollar assets, the United States itself has also been blown into a bubble. In short, the US current account deficit has destabilized the global economy. That was the theme of my book, The Dollar Crisis: Causes, Consequences, Cures (John Wiley & Sons, 2003, updated 2005).
Before the breakdown of the Bretton Woods International Monetary System, international trade balanced. Subsequently, however, the gap between what the United States bought from the rest of the world and what the rest of the world bought from the United States began to steadily expand.
Under a Gold Standard, or the quasi gold standard Bretton Woods system, such large trade deficits would not have been sustainable since the US would have had to pay for its deficits out of its limited supply of gold reserves. However, the willingness of the United States’ trading partners to accept payment in dollars instead of gold meant there were effectively no limits as to how large the US trade deficits could become. This vendor financing arrangement allowed much more rapid economic growth around the world than would have been possible otherwise. The larger the US current account deficit became, the more the United States’ trading partners benefited.
When the foreign companies selling product in the United States took their dollar earnings home and converted them into their own currencies, it put upward pressure on those currencies. The central banks of those countries intervened to prevent their currencies from appreciating so as to preserve their trade advantage. They intervened by creating money and buying the dollars entering their countries. In this way, the exporters were able to keep their export earnings in their domestic currency and the central banks accumulated large foreign exchange reserves.
As the US current account deficit grew larger, central banks created more and more money and intervened on a greater and greater scale each year. In fact, total foreign exchange reserves have doubled over the past four years. In other words, during the course of the last four years, foreign exchange reserves have increased by as much (US$ 2.8 trillion) as in all prior centuries combined. The reinvestment of those dollar reserves into US dollar assets fuelled the credit excesses in the United States that culminated in an unsustainable property bubble there.
Russell Comment -- One of the current problems is that housing prices have become hugely inflated. The question is whether we are on the edge of a major deflation in housing prices. Richard Duncan's point is that the US will now have to inflate massively as it attempts to stave off deflation, and it could be world deflation. The amount that the US may have to inflate over the coming three or four years could be upwards of one trillion dollars.
ASX Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
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