Another Steep Sandpile?

This sandpile sure is looking steep to me.  I compiled these on 2/10/11.

Cascading Bubbles

For reasons unknown, I've never really liked the term "bubble", but due to a lack of a better term, I'll use it today to illustrate a point.  I've always liked the phrase "overshoot and collapse" which is used in the biological realm to explain the rapid growth and subsequent crash in the population of a given species.  That's a subject for a later post.

I thought it would be interesting to analyze the impact of the money supply through time on various "bubbles".  The chart below illustrates quite beautifully how the money supply (M3-black dash) impacts the rise and fall of all markets.  The chart compares 5 asset types: technology, financials, oil, homebuilding, and wheat.  These all have experienced drastic "rise and falls" since the mid to late 90's.  Many commodities followed the exact pattern, but I used oil and wheat as two examples.  Click on the chart for a larger view.

Observations that can be made:

1. 
   
   M3 (money supply) rises in the early 80's (Reagan), flattens in late 80's (Bush I), rapidly accelerates in 1995 (Clinton), and keeps rising rapidly after 2000 (Bush II).
2. 
   
   Reagan pulls us out of the doldrums not by magical things called "trickle down" or "supply side", but by turning on the "money supply accelerator" in the early 80's.  Note the M3 Rate of Change curve on the bottom.  A trending up curve indicates a rapidly increasing money supplly while the downtrend is decelerating.
3. 
   
   The Great Maestro, Alan Greenspan, pulls off the accelerator in 1988 and Bush I loses re-election.
4. 
   
   Note that during the "flat" M3 from 1988-1995, the markets are aligned and flat. 
5. 
   
   In 1995, Clinton leads the public to believe that he magically makes the deficit disappear and balances the budget.  Meanwhile, the money supply starts a significant upward climb.  Note the M3 Rate of Change on the bottom of the graph.  It rises rapidly.
6. 
   
   Subsequent with the rapid rise in M3 in 1995, the markets go into "chaos" mode.  The money supply drives the financials and technology through the roof.  Note the steepness of the curves after 1995 in all sectors.  The end result is the DotCom mania.  Now we understand where all of that crazy investment and venture capital money came from!
7. 
   
   DotCom crashes only to see the "credit bubble" move into financials, homebuilding, and commodities (oil/wheat).  2001 marks a "new beginning".  Same game, but different sectors.
8. 
   
   The markets all align in late 2008 subsequent with the steepest rise in M3 Rate of Change.  Then they ALL come crashing down.  As Robert Prechter with Elliott Wave International has stated, "all the same".  Equities and commodities crash together in perfect synchrony.
9. 
   
   Money supply has significant impact on the markets.  While the Federal Reserve was supposedly created to help "nudge" the market when it needed assistance, the contrary is presented from this 30 year history.  After 1995, it looks more like a heroin junky flying up and down.

Dow Jones Industrial Average Gold Ratio - An Update

Well my post yesterday morning about the "flash crash" was timely.  The market "flashed" again.  For you "techies", the DJIA broke through the 200 day moving average.  This typically indicates that there is trouble ahead.  Today could likely be another wild ride!

I haven't posted a DJIA/Gold ratio chart in some time.  Here's an update from yesterday:

Flash Crash

Yes, The Pundits have coined a name for the 1000 point market crash two weeks ago, "Flash Crash". Yes it occurred in a "flash" and that's what really concerns me most. We've heard many explanations for it, but no one seems concerned that the market can change so abruptly without any warning.

This geologist is noting the event as a "tremor" with the major quake still upon us. What really is shocking is that stock trades that occurred during the "flash" have been cancelled. Is this really a free open market or is it controlled by "handlers"? You probably know what I think. Stay tuned!

The Inflationary Boiling Frog

"The boiling frog story states that a frog can be boiled alive if the water is heated slowly enough — it is said that if a frog is placed in boiling water, it will jump out, but if it is placed in cold water that is slowly heated, it will never jump out. The story is generally told in a figurative context, with the upshot being that people should make themselves aware of gradual change lest they suffer a catastrophic loss." Source: Wikipedia

Inflation can sometimes be analagous to the "boiling frog". It gradually creeps in and slowly climbs. The term inflation is often debated. I align with the Austrian economic definition that inflation is the "expansion of credit". Deflation, the opposite, would be the contraction of credit. Traditional economic theory would state that inflation is the rising of prices and deflation would be the opposite. Austrian inflation can definitely lead to the rise in prices.

Our credit expansion since 1982 resulted in a significant rising in prices....homes, cars, food, fuel, stocks.... The Federal Reserve continues to expand credit at record levels. Prices could be heading to a new level, hyperinflation. I just received my medical insurance renewal that included a 20% increase from last year...... Are we that boiling frog!

The Patriot and The Restoration of Order

"Also, it is important not to confuse a desire not to go down with a sinking ship with patriotism. Such "patriots" who stand on the deck saluting the flag as the ship sinks will likely be of little assistance to other survivors left treading water. Only by attempting to position ourselves safely aboard sea-worthy lifeboats now will we be able to participate in any future rescue efforts. Protecting our wealth today should allow us to repatriate it tomorrow, thus enabling us to help rebuild a viable American economy."

"What nearly all politicians on both sides of the aisle fail to understand is that the current contraction and credit crunch is necessary to restore order to an economy that is horribly out of balance. Years of misguided fiscal and monetary policy and market-distorting regulations have resulted in reckless borrowing and spending on Main Street, pervasive gambling on Wall Street, and rampant fraud and corruption at every intersection. America’s borrow and spend economy, and the bloated service sector that evolved around it, must be allowed to topple, so that a more sustainable economy grounded in savings and production can rise in its place. Any government efforts to delay the adjustment and spare us the pain will backfire, turning this recession into an inflationary depression. Of broader concern however is the sharp turn in ideology, and what it means for the future of our nation. If this is a permanent shift, then America will lose any resemblance to the economic titan it was in the 20th Century. Our standard of living will decline sharply, our economy will be ravaged by inflation, tens of millions will be unemployed, more individual liberties will be surrendered, and rugged individualism will be supplanted by the nanny state. In short, Latin America may extend north to the Canadian border."

Peter Schiff, President Euro Pacific Capital, Author "Crash Proof" 11/17/08

His strategy: http://www.europac.net/videomessage.asp

His outlook:

U.S. Stocks

We believe that in general U.S. equities remain substantially over-valued, and that despite nominal new highs for some popular stock market averages, they remain in long-term secular bear markets when adjusted for inflation. As such we are bearish on the broad U.S. stock market, and only find value in certain carefully selected U.S. equities, generally those companies that are export oriented and/or commodities based, including mining and oil and gas.

U.S. Bonds

We believe that the U.S. bond market is in the process of forming a significant top, in what has been a major long-term bull market. Once completed, we expect bond prices to collapse. Given the highly unfavorable long-term risk reward situation, we recommend that investors maintain minimum exposure to any long-term debt instruments, be they treasury, municipal, or corporate. Those holding U.S. dollar denominated debt instruments should restrict ownership to only the highest quality, short-term maturities. Even those high income investors seeking tax-favored yields are cautioned that avoiding the inflation tax, which stealthily confiscates principal, is more important than avoiding taxes on mere income.

U.S. Residential Real Estate

If it looks like a bubble, walks like a bubble, and quacks like a bubble, it's a bubble. The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only, and negative-amortization mortgages, a can't-lose attitude among speculators, validated by ever rising "comps," the complete abandonment of lending standards, wide-spread corruption in the appraisal industry, rampant fraud among sub-prime lenders, and the moral hazards associated with loan originators re-selling loans to buyers of securitized products who perceive minimal risk and an implied government guarantee, has produced the "mother of all bubbles." When it finally bursts, it's not just real estate speculators and home owners who will suffer, but the entire U.S. economy, its banking and financial systems, and anyone with U.S. dollar denominated savings.

The U.S. Dollar

We believe the U.S. dollar is in a major long-term bear market, and as such recommend keeping exposure to the dollar at an absolute minimum. All long-term savings and investments should be denominated in select foreign currencies against which we believe the dollar is likely to fare the worst.

Gold

We believe that Gold is in the early stages of a new, secular bull market. Conservative investors are advised to have a portion of their savings allocated to physical bullion, while speculative investors are advised to own shares of carefully selected mining companies, both domestic and international.

Commodities

Like gold, we believe that commodities in general are in the early stages of a new bull market, and that conservative and aggressive investors should seek out appropriate ways to gain exposure to this sector.

Foreign Stocks

We believe that unique opportunities exist in many carefully selected foreign equities, particularly those that have minimal exposure to the United States, and are in no way related to U.S consumers, financial services, or technology. Many foreign markets are counter-cyclical to the U.S., and have recently emerged from long-term bear markets. In many cases valuations are low, yields are high, and prospects for earnings growth are favorable.

Foreign Bonds

Given our bearish outlook for the dollar, bond investors should concentrate their holdings in instruments denominated in select foreign currencies. However, given our global outlook for higher interest rates and rising inflation, shorter maturities are preferable. However, given current U.S. tax law, we believe that those seeking conservative, income generating investments should concentrate on high dividend paying, carefully selected foreign property stocks, utilities, energy trusts, and natural resource based companies.

The U.S. Economy

We believe that the growing imbalances in the U.S. economy, its twin budget and current account deficits, its lack of domestic savings, and the erosion of its industrial base, have now reached a point where a severe recession, culminating in a substantial decline in the over-all American standard of living, is imminent. The Federal Reserve, Congress, and the President, for political expedience, are likely to continue seeking to delay this adjustment, unfortunately in ways which will exacerbate its severity, making the inevitable recession that much worse, and increasing the probability of a hyper-inflationary outcome, which would render the U.S. dollar, and all U.S. dollar denominated financial assets, practically worthless in terms of real purchasing power, potentially creating a situation of extreme financial, political, and social unrest.

The above forecasts are made with much regret, as we realize that they foretell significant hardships for millions of our fellow Americans. However, it is our mission to help spare as many of our countrymen as possible from suffering this fate. In fact, we feel that it is our patriotic duty to help as many Americans as possible to safely protect their wealth though the acquisition of foreign assets. It is only through such actions that at least some Americans will retain ownership of financial wealth which may be repatriated in the aftermath of the collapse.

We remain hopeful that dire economic conditions will at least create a climate in which America can finally return to her constitutional traditions of sound money and limited government, providing a foundation upon which a sounder economy can one day be rebuilt. If out of the ashes of this collapse, the spirits of our founding fathers can rise again, it may one day be possible for America to reclaim her former glory, and once again be that shining city of which Ronald Reagan so eloquently spoke.

In our opinion the U.S. economic ship of state is in danger of sinking. As the problems with her hull are structural, current efforts by government officials and central bankers to plug up the holes will make it difficult to keep her afloat. Though we remain hopeful that she may one day be returned to a sea-worthy condition, there is nothing collectively that we can do to alter her fate, or that of the millions of Americans ignorantly dancing the night away on her decks. However, individually we can take defensive action to protect ourselves and our families by getting off the ship. In our opinion the lifeboat of choice is a carefully selected portfolio of relatively conservative*, high-dividend paying, non-U.S. export dependent, foreign equities.
Such investments provide three potential sources of protection. 1. They pay good dividends, many of which qualify for the lower dividend tax currently in effect. 2. More importantly, as these dividends are paid in currencies other than the U.S. dollar, their value will rise as the dollar falls, as will the principal value of the underlying shares. 3. They provide the potential for true capital gains, as the shares themselves may appreciate in terms of their local currencies.

Source: https://www.europac.net/outlook.asp

Crash Proof

My friend, Bubbaloo, turned me on to Peter Schiff, the author of the book, Crash Proof.

Checkout the video:
http://www.youtube.com/watch?v=6NvjrfC6i0I

Buy the book:
http://www.amazon.com/Crash-Proof-Economic-Collapse-Sonberg/dp/0470043601/ref=pd_bbs_sr_2?ie=UTF8&s=books&qid=1226069360&sr=8-2

Here's a great contrast of two views:
http://www.youtube.com/watch?v=Mwib3qODFOQ

"The reader of this book faces a difficult task, one that will put him in such an extreme minority that he will feel isolated and unsupported. By selling all of your stocks, you will take the maverick road, and you will take it alone. I have no doubt that by the time this bull market is ending, our call for a huge crash and depression will be laughed off the street. Do not lose your perspective when the time comes. It will take great courage to make money during this bull market. However, it will take greater courage to get out near the top, because that's when the world will call you a damn fool for selling."
Robert Prechter, At The Crest of The Tidal Wave, 1995, p. 217

Capitulation - Worden Brothers Perspective

interesting comparison.........

The Worden Report
Capitulation

The staff of Worden Brothers, Inc. laments the violence we witnessed this week and extends its condolences to all who lost loved ones or family members.

It is a sad way for it to happen, but the calamity we have experienced this week may well provide the psychological capitulation so many investors were waiting for. It has not been unusual for calamitous events to occur into declining markets. When they have happened, they have generally marked the bottom or the low occurs very soon after. The Cuban Missile Crisis and the assassination of John Kennedy are good examples. In both cases, the national psyche was held in thrall, as it is now.
(A zoom-three daily chart running from late April of '62 to early March of '63 shows the entire bottoming of the 1962 crash.)
The 1962 crash hit its first capitulation-type bottom in June. The subsequent rally peaked in late August. The market then began to sink toward a possible test of the June low (not dissimilar to the decline that began in May of this year). On October first, an intermediate rally within the intermediate downtrend began. Simultaneously, the U.S. became suspicious that medium range ballistic missiles were being deployed in Cuba.
On October 14, a Strategic Air Command mission obtained photographs that were the first hard evidence of MRBM sites in Cuba. On October 16, the minor stock market rally hit its peak.
On October 15, more evidence in was analyzed. Key Washington officials were briefed about the discovery. Troop and equipment deployments were aimed at increasing military readiness for a strike on Cuba.
On October 16, President Kennedy is informed of the MRBM sites early in the morning. He immediately named 14 advisers he wanted present at a meeting later in the morning. The group became known as the “ExComm.” This is the beginning of the Missile Crisis. The next five market days will be down and accelerating. Options discussed were 1) a surgical air strike; 2) an attack a various Cuban facilities; 3) an invasion of Cuba 4) a blockade of Cuba. In the second “ExComm” meeting that day, it was reported that the missiles could be fully operational within two weeks.
On October 17, intermediate Range Ballistic Missiles with 2200-mile ranges were discovered in Cuba, which would become operational in December or later.
On October 18, hours and hours of discussions and intense debate on whether a surgical strike or a blockade was appropriate. President Kennedy met with Andrei Gromyko, who argued that the Soviet Union was only interested in helping Cuba with its defensive capabilities.
October 20, the Washington Bureau Chief of the NY Times phones and asked key officials why there is such a flurry of activity in Washington. He was told but asked to withhold the story in the interests of national security.
October 21, leaks to the press were surfacing. Kennedy managed to suppress most of the stories.
October 22, SAC initiated a massive alert of the B-52 nuclear bomber force. B-52s were kept in the air continually, with a bomber taking off each time one landed. President Kennedy addressed the nation warning of a strict quarantine of offensive military equipment and warning the Soviet Union that any missile launched by Cuba against any nation would be regarded as an attack by the USSR on the United States, requiring a full retaliatory response.
October 23, Fidel Castro announced a combat alarm. Cuban forces were placed on high alert. It is generally believed that Soviet ships will defy the blockade. Moscow placed armed forces of Warsaw pact countries on high alert. The stock market declined over 10 points (equal to approximately 200 points today).
October 24, Soviet ships en route to Cuba capable of carrying military Cargos reversed their courses and returned to the Soviet Union. The stock market advanced 18.70. Thereafter, it advanced continually for three years.
President John Kennedy was assassinated on Friday, November 22, 1963. The market was shut down early, but not before it had declined 21.20 to 711.50 (equivalent to about 300 points today.) Unless you lived through it as an adult, it is difficult to appreciate the feeling of depression that descended upon the country. Much like what is being experienced in the current disaster.
At the time of the assassination, the market had been going down for about a month. On that fateful Friday it seemed to collapse. It was a weekend of national mourning and a funeral that was highly personal to American citizens, with little John-John wrenching hearts with his immortal salute as the casket passed by. The market stayed closed on Monday. It opened Tuesday and advanced 32 points. It continued to advance for over two years.
-DW