Contemplating Echo Bubbles
The study below originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, March 21st, 2006.
It's no secret Jas Jain is firmly in the deflationist camp when it comes to grand scale eventualities, as it were. And while having some reservations about certain aspects of his views, we do happen to agree with Jas that odds favor a deflation sequence at some point in the foreseeable future. Further to his thoughts, and to summarize his thesis in the attached, he rightfully sees the Fed as being excessively accommodative to banks, allowing them to pander un-needed credit onto a semiconscious society, more recently typified by an extending housing bubble, at risk of implosion if something is not done. Again, with all this, we must agree.
If there is one aspect of the message in Jain's work we cannot fully subscribe to however, which for most is a moot point as the ranks of speculators looking to capitalize on these swings are fading fast, it's the timing aspect, where like most observers in the deflationist camp these days, he sees the carnage beginning forthwith. This is where we essentially part ways by and large, because again, although we believe the 'system' will eventually deflate, causing revolutions across all measures of 'modern' finance and societies, bankers have not fully exhausted countermeasures designed to thwart their loss of power in my opinion. In the simplest sense, and a place we wish to reside whenever possible, ask yourself the question, 'if stocks are currently enjoying an echo-bubble, will we not first have to experience the same phenomenon with regard to the housing boom before it can be written off completely?'
While we do not intend to take the above question any further today, as the primary point we are attempting to make is best served with a look at some historical aspects of the stock market in our eyes, we do want you to know the purpose of asking this question was to stimulate thought. In this respect, whether one is deflationist, inflationist, or somewhere in between looking for the most probable sequence, which is where we are, in my mind it makes a great deal of sense to have an open mind concerning complex condition sets. And without a doubt, trying to get to the bottom of when we can expect to see a 'Grand' deflationary sequence commence in earnest with any degree of accuracy will require one to be at the top of their game, where constructive criticism aimed at putting the pieces of the puzzle together are always welcomed.
Turning to the task at hand now, where as mentioned above we will be using a historical look at the stock markets to help us identify the most likely sequence for the largely anticipated deflation cycle to commence in earnest, we draw your attention to our recently published piece prepared on the subject, attached here. As you can see in this work, and as mentioned above, we agree the vast majority of empirical evidence available to us today does indeed suggest what could be viewed as a K- Wave Winter should be foremost in our minds soon, but that like Nelson Hultberg pointed out back in 2002 when the big K-Wave tour was on featuring Ian Gordon, 'Our Awareness of the Cycle Will Alter It'. At the time, you will remember global stock markets were in the 'depths of despair', with tech stocks down some 80 percent, making an impending K-Wave Armageddon scenario an easy sell at the time.
Fast forward to today, while stock markets have risen from the abyss, where by any standard many investors were fleeced of a relatively large part of their savings in the tech mania, we cannot help but marvel at the degree of speculation that still exists, albeit more in the hands of fewer and increasingly leveraged players these days. And of course this says nothing of the new and grander bubbles currently playing out in real estate, commodities, etc., all tied together under the debt bubble. Therein, without a doubt in the grand scheme of things this will all prove to be a recipe for disaster, but what is surprising to us, and as suggested above, is the rapid increase of information on the subject, primarily fueled by the rapid advancements in search engines, like Google.
Further to this, and as our larger degree cycle work suggest, with an increasingly concentrated investing population now focused on 'big picture' considerations, it should not be surprising to anybody intensifying negative bets on stocks continue to characterize the trade, where in the US, much of this insurance / speculation is facilitated via options. This of course accounts for the high index related put / call ratios, where institutions, lead primarily by hedge funds, purchase puts to insure their portfolios against leveraged plays in the cash markets. Of course the brokers love this, where they have been more than happy to write these contracts, along with pitting their better-informed trading desks against the hedgers as well. Indeed, this has been a win / win scenario for the brokers, as evidenced by their growing / record earnings, along with the perpetual short squeeze this creates against a backdrop of continuously expanding liquidity provided by the Fed. Albeit, as with a junkie, it's getting harder to 'get off' these days. Never the less, the sickly US stock and bond markets remain inflated, and brokerage stocks continue to rise like magic due what is known as monetization, where the Fed provides liquidity to an otherwise bankrupt system by directly expanding its own portfolio with money they themselves create out of thin air. It's great work if you can get it. (See Figure 1)
Anyways, the question then begs, is this condition set about to change fundamentally? Answer: Allowing for a relatively short-term and shallow correction, not until next year at the earliest in our books. And while some are hypothecating the current inflation cycle still has a good number of years in it based on previous comparable commodity bull markets, we are not so optimistic in this regard based on the understanding shorter term market / business cycles have been superseded by the larger credit cycle now, which is consuming everything in its path. On this basis, and in performing a count on the two preceding Super Cycles of the Dow (see Figure 2), in measuring such things in terms of stock prices, a simple linear projection past previous occurrences puts a likely top for the blue chips in January of 2009. In this respect, even Jim Rogers thinks all things equity will get hit once liquidity becomes an issue just based on what happened in the late 70's and early 80's, and he generally likes to keep his analysis straightforward. Of course this time around we could be subjected to a more extreme hyperinflation sequence courtesy of the new nutbar in charge of the Fed, where he damn well knows he will never be a Paul Volcker.
In fact I would think it's safe to hypothesize Volcher is quiet happy not being in charge of this mess, one that just gets bigger and bigger every day. When he was in charge people had savings, real wages were growing, and the US was the largest creditor nation in the world. Of course the party is always at its best when just getting started, which is what the 70's represented in terms of the mature debt monster we see today, so it's difficult to argue how he would have done under similar conditions compared to present. That being said, the degree of measures authorities are undertaking to keep things afloat today is truly mind-boggling, as well as being unsustainable for much longer.
As mentioned last week, if real rates were to rise any further past current levels, the debt / real estate bubble would be in serious trouble. Of course a good argument can be made this is already the case. If true, authorities will have to come up with an accelerating war scenario sooner than later, or it will be difficult to justify printing the currency that will be required to keep the economy afloat. It appears they will not have to look far if this report is accurate. This should all be good for gold in terms of creating the potential for additional surges higher. Gold is like the energizer bunny under conditions like these, which again, should be especially true after this coming Thursday. Oh yes, a war would also mean the double talking Japanese monetary authorities had better not cut liquidity in the banking system just yet as it may be needed to ramp up production associated with any new war efforts.
When we first started talking about this Bank Of Japan (BOJ) chatter it was pointed out what was really happening here is 'jawboning'. That is to say central bankers and politicos don't like to see commodities rising because higher prices mean the consumer will have less disposable income to pay taxes, along with increasing interest payments needed to keep bank stocks buoyant. So, with commodities having been on a tear over the past three-years and looking like a parabolic move was building, it should be of no surprise we have been hearing these fairy tales out the BOJ. They are hoping the dumb hedgers will take such talk seriously and dump their commodity positions. One should find it interesting precious metals investors don't believe them, where if the consensus were pressure is coming out of the pipe for real, the correction in gold would be as well. Instead, it looks like gold is in the process of building a bull flag that should carry prices to test the $600 mark, and you know how important this resistance milestone is because of the discussion surrounding this chart we had last month. (See Figure 2)
Source: The Chart Store
Is it any wonder authorities efforts to fool the public are not working, especially with a 'lack of confidence man' like Bernanke at the wheel over at the Fed. Yesterday may be looked back on as a bad day for Ben, because not only are more people realizing backward looking inflation targeting policy is not possible in the real world, the next few days are going to test his mettle on the currency manipulation / jawboning front, where a break lower in the $ after comments directly aimed at accomplishing the opposite would bring into question his respect factor in the market. Considering his nickname is Helicopter Ben, where the inference is derived from a speech on how he would deal with deflation many moons ago, we would not be surprised if the Greenback breaks down for real in coming days. It's either that or interest rates will continue climbing, but as you know, this could bring the house of cards down as well. Only a numb skull would have taken his job at the Fed truly understanding the depth of problems the US / global economy faces. Of course everybody knows Bernanke is just a White House lackey anyway.
This is a tradition he learned from his predecessor, where before he sold out, Mr. Greenspan was what appeared to be an honest intellectual. But, once he was confronted with reality, whatever that means, evidence proves his views changed radically. Capitalism in any form doesn't work if growth is absent, and when he first took his post back in the 80's, it must have struck him that this was the case. This is the point at which moronic bankers think it's necessarily their job to create it out of thin air, even if we are at the absolute limits of our full potential. And as you can see in the attached, some very smart people think we at those limits now in terms of how much energy humans can expect to exploit at any one time. Can you say, crash time soon.
Well, that's probably enough to chew on for today. To finish things up, we will simply point out that movements in all the markets covered here are progressing as expected, and that new subscribers should review commentaries from over the past month or so to become familiarized with our views. In this respect, you may notice we are talking increasingly about how coming changes in our economies will likely affect our lives directly on an increasing basis, where it's hoped such thoughts are of interest to you. The basic premise behind this integration process is a result of the realization changes are coming fast, and that one should begin preparing for what will undoubtedly be a far more challenging environment to survive in just a few years out now. This we expect for sure, and we prefer to be ahead of consensus views here as well.
In leaving you now, we invite you to visit our site and discover more about how an enlightened approach to market analysis and investing could potentially aid you in protecting your finances into the future. And of course if you have any questions or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.
Good Investing all.