Equities Are Likely Heading Lower: Resist the Temptation to Short Them

"Inflation is the senility of democracies."

-- Sylvia Townsend Warner

In my last article I observed that, in a poor economy, bear market traps are driven primarily by a collective flawed perception of current and future corporate earnings. I pointed repeatedly to the lagging earnings trends of the 1929 to 1932 correction, as well as to the sheer number of times reckless investors were drawn to deceptively attractive price-to-earnings ratios and high dividend yields, only to see those numbers destroyed by an ever-worsening economy. And that's exactly where we are right now – in the middle of yet another bear market rally driven by faulty earnings and dividend expectations. How do I know this? Because corporations depend on consumers, who have lost almost all ability to borrow money. The spending-spree is inarguably over.

Let me give you a working example of the sort of optimism that might get an investor in trouble. Pfizer (PFE) is a great company – a value investor's dream – sporting a history of consistent and stable earnings, well-managed debt, and strong, albeit relatively similar dividend yields to other strong large-cap stocks. After the crash last November and December, however, Pfizer's dividend yield jumped to over 9%, while its p/e collapsed! I did all the usual research, salivating profusely, almost completely convinced that Pfizer at a price of $17 per share, was a steal. I took a significant position, and yet a little voice in the back of my mind told me to look deeper, and after doing still more research – which inspired this article, as well as the last one -- I unloaded the position, fortunately at a slight profit. Almost immediately thereafter, Pfizer reported lower earnings, and it slashed its dividend. The stock price tumbled accordingly.

Since writing my last article, I have been inundated with emails asking the same question: in light of my findings, is it time to short equities? And the answer might seem obvious – if earnings are going to fall further, and companies are cutting dividends, wouldn't the best move be to short an index or two? Things, however, are never as simple as they seem. I've said it many times before, but it might surprise you to know I actually believe the stock market is going to go up from here – if only moderately. The reason? Inflation.

From 1929 to 1932, the U.S. government was significantly impaired by the gold-standard, and wasn't able to manipulate the money supply with anything even approaching the current printing spree we're witnessing. As one reader pointed out, the government did re-set the price of gold, in dollars, in the early 1930s, but in real terms that move was so insignificant as to be non-existent -- compared to the $12.8 trillion the government is going to have to print to cover its budget for the next two years (this article should put the magnitude of that sum in perspective for you).

What this means is that a savvy investor could have shorted the market during just about any bear market trap during the 1930s collapse and fared very well – in real terms – because prices were falling as people deleveraged. The specter of inflation was nowhere to be seen. Today, however, although we find ourselves in the same deleveraging environment, inflation is a colossal threat, and it is only a matter of time before prices skyrocket.

This is why I believe the stock market will probably go up a little bit from here, in nominal terms. In real terms, however, I believe the stock market is going to do much worse than even the 90% or so that it lost from '29 to '32, and this makes our current environment so much more dangerous to those uninitiated: it's one thing to see the market falling, and to know how much money is actually being lost. It's quite another thing when the average investor sees the market rising and believes he or she is actually getting rich -- when in fact the losses, in real terms, are staggering.

The truth is, you could short the market here, and even if it goes up, you'll probably make a little money in the end -- after adjusting for inflation. But as I see it there are three problems with this strategy:

1. I have no idea how long it will take for prices to start rising (and neither does anyone else). If my theory is correct, the market will probably hover at current levels for a while.
2. Once prices do take off, the stock market will probably rise with them -- although at a slower rate. You'll be left in the uncomfortable position of having to battle the psychology of reverse-mathematics – constantly reminding yourself that even though it looks like you're losing money, you're not. In other words, you'll be short the market, which will start to climb with the rising prices of goods and services -- but at a slower rate. Any short positions will appear to be losers, but since they'll be beating inflation, they'll actually be making money, in real terms. Frankly, that's just confusing as hell, and it certainly doesn't sound pleasant to keep track of.
3. I still believe in the productivity and innovation that defines many U.S. companies, and eventually they're going to turn around. When they do, I believe their bull run will be as unprecedented as the horror that precedes it. Being short -- no matter how cogent my arguments for the coming storm – means betting against the aforementioned productivity and ingenuity, and that means you'll have to pick the bottom. For my part, I suck at timing markets, and I don't want to have anything to do with trying to find that nadir.

I think there are better strategies, including buying gold and oil, and shorting Treasuries. These positions stand to outperform inflationary pressure by a wide margin, and yet offer relatively little downside risk – at least in this environment. Yes, the time will come to offset short Treasuries, as well as to sell gold and oil, but that time is a long way off. I can't say the same for equity markets.

Disclosures: Long TBT, UGL, and DXO. Author also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

The author will be giving a workshop entitled The Death of the Dollar: How We Can Survive the Coming Collapse at the 21st annual Las Vegas Money Show, Mandalay Bay Resort, Tuesday, May 12, 2009, at 11:30 a.m. He hopes to see you there.

Comments

[trapshooter3:]

in other words, you like so many others on this site are clueless as to the future direction of the market.

Apr 26 02:48 PM

[Jasper M:]

Author seems to think the absence of a gold standard frees it completely. I would argue that it merely frees it to find the level of discipline that will be imposed by the bond market.

Author correctly ID's that consumer spending spree is over. I would add that Fed's demonstrable inability to keep 10 year note much under 3%, even with QE, shows that the US government's spree is also nearing an end.

and '29 to '32, just a Correction?! Okay, in the largest picture, technically true; but in context, misleading.

Apr 26 03:06 PM

[Raymond Mic...:]

If inflation is, say, 10% and the Fed funds rate is, say, 6% (and rising), and the short rebate is Fed funds less a small spread (call it 25 bps), and the stock market rises less than inflation--assume it rises at 6% annualized, how does one beat inflation by being short the market while it is rising (even if it rises less than inflation)? One would lose 6% on the stock market short, gain 5.75% from the short rebate, so one would essentially be flat (down 25 bps), whereas inflation is 10%--so one would be down 10.25% relative to inflation, no?

I get what you're saying in the sense that the stock market would be underperforming inflation, but in that case, one would not want to be long or short equities, if one wants to keep pace with inflation. Or so it seems.

Apr 26 03:45 PM

[Minlita:]

"Author also holds U.S. dollars by necessity"

LOL buy what you are going to need in the future (food and supplies) right now while your dollars still have some value.

We all know that any major currency not backed by gold in the history of the world has eventually failed, and the actions currently taken by the U.S government and by the FED will lead the dollar to a collapse too.

This chart from the FED shows the U.S. monetary base from 1960 untill 2009, currency in circulation just exploded since 2008:
3.bp.blogspot.com/_b3G...

And inflation acts like a tax so you make some good money now, you buy less then you could buy before.

Apr 26 03:58 PM

[Andrew Butter:]

So how about if are in the 1940's?

See seekingalpha.com/artic...

Apr 26 04:11 PM

[latamike:]

Got to love a mindless article like this. Don't short but don't go long. What a waste.

Apr 26 04:16 PM

[ur2smrt4me:]

Don't forget "inflation is coming but I don't know when"


On Apr 26 04:16 PM latamike wrote:

> Got to love a mindless article like this. Don't short but don't
> go long. What a waste.

Apr 26 04:49 PM

[helplessobs...:]

Back in the 70's bear market, inflation crushed PE ratios while interest rates ran up as investors demanded compensation for their loss of buying power. On the AMEX it was not unusual to see PE's and stock prices both below five as the market discounted inflation adjusted earnings.

Apr 26 05:38 PM

[GoochyPuppy:]

Gosh... what a clueless article. In the sense ... the author doesn't have a clue and doesn't offer us a clue either.

I quote: "Any short positions will appear to be losers, but since they'll be beating inflation, they'll actually be making money, in real terms. Frankly, that's just confusing as hell, and it certainly doesn't sound pleasant to keep track of."

What the ??????

Apr 26 05:46 PM

[mikebrah:]

The thing is...
None of this new money is going to be entering the system for quite awhile. It is all going to fill in humongous balance-sheet holes. There may be some blips of lending here and there but for the most part this is equivalent to giving a trauma patient a massive blood transfusion. Once the body recovers, there will be too much blood but that is not the administration's present concern.

Also, I think there is a paradigm shift occurring for most Americans. Even if consumers were getting the freshly printed money, I think they are much less apt to immediately spend it. For the most part, they would treat it the same way the banks are (if only we each had our own printing presses).

People are increasingly revisiting the concept of a "need" vs. a "want." This trend is in its infancy and will continue (I believe) for some time. As it does, "thrift" will become the new cool and people that live beyond their means will be recognized for what they are: douchebags. Just like when markets overcorrect, I could see savings rates hit 15-20% over the next decade before normalizing.

I agree inflation is a long term inevitability but it is still several years out. I think BIG inflation will not hit until there is a firm economic recovery, and I think that is several years away.

Apr 26 05:52 PM

[Dave Wrixon:]

Currencies are a zero sum game. Dollar goes down, everything else goes up. (Hyper-inflation will be a symptom of the value of the dollar dropping). OK, you can count Gold as a currency if you like, but it is really minuscule in the scale of things. Of course due to the short-sighted xenophobia of your average American Investor, Gold is likely to rise rapidly in the short-term, simply due to the limited supply. Having said that Uncle Sam may yet be forced into liquidating his reserves.


On Apr 26 03:58 PM Minlita wrote:

> "Author also holds U.S. dollars by necessity"
>
> LOL buy what you are going to need in the future (food and supplies)
> right now while your dollars still have some value.
>
> We all know that any major currency not backed by gold in the history
> of the world has eventually failed, and the actions currently taken
> by the U.S government and by the FED will lead the dollar to a collapse
> too.
>
> This chart from the FED shows the U.S. monetary base from 1960 untill
> 2009, currency in circulation just exploded since 2008:
> 3.bp.blogspot.com/_b3G...
>
>
> And inflation acts like a tax so you make some good money now, you
> buy less then you could buy before.

Apr 26 06:20 PM

[nmelendez:]

Doom and Gloom, the world is ending....store canned goods and dust off Ole' Betsy. Don't forget the backyard Bio-Nuclear shelter.
I know things are bad but, sheesh, get a grip. This too will pass.

Apr 26 07:14 PM

[Jasper M:]

mikebrah:
You lead with a 'velocity' argument. Good for you. Most can't seem to get their heads around it. I salute you.

Apr 26 07:25 PM

[mr freddo:]

I agree with the author on several points:

1. The stock market will start to move forward in nominal terms because of inflation, but will continue to provide negative returns as compared to the inflation rate.

2. Gold and Oil will increase in value relative to inflation as investors seek out safe havens to protect their capital. You can add all commodities and materials to this list as well as emerging markets rich in materials like Brazil and China.

3. It is a treacherous time to be seeking income as you may get stuck in a Pfizer-type situation. Better to just cut spending to the bone and focus on capital preservation.

I disagree with the author about the pace of inflation and the magnitude of real losses. Inflation will increase, perhaps to the levels of 10% per year for several years. The Fed will begin to raise rates at this point, possible causing a double dip recession, and inflation will be tamed. The end result will be a long period, perhaps 5 years, of stagflation.

Although their is much evidence to support the thesis that we are now engaged in a bear market rally and that March lows will be tested again and tested sooner rather than later, the prudent investor shouldn't be shorting.

But then, I believe that shorting is not investing but gambling and is not productive in the long run. Ask yourself this question the next time you short something. What if everyone did this? Shorting is basically immoral. If everyone did it, we could drive every public company in the world to 0 and destroy the entire world economy. If you are making money this way, you should think about doing something more productive with your time and money.

Apr 26 08:04 PM

[conceptwizard:]

Its a deflationary market for at least the next 12 months. The Fed might as well lock the rate right where it is for the next year just like Canada did, this provides clarity Until the housing market turns around and some stabilization in the jobless numbers along with steady rising retail sales and oil at $70 at least there is nothing to inflate.
I can't see the markets moving ahead on any news in the future save doctored financials from the stress tests. This will be shortlived with the commcercial real estate implosion and the commercial loan balance sheets along with further housing foreclosures and credit card/loan debt writeoffs jumping to 10%. This will drive pricing down and further tighten credit. The Government changing credit card systems for the banks will also tighten up credit as they will only want to lend to the best credt scores. We have a ways to go yet.

Apr 26 09:09 PM

[Erick Tippett:]

You comment that you took a "deeper look" at PFE before unloading
it. What was it that you actually saw that spurred your decision is
what would be helpful to novice investors attempting to unravel the
contorted web of market movements during times like these.

EDT
Chicago, Illinois

Apr 26 09:54 PM

[logicalman:]

fairly simple to get.....wait for now...inflation will be coming, when ,is anybodies guess, but is certain in the future...if you want definite answers to these questions, you're in the wrong business...try the undertaker bus. quite certain but not much growth!!!


On Apr 26 04:49 PM ur2smrt4me wrote:

> Don't forget "inflation is coming but I don't know when"

Apr 26 09:55 PM

[Glen Bradford:]

You say: "The truth is, you could short the market here, and even if it goes up, you'll probably make a little money in the end -- after adjusting for inflation."

Let's see how this works out. If you short stocks now and take the cash and sit on it as inflation rises and the stock market rises slower than inflation and then you buy your stocks back --- what happens?

1. You have less dollars than you started with.
2. Inflation eroded your dollar while you were missing a market rally.

This is precisely why I don't plan on attending "investment seminars" at the gambling capital of the world.

That said, I agree with TBT. We are about to see a reversal of the run to the security of US Treasuries/US Dollar.

DXO is a weaksauce pick. If you were to look a little bit you'd find that there are oil producers out there trading at a P/E of 2 if oil is below $50 --- and they make their money in denominations other than the dollar. Just imagine how quickly they would appreciate when the dollar crashes and OIL surges.

Apr 26 10:42 PM

[Big K:]

Stop living in the past, this is not 1929. There is much more wealth in the world today. The flames of the coming inflation will shrink the massive debts allowing people and the government to keep borrowing. The way to keep up with inflation is to buy equities such as KO and JNJ. Despite the author's suggestions that companies will slash their dividends, these two companies and many others have actually raised theirs. The ones slashing their dividends are those who criminally gambled their shareholders money on games called CDS or CDO, or securitized junk mortgages marked with a AAA rating.

The author is also clueless about Pfizer (PFE). The reason they cut their dividend was to stockpile cash for the Wyeth buyout. Had nothing to do with the economy or going back in time to 1929. Bears romanticize about 1929 in this forum and wax fawningly over their overly pessimistic leaders. In this case, comparing the PFE dividend with the depression of the 1930s is not only inappropriate, but dead wrong.

Apr 26 11:04 PM

[ArtfulDodger:]

mikebrah:

You had a very good comment going and then had to go and call people who want to spend their money lavishly "douchebags."

Did they not teach you young folks the value of freedom in school? Should humans not be free to dispose of their funds as they wish as long as they don't harm others?

The devaluing of freedom in America is much more worrisome to me than the devaluing of the dollar.


On Apr 26 05:52 PM mikebrah wrote:

> The thing is...
> None of this new money is going to be entering the system for quite
> awhile. It is all going to fill in humongous balance-sheet holes.
> There may be some blips of lending here and there but for the most
> part this is equivalent to giving a trauma patient a massive blood
> transfusion. Once the body recovers, there will be too much blood
> but that is not the administration's present concern.
>
> Also, I think there is a paradigm shift occurring for most Americans.
> Even if consumers were getting the freshly printed money, I think
> they are much less apt to immediately spend it. For the most part,
> they would treat it the same way the banks are (if only we each had
> our own printing presses).
>
> People are increasingly revisiting the concept of a "need" vs. a
> "want." This trend is in its infancy and will continue (I believe)
> for some time. As it does, "thrift" will become the new cool and
> people that live beyond their means will be recognized for what they
> are: douchebags. Just like when markets overcorrect, I could see
> savings rates hit 15-20% over the next decade before normalizing.
>
>
> I agree inflation is a long term inevitability but it is still several
> years out. I think BIG inflation will not hit until there is a firm
> economic recovery, and I think that is several years away.

Apr 27 12:46 AM

[ArtfulDodger:]

Paco:

A very well-written article. But I have to agree with several of the comments above: it will be longer than most think before we have to concern ourselves with rising prices.

For as noted by several commentators, a lot of the money you're speaking of has not gotten to the street yet. When it does it may not necessarily be spent quickly, because it is true that most people are pulling in their spending reins.

This and a few other things should hold prices down for a while, but sooner or later, if the Fed doesn't sap up a lot of the funds it's scattering about, you are right Paco: prices must go up.

Apr 27 12:52 AM

[mikebrah:]

Artful Dodger, you said:
"Should humans not be free to dispose of their funds as they wish as long as they don't harm others?"

But they are harming me. My taxes are going up and my savings diminished because these "douchebags" are being favored. I am a libertarian so the main thrust of my life philosophy is: do whatever you want so long as it doesn't affect my rights.

I live within my means. I spend lavishly on items that others may find foolish. But I do so with my own dollars. I don't have a credit card. And I have had to swallow some painful losses, especially in the last 15 months of the stock market, without ever considering putting others on the hook for my mistakes.

Then you said:
"The devaluing of freedom in America is much more worrisome to me than the devaluing of the dollar."

The two are synonymous. Money represents your labor which represents your time which represents your freedom. Devaluing one necessarily devalues the other.

And the suggestion that me calling someone a douchebag for spending money they don't have on stuff they don't need somehow devalues freedom is erroneous. It's my freedom to call a spade a spade. As a society I think we could use a little more bluntness.

Apr 27 01:15 AM

[mikebrah:]

PS
you said: "Did they not teach you young folks the value of freedom in school?"

I'll ignore your condescension and just say of course they didn't teach me this in school. Nothing consequential is taught in school today.

MM

Apr 27 01:19 AM

[ArtfulDodger:]

Agreed.

No condescension or disrepect meant. I seriously don't see anyone but the older Boomers showing that they value freedom very much at all.


On Apr 27 01:19 AM mikebrah wrote:

> PS
> you said: "Did they not teach you young folks the value of freedom
> in school?"
>
> I'll ignore your condescension and just say of course they didn't
> teach me this in school. Nothing consequential is taught in school
> today.
>
> MM

Apr 27 01:50 AM

[Cliff Wachtel:]

As usual, a provocative article that I'll need to review and think about. You also inspire a great group of equally valuable comments. Kudos to them as well.

For those who haven't already done so, consider as one investment alternative the inflation-resistant high dividend stocks that I've been discusssing here on SA in my series "The High-Dividend Investor's Collapsing Dollar survival guide. You'll get high yields, steady reliable dividends (except for the energy producers, who may yet see some further divy cuts, though their appreciation potential makes them well worth the risk) while you wait for the market's recovery. In addition, these stocks provide USD inflation protection by a variety of means, including their holding hard assets, vital commodities, and/or near monopoly pricing power.

An additional advantage of this approach is that it is well suited busy buy and hold investors who cannot dedicate lots of time to the market. Most of us are poor market timers and should avoid trying too much to do so except for obvious moments of panic (then buy) or euphoria (take profits) - and even that is hard to do because we too get caught in the emotion.

I look forward to your collective comments, from which I learn so very much. Regards, Cliff Wachtel

Apr 27 02:41 AM

[Fred Voetsch:]

People overthink all of this and end up doing foolish things with their money. Quite simply every bad thing that can happen will lower stock prices: deflation; inflation; a rising dollar; a sinking dollar; war;

Right now we are in a crisis era that will last another decade or two and while stock prices will not go down for all of that time they will get to a point where they are an OBVIOUS buy with low P/E ratios (unlike the current 56 PE for the S&P 500 or the 28 PE for the DJIA) and high dividends. It will take a few more years probably and everyone will assure you that stocks are a terrible thing to own and THAT, my friends, is the time to go long in a big way...will you have any money left?

Apr 27 03:47 AM

[optionsgirl:]

Poor market timers don't have a comprehensive exit strategy. If your stock is moving up and you are profitable, you have to adjust your stops (whether they are actual stop loss orders or just in your head). When we are losing we have to set a real stop loss based on the % of risk we want to assume. If you don't do it with a stop loss order, than consider purchasing a put or selling a call. You won't get stopped out all of the time, you will take profits based on a formula ( leaving emotion out of it), and best of all, you will pare your losses. Discipline is the key. It is really hard to maintain that discipline, but when you wake up one morning and the Dow is down double digits, having stop losses in place keeps you from agonizing over what to do. The market does it for you. You can sleep better at night, too!



On Apr 27 02:41 AM Cliff Wachtel wrote:

> As usual, a provocative article that I'll need to review and think
> about. You also inspire a great group of equally valuable comments.
> Kudos to them as well.
>
> For those who haven't already done so, consider as one investment
> alternative the inflation-resistant high dividend stocks that I've
> been discusssing here on SA in my series "The High-Dividend Investor's
> Collapsing Dollar survival guide. You'll get high yields, steady
> reliable dividends (except for the energy producers, who may yet
> see some further divy cuts, though their appreciation potential makes
> them well worth the risk) while you wait for the market's recovery.
> In addition, these stocks provide USD inflation protection by a variety
> of means, including their holding hard assets, vital commodities,
> and/or near monopoly pricing power.
>
> An additional advantage of this approach is that it is well suited
> busy buy and hold investors who cannot dedicate lots of time to the
> market. Most of us are poor market timers and should avoid trying
> too much to do so except for obvious moments of panic (then buy)
> or euphoria (take profits) - and even that is hard to do because
> we too get caught in the emotion.
>
> I look forward to your collective comments, from which I learn so
> very much. Regards, Cliff Wachtel

Apr 27 09:06 AM

[ramram:]

right now -- asset prices are deflating. Real inflation is driven by tight labor markets and rising incomes. The inflation most are talking about is currency depreciation driven by foreign investors who demand a higher interest rate to compensate for the depreciating dollar currency. This may well happen, but right now most other currencies/countries are in bigger trouble than the US -- eg. Britain, Europe and Japan -- each for different reasons. I dont see inflation from tight labor markets for many years. The inflation from currency depreciation is probably a few years away -- once a recovery is in hand.

Apr 27 09:12 AM

[jambo:]

Harsh, very harsh but nonetheless on target, imo.


On Apr 26 02:48 PM trapshooter3 wrote:

> in other words, you like so many others on this site are clueless
> as to the future direction of the market.

Apr 27 11:14 AM

[jambo:]

Awwwwk, google and apple, google n apple, aaawwwwwkkk.


On Apr 26 03:59 PM Cetin Hakimoglu wrote:

> But the appreciation of some equities like GOOG and AAPL, for example,
> far far exceed inflation so going long may be the best bet.

Apr 27 11:16 AM

[Harry Tuttle:]

Inflation is bad for stocks.

P/E's go down, capital is diverted to fixed income, margins are squeezed,...(there are other reasons).

Apr 27 11:23 AM

[Paco Ahlgren:]

Unless I'm missing something, this is the sum of your response: you started with the word "Gosh," which is a bad sign, after which you used the word "clue" and one of its derivatives three times, finally ending with a bunch of question marks.

I've written profusely on this subject -- on Seeking Alpha and other sites -- for a very long time. If I am indeed "clueless," don't you think you should put a little more substance behind the ascription, edifying me and members of this audience as to the exact form of said cluelessness?

I think I speak for everyone when I suggest that refutations should be meaningful. I certainly don't mind having critics, but about 80% of you are going to have to do a little better than this...


On Apr 26 05:46 PM GoochyPuppy wrote:

> Gosh... what a clueless article. In the sense ... the author doesn't
> have a clue and doesn't offer us a clue either.
>
> I quote: "Any short positions will appear to be losers, but since
> they'll be beating inflation, they'll actually be making money, in
> real terms. Frankly, that's just confusing as hell, and it certainly
> doesn't sound pleasant to keep track of."
>
> What the ??????

Apr 27 11:26 AM

[Paco Ahlgren:]

Referring to the quote below: once that money "fills in humongous balance sheet holes," does it just sit in some coffer indefinitely? Of course not!

This the fallacy of the entire Keynesian argument! Yes, companies will fill their balance sheets with the cash, but balance sheets are snapshots; the money is going into the economy sooner -- not later -- and prices are going to explode.


On Apr 26 05:52 PM mikebrah wrote:

> The thing is...
> None of this new money is going to be entering the system for quite
> awhile. It is all going to fill in humongous balance-sheet holes.

Apr 27 11:30 AM

[ArtfulDodger:]

Dear Cliff Wachtel:

A very excellent and reasonable comment indeed. Thank you.

Very good advice too, which should allow you to "market time" very well: buy panic; sell euphoria.

CW, a couple of other things I use that have helped me greatly over the years come from the great investor and teacher, Philip Carrett. One of his rules was "Be quick to take losses, reluctant to take profits." I like to say: Let your winners run and let the dogs bark elsewhere.

This leads me to say that, I think not understanding (or knowing about) this excellent investing philosophy has kept a lot of investors from making money over the years. They sell their winners too quickly; and hold their losers too long.

And certainly, if you sell all your winners you'll be holding nothing but losers. Does that make any sense?

Philip Carret also had some good rules about the Fed, too, which can be found in his "The Art of Speculation," which has been republished recently. (I have an original from the 1930s that I obtained in the 1960s at a book store in Atlanta.)

The best to your investing, AD.



On Apr 27 02:41 AM Cliff Wachtel wrote:

> As usual, a provocative article that I'll need to review and think
> about. You also inspire a great group of equally valuable comments.
> Kudos to them as well.
>
> For those who haven't already done so, consider as one investment
> alternative the inflation-resistant high dividend stocks that I've
> been discusssing here on SA in my series "The High-Dividend Investor's
> Collapsing Dollar survival guide. You'll get high yields, steady
> reliable dividends (except for the energy producers, who may yet
> see some further divy cuts, though their appreciation potential makes
> them well worth the risk) while you wait for the market's recovery.
> In addition, these stocks provide USD inflation protection by a variety
> of means, including their holding hard assets, vital commodities,
> and/or near monopoly pricing power.
>
> An additional advantage of this approach is that it is well suited
> busy buy and hold investors who cannot dedicate lots of time to the
> market. Most of us are poor market timers and should avoid trying
> too much to do so except for obvious moments of panic (then buy)
> or euphoria (take profits) - and even that is hard to do because
> we too get caught in the emotion.
>
> I look forward to your collective comments, from which I learn so
> very much. Regards, Cliff Wachtel

Apr 27 12:11 PM

[mikebrah:]

Paco,

You used my quote out of context. The rest of my argument readily conceded a nasty bout of inflation is on the way, when I said:
"I agree inflation is a long term inevitability but it is still several years out. I think BIG inflation will not hit until there is a firm economic recovery, and I think that is several years away."

Nowhere in my statement did I suggest that it would sit in some big coffer indefinitely. That was not the point of my post (or the article).

As I understood it, the whole point of this article was a debate about WHEN the inflation would hit and whether it still makes sense to short stocks. My statement about bailout money not circulating in the near future was simply support for my argument that I think price increases are still several years away and therefore stocks are still very "shortable" at current levels.

MM


On Apr 27 11:30 AM Paco Ahlgren wrote:

> Referring to the quote below: once that money "fills in humongous
> balance sheet holes," does it just sit in some coffer indefinitely?
> Of course not!
>
> This the fallacy of the entire Keynesian argument! Yes, companies
> will fill their balance sheets with the cash, but balance sheets
> are snapshots; the money is going into the economy sooner -- not
> later -- and prices are going to explode.

Apr 27 01:34 PM

[Victor Lacy:]

This article is an example of the sort of irrelevant, unaware churning that passes for valid commentary during the current economic unrest.
Almost no one speaks from any real sense of history. Everything is "Latest event!" , "What does it mean?" , "What can we do?". For an
entirely different take on things see uncommon-comments.blog...

Apr 27 01:40 PM

[nobby73:]

"prices are going to explode"? And who exactly will be doing the buying?

Banks have plenty of cash that they would be happy to lend, but
a dearth of decent credits to lend to.

If there is inflation, this may be better for unit sales, but not for bottom line revenue, as the inflationary forces won't reach as far as salary increases.

Much of the current deflationary cycle is the impact of clearance of old stock. Once it has worked its way through the system I expect retail prices to rise but unit sales to remain low, which is terrible for company profits. Stagflation is the biggest threat, which is rightly what the central banks are most concerned about, but they have decided to fix the problems with the banks first and it turns out they need so much capital, there's not enough left to fix the heart of the problem.


On Apr 27 11:30 AM Paco Ahlgren wrote:

> Referring to the quote below: once that money "fills in humongous
> balance sheet holes," does it just sit in some coffer indefinitely?
> Of course not!
>
> This the fallacy of the entire Keynesian argument! Yes, companies
> will fill their balance sheets with the cash, but balance sheets
> are snapshots; the money is going into the economy sooner -- not
> later -- and prices are going to explode.

Apr 27 04:29 PM

[djc:]

Jobs. Why does no one talk about jobs ?

We've gutted our economic base for years as we send all the skilled jobs (aka high-paying jobs) overseas, and our people have had to accept lower salaries.

Perhaps this is a normal 'equalization' of wages with the rest of the world as you would expect with globalization, but nonetheless, we were on the high side of the wage scale, so we (as a country) take the bigger hit.

The bottom line is that without the jobs (notice how people who invest rarely talk about American job loss as a problem, because it increases corporate margins), there is no corporate revenue, no home buying, no tax revenue, and the system collapses. Social program get used more, with decreasing revenue to pay for them.

This is deflation, whos supposed cure is to sew the seeds of inflation and hope they grow. To those who wish the author to perfectly time it for them I can only say 'get a grip'.

We've gutted this country both morally and monetarily. Its carcass lays on a gurney, being propped up by funny money and platitude. They should have let it all just crash -- then at least we would have a real chance to change, rather than propping up the bozos (both in corporate and federal) who facilitated the destruction. Without the needed change, we are just putting off the inevitable.

At this point its just a slow burn down the social scale, rather than a sharp dump.

Jobs would fix everything. Where are they gonna come from ?

Apr 27 04:55 PM

[Old Trader:]

latamike, as well as trapshooter,

I know its TERRIBLY boring, but there ARE times when the most prudent course is doing nothing, until there's more clarity. I don't think that many here would disagree that the situation is "fluid", and big bets in any direction carry even bigger risks.

I tend to agree with the author that now is not the time to place any heavy short side bets. At least he's being honest in his assessment, imo.


On Apr 26 04:16 PM latamike wrote:

> Got to love a mindless article like this. Don't short but don't go
> long. What a waste.

Apr 27 05:15 PM

[Paco Ahlgren:]

"Sometimes the best reaction is no reaction at all..."

That's from my book -- a shameless plug, no doubt, but also a low-hanging piece of fruit too sweet to pass up... :-)

Apr 27 06:34 PM

[ArtfulDodger:]

By qualifying your comment we have another animal we're speaking of, mikebrah.

But how are you going to stop people from spending and borrowing as they please?

If two people go into a contract, such as credit card companies do with people, to allow one to borrow money to spend as they please, then how are you going to stop that?

Govenment restrictions and regulations? We've had a ton of them, and they've not worked.

The education system is not going to help them, by teaching them how to handle money; we've already agreed on that.

If the private sector allows it by giving credit to people who can't repay, then who else could stop such things but the government?

And we don't want to go there, surely!

Freedom is very expensive.

When one person stiffs another for a debt, we all suffer. You are right! And neither of us likes it.

It should not happen, but it's freedom.

I pay my bills, too, mikebrah, but I have neighbors who won't pay attention. They're living in a large house in an expensive area, and yet they owe everybody. The man won't work and he's gone to the government to get help several times. His parents are old and they're paying their mortgage so they can stay in the house.

They've stiffed six different credit card companies that I know of.

How are we going to stop that with the system that we have in America without sending troops to their door and ordering him to get out and go to work?

So, you and I have to pay in taxes, higher credit card fees (and interest if we skip a month), and much else.

And we don't like it, do we?

But it's part of the cost of freedom!


On Apr 27 01:15 AM mikebrah wrote:

> Artful Dodger, you said:
> "Should humans not be free to dispose of their funds as they wish
> as long as they don't harm others?"
>
> But they are harming me. My taxes are going up and my savings diminished
> because these "douchebags" are being favored. I am a libertarian
> so the main thrust of my life philosophy is: do whatever you want
> so long as it doesn't affect my rights.
>
> I live within my means. I spend lavishly on items that others may
> find foolish. But I do so with my own dollars. I don't have a credit
> card. And I have had to swallow some painful losses, especially in
> the last 15 months of the stock market, without ever considering
> putting others on the hook for my mistakes.
>
> Then you said:
> "The devaluing of freedom in America is much more worrisome to me
> than the devaluing of the dollar."
>
> The two are synonymous. Money represents your labor which represents
> your time which represents your freedom. Devaluing one necessarily
> devalues the other.
>
> And the suggestion that me calling someone a douchebag for spending
> money they don't have on stuff they don't need somehow devalues freedom
> is erroneous. It's my freedom to call a spade a spade. As a society
> I think we could use a little more bluntness.

Apr 27 08:36 PM

[fireball:]

paco
i liked the opening quote especially.
i am completely ready to admit i won't mak many guesses at all with all the tinkering and meddling going on.
i have to give old trader the thumbs up. caution seems prudent. if you don't bet you can't win but you can't loose either. small trades are my course for awhile. i prefer investing but... who can make a decent guess right now.
i like some of cetin's ideas but i think we are due for more carnage before it is time to buy for the long haul. i am more oriented toward things like bhp, xom, chk, tnh later if we get on thicker ice.

a.d. and mikebrah
it is a dilemna. i have always tried to steer clear of credit as interest is to make the rich, richer and to keep the poor, poorer.

Apr 27 10:09 PM

[Plan B Econ...:]

...here's a graphic display of the bear market rallies during 1929-1932 that the author discusses.

www.planbeconomics.com.../

Apr 27 11:40 PM

[Laughing:]

Ya I guess those data entry and call center jobs we offshored are the high paying ones that you are referring too?

The big problem is that nobody wanted them before, and now, when we hit the wall, everyone is wondering why we offshored everything. Well, because the cost of living in America is expensive, that's why!

But, not to fear, TGIFridays and Subway are now offering $5 meals, woot!

More will follow, deflation is in session.


On Apr 27 04:55 PM djc wrote:

> Jobs. Why does no one talk about jobs ?
>
> We've gutted our economic base for years as we send all the skilled
> jobs (aka high-paying jobs) overseas, and our people have had to
> accept lower salaries.
>

Apr 28 12:50 AM

[network2:]

Pfizer cut their dividend by 50 percent. How soon do you think they are going to do that again? Years ago, a friend of mine subscribed to Value Line, and he gave me the historical chart of the DJIA (that came with the big black notebook), which still hangs on my bedroom wall. I woke up one morning a couple months ago and looked at the graph on the wall with the line ending in about 1988 or so. I observed and noted that with the exception of the period from 1925-1935, which encompasses a sharp spike above and a sharp spike below, the remaining line is a smooth slowly rising incline from beginning to end. If you are not already retired or going to retire in less than 10 years; buying now and holding could work out nicely. With a tsunami of stimulus dollars coming in the near future and the FDIC insuring deposits and preventing runs on banks, the next anticipated downward spike in equities may never materialize. Banks are reporting marked declines in newly nonperforming loans in March. Future inflationary pressures may be equally offset by sluggish reviving economic activity and getting people back to work. Truth is, history never repeats itself. How could it, unless time runs backwards and forwards again? This is the future. Give up your angst and get used to it.

Apr 28 01:28 AM

[djc:]

Laughing:

If you think they are just call center and data entry jobs, then you really have been asleep !

Apr 28 08:17 AM

[Laughing:]

Enlighten me please be specific on what high paying jobs have been offshored?


On Apr 28 08:17 AM djc wrote:

> Laughing:
>
> If you think they are just call center and data entry jobs, then
> you really have been asleep !
>

Apr 28 09:33 AM

[djc:]

Well in my particular field, any job that /can/ be offshored -- more specifically hardware and software engineering, and just about any IT job that they can offshore.

IBM just announced gobs more, and HP has been offshoring for years now.

At the same time they want these VISAs for foreigners to come into this country as engineers -- becasue anyone who would spend the money for an education in IT would be crazy to do it. The job goes to the lowest bidder these days, regardless of quality -- bad quality is only seen after a few quarters, when the CEO has already collected his quarterly 'financial incentive' and is applauded by wall street for his cost cutting measures. YAY !

There was a study done (at harvard, iirc) that concluded that 33% of american jobs in total were subject to offshoring. If you dont think that does damage (or actually has an equalizing effect with the lifestyles in the rest of the world), then again, I think you need to study the subject a bit more.

I dont have to mention our manufacturing base do I ?

My original point was, and is: how do we replace those jobs with jobs of at least the same quality ?

Just another deflationary force. I dont deny that its a natural evolution of globalization, I just point out that it is and will continue to be a large force towards deflation.

Another sign of the effect of globalization is that through the whole (fake?) economic boom of 2003-2007, wages remained essentially flat for the american worker -- and if i remember right, wage data doesnt count layed off workers.

Apr 28 10:54 AM

[Hot Richard:]

Paco,
80%?! Again with your optimism!

I'd encourage readers to ponder Hot Richard's 6 Points of Light:

1.) Real vs. nominal returns
I only care about that which is real.

2.) speculating vs investing
Which one are you really doing if in equities today?

3.) risk analysis vs "ignoring any and all risks"
If too risky, I don't invest...because then it'd be too much like speculating.

4.) wealth creation vs. wealth transfer
You can get rich either way, but the global economy only grows via wealth creation.

5.) crystal ball vs. reality
No one has a crystal ball. "The absence of a crystal ball is not the same as clueless" (my dad "Handsome Richard" said this).

6.) What is inflation?
The author did a sensible thing in defining inflation in a previous article. Inflation is like a monkey with a chainsaw and that's at least "kind of risky".

PS: Knives fall quickly and I don't want my only exit strategy to be converting to $US. What's your plan?

Apr 28 10:56 AM

[TraderRob:]

Inflation is not a real threat in the short term. All firms are hoarding cash and non-AAA+ credit rated firms are unable to raise capital. Deleveraging is the current reality and will continue until the consumer resurfaces. Take a look at Goldman's store sales data for April minus Easter week... not exactly consumer renaissance.

Apr 28 11:24 AM

[Joshua Harwood:]

I've been following Ahlgren for a long time -- ever critical of his absurd theories. How can anyone believe that pure capitalism is a solution, after it has failed so demonstrably over time?

I admit that I am not a follower of this site, although I see that there are a lot of like-minded people here. I am going to contribute to the debunking of Ahlgren as much as I will be allowed to. I will be civil and fair, and I will never cross any boundaries that transcend chivalry and substance. If any of you are interested in seeing my critique of Ahlgren's "philosophy", feel free to visit my site at:

thatstherub.com/therub...

Apr 28 09:42 PM

[Hot Richard:]

Joshua,
I agree with you. "Pure capitalism" will fail. But, "pure capitalism" has NEVER failed.

Now...I define "fail" as "not be adopted by a majority of the human population at this point in time". You have to define your terms or at least establish the success/fail criteria! Hey, democracy didn't do too well in 1000 B.C., either. Make no mistake, there is an increasing number of "us" that are more than capable of pure capitalism. We just need to figure out a way of getting away from "you".

Remember, communism was a great success...for some set of success criteria.

North Korea is a great success...for some set of success criteria (like keeping Lil' Kim in power...greatly successful). Lil Kim goes to bed on his gold pillow every night and feels very successful.

Looking forward to your posts, but you'll need to up the ante on substance in your debunking! This is SA! It ain't no clown party!

Follow Hot Richard, Josh!

Apr 29 10:12 AM

[Hot Richard:]

OK, I was interested and checked out your site.

"I will be civil and fair, and I will never cross any boundaries that transcend chivalry and substance."

You certainly do not adhere to three of these qualities on your site. In fact, you are not civil, not fair, and not chivalrous (I looked up the definitions in a dictionary...I had to make an assumption on your use of "boundaries that transcend" in this context). You do provide some substance, though.

Formal schmormal...get to the point. Keep it about financial markets.

Apr 29 11:18 AM

[Mad Hedge F...:]

don't short them, but dont buy them either. There is something wrong with this picture. The Chinese stock market is shouting at us that the bull market is back, while the price of crude is telling us in more surreptitious tones that this is a bear market rally that will fail. If we were in a true economic recovery, crude would have run back up to the $70-$90 range by now. Who is right? Certainly large scale Chinese buying of economically sensitive commodities like crude and copper has been the hallmark this seven week move in global equity markets, which have brought a welcome $7 trillion boost in valuations. But how much of the move has been mere short covering? What is the extent of the dead can bounce? Until a recovery in corporate earnings signals the “all clear” we could be stuck in a trading range here, possibly until the end of the year, and maybe for years. “Sell in May and go away” is looking better by the day. Sell a few short dated calls above the market against your long positions. Pass the sunscreen?

Apr 29 05:57 PM

[aarc:]

Here's my take:

SnP500 is still headed to 982 for this current pullback or bear rally as they call it. How to get there is the hard part. Best scenario is a pullback to 808 then a rally to 982. Use the potential inverted Head and Shoulders pattern on the daily chart to find 808. This price pattern can easily change depending on what news will come out in the days ahead. However, the 982 handle is based on price structure rather than on daily news.

After the 982 handle, the capitulation sell-off should follow to either 663 or extend a bit to 576 or over-extend to maximum 465 in case of panic selling. Capitulation sell-off should take 5 to 6 months. It is going to be a slow grind down.

How to get 982?

Add the pullback in Jul-Aug 2008 to that of the pullback from Nov08 to Jan09. Then add the sum of the 2 pullbacks into the last bottom of Mar09 which is 666. Rough estimate 982.

How to get capitulation sell-off target? Use the sell-off from Oct07 top to Mar08 bottom as a template for the capitulation sell-off. Subtract that sell-off from 982 and get an equal move target of 663 as the highest probability target. Just in case 982 does not materialize as expected, use the same template to the top of this current bear rally to find the most probable final bottom. Very hard to do that with reasonable certainty until after a significant portion of the capitulation sell-off has already happened.

They usually happen in symetrical pattern only that the capitulation sell-off can extend more than 100% and the most usual extension is 127.2% fibonacci ratio which is 576. Over-extended run can happen if something really bad happens but usually that should not extend more than 162.8% for a maximum target of 465. Very rare that 162.8% can be exceeded. Not many instances of more than 127.2% extension either.

No guarantee but that is how I usually was able to make quick and dirty targets for pullbacks and sell-offs as this type of pattern unfolds. The bottom portion of the sell-off usually follows symmetrically with the top portion of the sell-off in price. In most cases the lower portion pullback consumes more time than that at the top. However, SnP500 has shown almost equal time consumptions on bottom pullbacks to that of top pullbacks in almost all facets of this 19 months of run downs and pullbacks that started in Oct 2007.

The pattern is a 1-2-i-ii-iii-iv-v-3-4-5 in Elliott Waves parlance if you know EW (we are now at the 4th wave, 5th wave is what they call the capitulation selloff). If not, simply make an inverse mirror copy of the top sell-off into the bottom sell-off but that is very hard without knowing where this current pullback from Mar 2009 is going to end.

Another quick and dirty method is simply find the mid-point of the expected total sell-off from top to bottom. But since the bottom has not been set yet, then use the mid-range of the symmetrical sell-off from May2008 top to Mar2009 bottom. And get the midpoint value of 1053.50. Notice that the sell-off at the top and the pullback during that time period are almost identical to the bottom pullback and final sell-off. The highest top is 1576 in Oct 2007. So using symmetrical run down, the target is 533. Quick and dirty.

This type of quick and dirty estimate does not consider how the individual wave counts behave and their fibonacci ratios but is good enough in many cases since most runs are basically affected by the accumulated news on the day to day basis. Only that there is no way to find price targets based on news alone. We have to use technical analysis to make reasonable estimates as to when and where the sell-off is going to end. Fundamental analysis has a very wide range of targets they are almost useless in precision timing the markets.

Still, the better way to really find the final bottom is to count the waves as they unfold on the monthly, weekly, and daily basis, using fibonacci confluence levels and momentum indicators will help considerably in finding the final bottom with reasonable precision and thus prevent excessive drawdowns to capital or lost potential profits if the analysis turns out to be wrong.

For now we have quick and dirty targets that can be used as temporary roadmaps. This roadmap helps since the news coming out during the capitulation selloff will be the worst there are (most probabily many small and medium size companies with limited cash reserves will be declaring bankcrupcies by that time). They will usually prevent even hardened traders from hitting the buy botton.

Hopefully, we will see the final bottom by Nov/Dec 2009 using price and time analysis. This 2007 to 2009 sell-off is not expected to consume more time than that of the 2000-2002 sell-off which lasted almost 2 years and 8 months.

This 2007-2009 sell-off is a C-wave in an A-B-C pattern, and C-waves usually consumes a little less time than the A-wave. 2000-2002 is the A-Wave while 2002-2007 "bear rally" is the B-Wave. The current chart pattern has been going on for more than 8 years that should last till the end of 2009 or early 2010 just in case the 4th-Wave of the C-Wave goes into extended time consumption mode.

This is quite different from the triple zigzag pattern or abc-x-abc-x-abc pattern that the 1929 to 1932 was able to produce.

The sell-off during that time was extremely punitive rather than corrective and consumed massive amount of price range (470 to 42 or 91% haircut) at an extremely short period of time (3 years) that resulted in the Great Depression once massive amount of wealth had been irrevocably destroyed mostly by wholesale bankcrupcies of many companies at that time not only in the US but throughout the Western World. This time around, we have a corrective sell-off of 2000-2002 and a punitive sell-off of 2007-2009 with no expectation of wholesale bankcrupcies of our industries both in America and the rest of the world except perhaps Eastern Europe - which remains to be seen.

There are many other possible scenarios but this is the highest probability so far with more than 90% of the cases of this pattern that I have analyzed have completed. The ensuing rally was also fast and furious after the pattern has completed rivaling that of the sell-off but takes more time to finally recover. More than 3 years but less than 5 years will be required for the recovery process with the initial rally from the bottom the most violent.

Good luck.

There is no such thing as a crystal ball that can give us what the future holds. What we can do to improve our chances is to speculate to the best of our abilities whether by using technical, statistical, fundamental and/or sentiment indicators.

Apr 29 06:51 PM

[john s. gordon:]

just remember, the market can remain irrational a lot longer than you can remain solvent.
> jack

May 03 09:01 PM