Before I start this piece let me acknowledge all of the Prechter haters that I hear from every time I bring him up. He was back in the news after doing this CNBC interview yesterday.
I found it amusing that the DOW sold off as Prechter was preaching his doom and gloom only one day after hedge fund giant David Tepper's comments triggered a 200 point rally.
Like all analysts, Prechter has gotten things wrong at times just like everyone has at one time or another. This doesn't mean that his comments should not be taken without merit.
In fact, I will take Prechter over any economist out there becasue I can't name an one besides David Rosenberg that has gotten anything right in the last few years.
Now, do I think the DOW is going to hit 1000, 2000, or 3000? I have no idea. If it does, I hope you have some canned goods and gold in the basement because this country will not be able to function properly after a 90% correction.
What I do know is that Dr. Prechter made some excellent points during his analysis which is all I ever care about.
I couldn't agree more with him when it comes to the high yield bond market. Folks, they are called junk bonds for a reason. The fact that the market can't buy enough of stuff that's most likely worth zero without mark to market accounting standards is frightening to say the least.
I feel like I am watching a group of sheep being led to slaughter as I watch stock brokers continue to pile their clients into this toxic debt.
I thought Prechter's information around fund managers sitting in only 3% cash (which is the lowest levels since the crash) was also very telling.
Here is the first question that comes to my mind after hearing this: How is the market going to move higher if the fund managers are 97% "all in" at this point?
The DOW has gone NOWHERE in about a year. Is this the best they can do while sitting in only 3% cash? To be fair I am sure they have significant positions in bonds after their huge run.
I would love to know what % of bonds these funds hold.
Prechter is basically calling for a classic delflationary death spiral. The dollar soars and equities crash in such a scenario.
At this point this would be considered a classic contrarian view when you listen to the market participants.
Calling deflation the "contrarian view" first appears to make no sense when you see what happened to the 10 year yesterday (as well as the whole year):
Both camps can make their case when you look at the markets. The hyperinflationists scream "Look at $1300 gold!" while the deflationists respond by screaming "Look at bonds!".
Too see such market dislocations is really unprecedented. Talk about mixed signals.
Nonetheless, the hyperinflationists seem to be in the lead for now because the Fed looks to be heading straight towards the QEII path.
OR have they.....
The Wall Street Jornal is reporting that the Fed might end up somewhere in between as they contemplate trialling a "mini" QEII:
"Rather than announcing massive bond purchases with a finite end, as they did in 2009 to shock the U.S. financial system back to life, Fed officials are weighing a more open-ended, smaller-scale program that they could adjust as the recovery unfolds.
The Fed hasn't yet decided to step up its bond purchases, let alone agree on an approach. After its last meeting, the Fed's policy committee said it was "prepared" to take new steps if needed. A call on whether to buy more bonds depends on incoming data about economic growth and inflation; if the economy picks up steam, officials might decide no action is needed
A leading public proponent of a baby-step approach, James Bullard, a 20-year Fed veteran who has been president of the St. Louis Federal Reserve Bank since 2008, says he has made progress convincing his colleagues to seriously consider that approach. "The shock-and-awe approach is rarely the optimal way to conduct monetary policy," he says. "I really do not think it is the right way to go except in really exceptional circumstances."
Under a small-scale approach, Mr. Bullard says, the Fed might announce some target for bond buying, say $100 billion or less per month. It would then make a judgment at each meeting whether continued action was needed, he says, based on whether "we're making progress toward our mandate of maximum sustainable employment and inflation at our implicit inflation target."
The Bottom Line:
So does the "deflationist" Robert Prechter have it right or will the inflationists be proven right as we watch the dollar crash as the Fed caves into the pressure of Wall St's QE2 demands?
The question remains unanswered in my view. Who knows, maybe they will both be right and we see a little of both when it's all said and done.
For now, yesterday's article in the WSJ suggests that the Fed might be backtracking from their FOMC statement last week. I had suggested on Friday that they might have painted themselves into a corner with their statement. The last thing they want to do is to lead the market into thinking "don't worry, we got your back".
There is enough speculation in the market as it is. This has resulted in a total lack of confidence by most investors who have responded by getting out of the game.
Yesterday's article tells me that maybe they are realizing that they might have gotten ahead of themselves with all of their QE2 talk.
Although I am against any QE, Bullard's argument makes the most sense if they are going to pull the trigger.
There is nothing wrong with testing the waters. You don't need to jump all in at once whenever a crisis arises. We have repeatedly done this during our crisis. This often leads to catastrophic mistakes. TARP anyone?
One thing is for sure, the market really doesn't know what do believe and they are hedging their bets by owning both gold and bonds in order to protect themselves from either scenario.
Disclosure: No new positions taken at the time of publication