The “Bottom Line

"Stock prices have resumed their historic decline; and foreign currencies, precious metals, oil, and other commodities have also resumed their declines which, along with real estate prices, will likely prove crushing to most investors. Declining monetary aggregates and rising interest rates on all but the highest quality short-term debt are resuming as the credit crisis returns amidst a scramble for liquidity in the emerging “Greater Depression”.

ALL prudent investors, who are not astute traders, should now be out of stocks and bonds. Expect stock prices to decline farther and faster than they did in the Fall and Winter of 2008-09 and than they declined in 1929-32.

While U.S. Treasury bond yields may drop somewhat as stocks sell off stongly, interest rates must continue their rise over time as the finances of the U.S. and most other nations become increasing unwieldy.

This may be investors’ last chance to get their assets out of harm’s way. Those who are properly prepared may yet profit and live in relative abundance as global wealth is devastated and chaos reigns.

Economic Fundamentals Remain Very Weak

Home sales, consumer debt, and rising unemployment/underemployment offer brutal evidence that the economy here and globally is still, more or less, flat on its back. 43 states saw rising unemployment in December, sharply up from 36 in November. Nationally, many workers are not being tallied in unemployment statistics because they are discouraged from looking for work (600,000 in December). True U.S. unemployment is approaching 20%. Many are seeing their unemployment benefits run out.

An estimate of $350 billion for the States’ fiscal 2010 deficits will surely be revised higher. Also, those deficits are artificially reduced by Federal stimulus which, itself, will soon have to be withdrawn. As I reminded in the August 31 Bulletin, persistently rising consumer credit and real estate problems and growing weakness in commercial real estate, along with steadily rising unemployment and underemployment will eventually and cumulatively reassert sufficient gravity that will also cause hopes for recovery to turn to fear and then to panic. Those concerns are growing.

Growing inability of nations to borrow and spend to support their economies and also to remain solvent will result in more of their “stimulus” programs being reduced before long. Reported growth in economies is largely due to such borrowing and spending. (U.S. GDP statistics do not disclose the source of sector spending.) Spending by government – that can only consume or redistribute and cannot produce wealth – cannot build productive wealth of nations or of their citizens.

In the U.S. all reported economic growth is the result of these irresponsible and short-sighted practices.

Meanwhile, the real collateral and capital base of nations necessary for their borrowings and growth is dissipating at accelerating rates. Nations, not just homeowners and businesses, are becoming “upside down”. Severe recession and deflation devour tax revenues at all levels of government so expect their deficits to become even more problematic and alarming.

How could real prospects be positive when government interventions are draining our substance and strangling incentives of producers, frustrating efficient and profitable asset allocation, and encouraging foolish and unproductive investment and spending decisions within our economy? And when mountains of debt in all sectors of the global economy are unserviceable and deflating? And when the fierce but futile efforts by government and financial system to keep prices and wages high will extend and deepen the “Greater Depression” ahead.

Lack of confidence is growing in mythical “green shoots” economic recovery. Recognized inabilities of governments and their central banks to borrow, spend, and inflate their way back to prosperity is returning and will predictably turn from extremes of unfounded optimism to panic as deflationary declines accelerate. Securities valuations are increasingly seen as optimistic given economic performance that is, at best, soft; and markets – stocks, bonds, commodities – are poised for sharp declines.

Creditworthiness of national governments is showing increasing signs of fracture. Dubai, Greece and Portugal, France and others in the Eurozone plus Great Britain are the latest names to add to Iceland, Ireland, and Eastern Europe. Bailouts of the largest financial institutions and of governments, such as Dubai recently, reveal the global enormity of our harm’s way economic crisis. I discuss the looming “debt trap” of historic proportions in Harm’s Way Financial Planning and Asset Management.

Japan, the second largest national economy, has far higher debt levels than any major country, and with their interest burden at near zero rates has nowhere to go but to dramatically larger borrowing costs and deficits. Indeed, that is the future for most large countries, including the U.S. China has overreached on stimulating their own economy and is seeing customers for their exports struggling. Nations are adopting protectionist policies back home that will further reduce economies of major exporters like China and isolate them from global trade. To assume that China will continue to hold large amounts of debt of the U.S. and others is foolish.

While the U.S. benefits from “flight to quality” with both dollar strength and demand for our (especially shorter maturity) Treasury debt, the U.S. debt crisis remains just over the horizon.

Deflation is again raising its ugly head. Deflation, deleveraging, and global economic decline are resuming here and globally as the broadest measures of the money supply contract. Deflation reigns despite frantic efforts to reinflate through governments’ “stimulus” borrowing of massive amounts and through the Fed and other central banks buying that debt and debts of others in order to create new “money” in their economies. Nonetheless, broad measures of money and credit are dropping, and the “global village” is under great pressure.
The total bank credit shows that the economic sluggishness is consistent with the new downtrend in money and near-money assets.

M3, the broadest monetary aggregate, plus total bank credit trends turning down show that that the deflationary threat is very real. It includes large time deposits, institutional money funds, and other large liquid assets along with narrower aggregates that include coin and currency and deposits of consumer, business, and government deposits in the banking system (M1 and M2).

EWI does not expect inflation to return until, at least 2012, and probably not until at least 2014. The signs are saying that a more rapid and powerful decline in the current Primary Wave 3 bear market leg could end sooner the most powerful portion of the deflationary decline. Possible shortages in food and other key commodities, like energy, could cause those prices to rise in crisis. Commodity prices react to fear of shortages and not to optimistic social mood. Indeed, panic can fuel powerful spikes in commodity prices, hence the need to prepare for shortages of critical tangibles.

High global debt levels are both financially destructive and deflationary because they require increasingly scarce cash to pay interest, much less principal. How can real growth occur as assets and incomes are deflating, debts are turning sour and people save and shrink debts instead of spend and invest? People have been realizing that their cash is more valuable to them than what they can buy with it. This reality should be seen even more powerfully in months ahead.

Since “money” is borrowed into existence by the banking system, shrinking bank deposits and credit outstanding equals deflation and economic decline.

Market and Economic Analysis Highlights

The break of the 10-month trendline of the Dow Jones Industrials Average from its March lows indicates the next major decline of the greatest bear market in at least 290 years has begun. That rally in stock prices reached highs (10,729.90 in the Dow) on January 19th. Just two days later, the Dow index closed decisively beneath its uptrend line on an increase in volume and the strongest downside breadth (issues sold greater than bought) in the last two months. The decline continues and, despite rallies, such as a counter-trend bounce that began today, should accelerate to the downside. Such rallies provide opportunities to exit or go short.

Recent declines also broke the late-November and mid-December lows, erasing 10 weeks of gains in just three days as prices in all indexes declined impulsively. The rally ending satisfied many analytical price and time targets. Market internals have been weakening for months as optimism, by some measures, was even stronger than at the October 2007 highs. of Investor optimism extremes signal significant tops. Optimism has begun to decline as the crowd begins to grasp reality and market volatility increases.

Expect that, for several reasons, the Primary Wave 3 decline which appears to be in its earliest stages, will drop farther and faster than did the 1930-32 decline, though we should also experience powerful snap back rallies along the way as I illustrated in the October 31st Bulletin for 1929-32. Each rally, however, should be more than fully retraced as stock prices continue to work their way lower. Expect that pattern to be similar to the 5-vave impulsive decline seen above in the second chart that tracked the Dow’s 17-month Primary Wave 1 decline into the March lows of last year.

In the global scramble for liquidity as over-priced and over-financed assets deflate, the dollar has begun a major advance against other currencies that will likely last through 2010. Dollar strength corresponds to valuation declines in gold and silver, oil, and in other commodities which are also under pressure because global demand resumes its decline as recession becomes depression. The Elliott Wave Int’l price target for gold is “below $680 per ounce”.

Be Ready for the “Big One”
Before this extremely large degree Primary Wave 3 down ends, the Dow should be below 4000, perhaps even below 1000, as the following projection chart by EWI suggests. After a relatively weak rally then, Primary Wave 5 down should eventually find a final bottom below Dow 1000. EWI’s target is “below Dow 400”. Expect stocks to be crushed for many years.


Expect the current first leg down in Primary Wave 3 (Intermediate wave 1) to break the March low of 6470, or at least roughly 40% below the final January 19th high of Dow 10,729.90. Dow 4000 would be 63% below that high and more than 70% below the final bull market high reached in October 2007. While broader stock indexes, such as the NASDAQ and smaller capitalization issues, fell further, they also tended to rally more but should now again experience even greater declines than the Dow.

We cannot know how long the decline will take or its final bottom, but we can be confident that investor pessimism will be significantly more negative than in late 2008 and early 2009. The most powerful point of decline should occur at its center (at the center of wave 3 declines of various degrees). At that point, investors will stop focusing on possible upside potential for the markets and start worrying about how far down it will go.

This “point of recognition” occurrence (“Prechter Point”) should be stunning enough to set all-time records for financial panic. Thereafter, pessimism becomes the dominant expression of social mood. EWI’s projections for reaching the all-time lows in social mood are around 2016. Regardless of when pessimism bottoms, be prepared for meaningful recovery to be deferred for much longer".