Bill Bonner (The Daily Reckoning, UK Edition):
The Dow fell slightly on Friday. Oil ended the week at $77. The dollar went nowhere.

But gold rose to a new high – $1,146. Today it’s hitting more new highs above $1,160…

Whatever else may be going on, there’s a real bull market in gold. It’s a bull market that began ten years ago. If you’d bought stocks then, you’d have about what you have now… less inflation. If you’d bought gold… you have about 4 times what you had then.

Today, a quick glance at a chart shows gold looking a little toppy. Expect a correction. But remember, this is a bull market. In a bull market, you buy the dips.

Stocks, meanwhile, are in a bear market. In a bear market, you sell the rallies. This looks like a good time to sell – if you haven’t done so already.

“Take Your Gains,” says Forbes. And once you’re out of stocks, stay out until the bear market is over… probably at around 3,000 – 5,000 on the Dow. When the price of gold equals the price of the Dow, it will be time to switch.

We haven’t seen the last of this bull market in gold. It’s what you buy when you think government is making a mess of the monetary situation. You put your trust in gold as an antidote… as protection… as wealth insurance.

Are the feds making a mess of the monetary situation? Oh dear, dear reader… please ask us something harder. Trillion dollar deficits as far as the eye can see… Stimulus spending that turns the US into a Zombie Economy… Handouts to the bankers… gifts to the carry traders…

The feds are out-doing themselves… more below…

As for the bear market on Wall Street, investors are counting on a miracle… a ‘recovery’ that doubles corporate earnings in just a couple years. They think it’s “just like 1982”. Of course, it is just the opposite of 1982… see the table below.

Besides, there is no recovery… and profits will go down, as businesses compete for less spending.

The recovery may be all in your head, writes Robert Shiller, in the New York Times:

“Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again — in turn, generating visible signs of recovery. This may seem absurd, and is rarely mentioned as an explanation for mass behavior late in a recession, but economic theorists have long been fascinated by such a possibility.

“Back in 1931, for example, The New York Times attributed the emerging economic cataclysm to a “mood of pessimism which had been carried to grotesque extremes.” In 1932, it compared reckless talk about “depression” to shouting “fire” in a crowded theater.”

It doesn’t matter what anyone says. It’s a depression. It’s nothing like the garden-variety recessions of the Post-War period.

It’s a depression because of the nature of the work it has to do. It has to clean up 3 decades’ worth of filthy balance sheets.

Click here for the rest of Mr. Bonner’s insightful commentary at The Daily Reckoning, UK Edition.

Mr. Market can do what he wants, of course. We’re just trying to read his mind. If we were Mr. Market, what would we do? We’d give investors a fright!

Two things make us think the bear market is not over.

First, there is market history. Bear markets do not end with stocks still trading at nearly 20 times earnings and the dividend yield barely at 3%. And they don’t end when people are hoping, praying and expecting them to end. They end in despair…after people have given up hope. They end with dividend yields over 5% and prices at only 5 to 8 times earnings.

What’s more, stock market trends tend to follow long cycles. The last bear market bottom was in ’82. It came after 14 years of disillusionment and disappointment. By the time stocks were ready to go up investors were sick of hearing about them. And then, you could buy some of the best companies in America for only 5 times earnings…and get paid to hold them, with dividend yields over 5%.

By our calculation, the bear market in stocks began in January of 2000. Since then, stocks went up in nominal terms. But adjusted for inflation, investors made nothing. Still, they didn’t seem to notice…and remained enthusiastic about stocks. Then, in 2007, a new down-cycle began…continuing until March of 2009, when the Dow hit a bottom at around 6,950. But was it THE bottom…or just a temporary bottom?

Most likely, it was a temporary bottom…a ledge from which investors could leap…before falling further down.

We say that because stocks never went low enough to qualify for a genuine bottom…and investors never showed the kind of disgust that you usually get at real bottoms.

We say that, too, for a second reason – the economy. In order to have a booming stock market, you need a booming economy. Earnings need to go up. That justifies higher prices. It also contributes to the positive mood among investors that persuades them that things are getting better and better…and that stocks deserve not only higher prices corresponding with their higher earnings, but also higher P/E multiples. That was the kind of mood that sent the Dow up from under 1,000 in August 1982 to over 14,000 twenty-nine years later.

But now the tide as turned. It rushes out between our toes and takes with it our fondest hopes. After expanding during our entire lifetimes, credit is now contracting. And that means more savings…but fewer sales, fewer jobs, and fewer profits. Can working people reasonably expect to earn more money next year? Five years from now? No. Can businesses expect rising sales and profits? No. Will the feds balance the budget, cut taxes, or increase benefits in the years ahead. No. No. No.

The outlook is not rosy. It’s grim. As we reported yesterday, household discretionary spending is at a low it hasn’t seen in 50 years. A half-century of economic progress wiped out! Real unemployment is closer to 16% than to the official 9% – and it’s rising.

Yesterday came a report from August: companies had cut more jobs than expected.

And even economists who are silly enough to believe the stimulus is working still say unemployment will likely remain stubbornly high for years to come.

So let’s add this up. Fewer people with jobs. Those who have jobs are paying off debt. Less consumer spending (back-to-school spending was disappointing, say the press reports). So, lower business earnings.

What would make stocks go up under those circumstances?

We also get word that insiders are selling stock heavily…and that consumer bankruptcies are up 24% over a year ago.

New economic boom? Not likely. New boom in the stock market? Not likely either.

But stocks don’t stand still. If they can’t go up…they will go down.

What will cause a break in the stock market? Who knows? Here’s a possibility: The Chinese stock market could crack. Maybe it already has. China is the great hope of the world economy. When it becomes clear that China is a bubble economy…and not a genuine growth economy…Western investors are likely to lose heart. Then…watch out!

We like the Bedford Springs Hotel. It is a 19th century resort…with class. It was in ruins in the ’80s, then bought by investors…who spent $120 million restoring it. They went broke 18 months later.

Not hard to see why. When we were there the place was almost empty. Still, it had a full staff…and beautiful appointments.

“Hey…this is pretty nice,” we said to the desk clerk. “No one is here.”

“They come on the weekends. We have a full house this weekend…and a full house in October, when the fall foliage is at its peak.”

“Oh…well…it looks kind of quiet now…”

“Yeah, it is quiet most of the time.”

“It is such a nice place, I think I might want to live here. I know you’ll take care of me. I could live quite well here.”

“Maybe you could give me a good price…and I’ll move in.”

“You need to talk to the management…”

On the wall of the Bedford Springs hotel is a short note telling us that George Washington stayed there when he put down the Whiskey Rebellion of the 1790s.

In fact, Bedford was his Western headquarters. But the real action was farther to the West. Bedford was more like a staging area, as near as we can figure.

The Whiskey Rebellion is a worthy subject for recollection, though a sordid chapter in American history. Accounts of it vary, depending on which history book you read. It is usually seen as a test of the new country…a test which Washington and Alexander Hamilton met with vigor and resolve. But by our reading of the history, the new republic failed on every count.

After the war against England, the federal government was in debt. It needed money. Hamilton saw an opportunity to raise money by taxing the small distillers out on the frontier. They were too far from Philadelphia to cause trouble. He figured they would resist. But this would give him an opportunity to march out at the head of an army, assert the power of the central government over the riff raff, and gain for himself a marshal victory that might elevate his stature closer to that of his boss, George Washington.

Washington himself may have had mixed feelings. He certainly had mixed interests. The tax was set up so to force small distillers to pay 50% more tax than large distillers. Washington was one of the largest whiskey makers in the country. He might be happy to see the small fry pushed out of business. On the other hand, he had spent much of his life out on the frontier. He knew how tough the frontiersmen could be; he probably wasn’t eager to tangle with them.

But the tax was proclaimed throughout the land, and the whiskey distillers took offense. After the war against Britain they had gotten the idea that they lived in a free country. Certainly, out on the banks of the Monongahela there was little to make them think otherwise. They were used to doing what they wanted, free from any sort of authority. So the sight of tax collectors trying to take their money (of which they had little…it was still a subsistence/barter economy out in the woods) probably set them off. At least one of the federales was attacked by a mob of them; his hair was shorn and he was tarred and feathered.

Then, Hamilton called up the New Jersey and Maryland militia…and set out for the West. He forgot, however, to provide sufficient victuals for his men…and soon the soldiers were cold and hungry. Naturally, they did what soldiers do under the circumstances; the robbed the locals. Thus did Hamilton’s army continue its march – in disorder, disgrace and larceny…stealing provisions from the people it was meant to protect from the scofflaw distillers.

Once on the field of battle, the whiskey men were ready for a fight. But cool heads prevailed. After a pow-wow, the feds arrested a handful of men…of whom two – a “simpleton” and an “insane” person, according to Washington – were charged with treason. Washington pardoned them, seeing no profit in hanging mental defectives. The rest paid a fine and were let off. One man died in jail. The rest went on their way.

Thus was the rebellion brought to a close. The distillers moved their stills out to Kentucky and Tennessee, where the feds couldn’t get at them. And the feds went back to doing what they always do – making a mess of things.

Until tomorrow,

Bill Bonner

Source: The Bear Market is Not Over

China has once again set the tone for our Monday market forecast. Roll the videotape:

Chinese traders dumped shares early this morning after a popular magazine rumored that the booming Chinese loan market is cooling off. Caijing magazine guessed that the Chinese loaned about $29 billion in August, a 43% crash from July. While that number isn’t official, traders around the red nation raced for the exits. The Shanghai Composite closed down 6.7%, its worst day in over a year. 16% of the stocks on the Shanghai Composite fell 10%, the daily limit down.

Thus, as we charted above, Chinese stocks are in a textbook bear market. In fact, down 23% since its 2009 peak earlier this month, the Shanghai Composite will be the worst performing major national index in the world for the month of August.

But still up around 50% for the year, is this the time to pile back into China — the great hope of the global market rebound? With the Shanghai Composite still priced 29 times earnings, it’s hard to be too enthusiastic. According to Bloomberg, the MSCI Emerging Markets Index is going for 19 times earnings.

If you’re debating buying this dip, you should check this out: Earlier this year, Addison Wiggin penned a report that spelled out a “triple timebomb” that would derail the global rebound… one of which was a faux boom in Chinese stocks.
China’s sell-off has hit just about every asset class today, especially commodities. You know the drill by now: Commodity traders of the world have pinned hopes on China’s rise, and every time they falter, oil and copper hit the bid. Light, sweet crude is down over 3% as we write, to $69 a barrel. Copper shed about 3% as well.
Gold took a little hit this morning. Traders raced out of stocks and into the dollar. Thus, the spot price shed about $10 at the New York open, and now rests just below $950 an ounce.
China frazzled the U.S. market too. The S&P 500 opened down 1%.

“This rally is on borrowed time,” opines Dan Denning. “We don’t know when. We don’t know why. But we do know what. And the what is that stocks are going to price in much lower earnings and investors are going to pay less for those earnings. Expect a lot of fall volatility.

“Energy investors ought to take heed, as well. Lately, there’s been a nice correlation between the oil price and stocks. The better the economy, the better it is for oil and earnings. Both have gone up.

“We’re still bullish on energy for a lot of reasons. But if the party ends sometime in September/October/November, you can expect lower oil and energy prices. That means if you have gains in energy stocks, you’d want to think about trailing stops and profit taking. In fact look for profit taking on the share market as a precursor to a new move lower.”
Oil service giant Baker Hughes bought fellow oil field tech company BJ Services today. The transaction will cost BHI about $5.5 billion.

“I’ve said over and over that there are only a small number of world-class firms that have the technology to find, drill and extract the world’s hydrocarbons,” says Byron King, who holds Baker Hughes in theOutstanding Investments portfolio. “Now there is one less.”

“BHI’s goal in this deal is to expand its international presence, and to leverage on BJ’s pressure pumping expertise. Now BHI can compete for the growing market for large integrated projects, by incorporating pressure pumping into the firm lineup.

“I expect that this acquisition will be good for the long term prospects for BHI. And it illustrates that there are other opportunities out there, smaller firms that are candidates for a takeout.”
While the Chinese growth story is faltering today, India is forging ahead: The Indian government said this morning that its economy grew 6.1% in the second quarter, narrowly beating Wall Street estimates. That’s really pittance compared to its typical 9% or greater growth over the last three years… but hey, we’ll take 6% these days.

“However, in light of the poor monsoons, the possibility of the growth of this magnitude continuing for the rest of the year looks remote,” write our Indian partners at equitymaster.com. “There are some who argue that manufacturing and services are fully capable of filling in the void left by agriculture, and hence, growth may not be as badly impacted. With rural India accounting for half of India’s consumption, such an assumption for the time being looks a bold one, indeed. Furthermore, if the central bank starts tightening monetary policy in the wake of high inflation that food prices are likely to bring, it may hurt growth prospects further. All in all, things point to a growth in the region of 6% with a downward bias.”
It’s Monday… time to find out which banks kicked the bucket over the weekend: With failures in California, Minnesota and our home state of Maryland, the FDIC has bumped the yearly total of failed banks to 84. The three shuttered banks had about $1.9 billion in assets, which ended up putting a $446 million dent in the FDIC’s deposit insurance fund.
“More than one in four banks announced an unprofitable quarter,” notes Dan Amoss, referring to the FDIC’s latest quarterly report, which we mentioned Friday. “There is still a long road of pain ahead for bank shareholders… here’s the crux of the FDIC report:

“Nonperforming loans now make up 2.77% of the entire banking industry’s assets. This is up from 1.4% in June 2008 and 0.47% in June 2006. As these loans get ‘worked out’ in today’s credit environment, the market will start to realize how severe net charge-offs will be.

“The FDIC published updated figures for the combined noncurrent loans and loan loss allowance at all FDIC-insured institutions. Here is an updated version of the chart we published in an Aug. 14 Strategic Short Report alert. The new figures — the moves from December 2008 to June 2009 — are highlighted in the dotted lines at the far right of this chart:

“You can see how problem loans are increasing at a much faster rate than the rate at which the banking industry is adding to its loss allowance. This means that published capital ratios are misleadingly high.”
The FDIC has put the government (read: taxpayer) on the hook for another $80 billion in potential future losses,The Wall Street Journal reports today. That sum is the totality of the FDIC’s “loss share” agreements — in which the FDIC promises to take a huge amount of possible future losses if another bank agrees to take on a failed financial’s assets.

The FDIC currently predicts the $80 billion in backstops will end up costing the insurer “just” $14 billion… $4 billion over the present balance of its deposit insurance fund. We’ll keep an eye on this one.
The Fed has made $14 billion in paper profits from emergency loan programs, the bank quietly announced today. Since the start of their unusual programs about two years ago, itty bitty interest rates and fees on loans worth hundreds of billions of dollars have actually netted the private/public bank an embarrassment of riches.

So where’s the money? Which banks owed what? What about the other programs, like the AIG bailout? Who knows… no one can audit The Fed. They just wanted you to know this morning that they’ve made a freaking killing bailing out the risky bets of their Wall Street buddies.
While it’s a little off our beat, we’d be remiss not to mention this: If given the chance, 57% of Americans would vote to remove every single member of Congress. A Rasmussen poll released yesterday gave participants two rhetorical choices: Either let ’em all stay or throw the bums out. When the dust settled, 25% said they would maintain the status quo, 57% would want a clean slate and 18% weren’t sure… or perhaps afraid they would end up on some “dissident database.”
Last today, another sign of the times… looks like capitalism will remain an easy target for a while. Here are the two feature films at this year’s Venice Film Festival:

Capitalism: A Love Story — Michael Moore’s new flick. While we trust this guy as far as we can throw him, the trailer looks like he spends a bunch of the movie making Wall Street execs and Congress people squirm, which is usually fun.

The Informant! — Matt Damon plays Mark Whitacre, the Archer Daniels Midland exec who exposed the companies lyin’ and cheatin’ in the ’90s.
“I agree with Bill Bonner,” a reader writes, referring to our issue on Friday, when we suggested, with Bill’s help, that many depression hurdles are still ahead. “We will be going through a lot of suffering and adjustments. My expectation is that we’ll probably come out of this crisis around 2016. This is based on the 17-year economic cycle.

“With 84 bank failures and 416 banks on the list about to go kaput, and the TBTF zombie banks, we have a long way to go. BTW, check out theBankrate.com’s star ratings on banks. They have replicated the FDIC’s CAMELS rating very successfully. All the three banks that failed last Friday already had a 1-star rating (the lowest rating).

“As we all know, we will see more banks, retailers, restaurants and companies catering to conspicuous consumption fail. I have started comprupt.com, a site where you can predict which company is going to implode next and when. Heck, this may just be Monopoly 2.0… at least trying to have some fun with the destruction all around us.”

The 5: That’s the spirit.
“Robert Prechter’s analysis indicates that we are in for a major retracement similar to what your graph shows,”writes an Elliott Wave fan, responding to the same edition of The 5. “He is also predicting deflation, instead of inflation, which will affect the prices of oil, gold and silver to the downside. The other contrarian prediction is the dollar will strengthen through all of this mess.”

The 5: Not a bad forecast at all. Bill Bonner shared a similar sentiment during his presentation this year at our Investment Symposium. To paraphrase him: Betting on inflation is starting to feel too easy.

Source:  China Sets the Tone, FDIC Falters, Fed Makes a Profit, India’s Surprise and More!

The big question preoccupying the talkers at CNBC is whether the post-March upturn is the beginning of a new bull market or only a pause in a bear market that will last for years. Don’t obsess over figuring out the answer. Markets are always perverse and unpredictable. Instead of trying to time your next buys and sells, think about what is going to happen over the next decade and how you will cope with it. You should be thinking about the purchasing value of the dollar.

Dremen, like your Notes editors, believes we are in for a bout of “wild inflation” – something along the lines of what we saw from 1979 to 1982. (For those of you too young to remember, this period saw the CPI rise 13% a year and long-dated US Treasurys yield as much as 15%.) Why this dire outlook? This, again, from Dremen:

Simply because our Treasury and its counterparts in other countries are printing money around the clock. They are also printing bonds, and with the same objective: reviving stagnant economies. The Keynesian belief that large fiscal stimulus is crucial to ending an economic downturn is prevalent among policymakers worldwide. No democratic government could stay in power these days if it didn’t undertake countermeasures against unemployment, the possibility of deflation and the worst financial crisis since the 1930s. It is inevitable that all this stimulus will be followed at some point by a period of rapidly rising prices.Central banks, including our not-so-omniscient Federal Reserve, will again fail to take the punch bowl away from the party soon enough, keeping stimulative polices going far past the point when unemployment has turned a corner and the financial debacle is behind us. Treasury Secretary Geithner and Fed boss Bernanke are trapped by politics and events. They make pronouncements downplaying the inflation threat, but inflation will hit like a tsunami within three years, maybe sooner..

So what can you do about this threat to your savings? First, sell long bonds. When inflation hits long-bond prices are going to plummet as yields skyrocket. Remember, bond market crashes can be as bad as stock market crashes.

Dremen also recommends repositioning your portfolio with heavier weightings in oil, natural resources and cyclical stocks… and cutting back on utilities and consumer staples. If you believe, like we do, that a crash in stocks is coming, hold off on buying stocks until values come off their current highs – buy the dips.

The third weapon in your armory against inflation is real estate. Dremen reckons real estate will be “one of the best investments in the years ahead.” Remember Buffett’s great contrarian maxim: “Be fearful when other are greedy and greedy when others are fearful.”

Also keep in mind Steve Sjuggerud’s rule of thumb for successful investing: buy assets that are cheap, hated and on an upswing.

You want to know the really funny thing? Traders and investors don’t care! All they care about is that Washington has Wall Street’s back. And that the Fed and the Treasury can keep on producing dollar bills like Willy Wonka produced Everlasting Gobstoppers.

In our eyes it’s no different to Bernie Madoff’s little scam. Big Wall Street players shoved money into Bernie’s Ponzi scheme knowing that the profits were ginned up somehow. But they didn’t care. They knew it didn’t really matter how Madoff was producing his profits; it just mattered that he was producing them. They knew that some poor schmuck down the road would get clobbered.

And that’s how it’ll be with this rally. When it seems like stocks are going up and will never come down… and the networks, giddy with excitement, can do nothing but praise God for the coming V-shaped recovery… and when every last mom and pop investor is sucked in… it will all come crashing down.

It may not be quite as spectacular as the end of the 48% 1930 bear market rally… But it will be ugly…

Of course, there are always pundits willing to give sensible reasons why stocks are defying gravity. Right now, there are three eminently sensible reasons being splashed around the mainstream press (hat tip, David Rosenberg):

Eminently sensible reason #1: Bernanke reappointedWe really fail to see how it could possibly be that the same central bank official, who, over a span of a decade, presided over two massive bubbles and their busts, can be viewed as being a positive force for the markets. Perhaps there is some solace in knowing that the same person who created this awesome and complex $2 trillion Fed balance sheet will be around to dismantle the largesse since he’s probably the only one that knows how.

Eminently sensible reason #2: The first monthly increase in the Case-Shiller home price index

As for the second point, there is a difference between a trendline and the noise around that trendline. Home prices are down a massive 31% from their peak and have been in a vertical-down pattern for nearly three years. Perhaps a respite is in order, but with the true underlying unsold inventory near 12 months’ supply, which is double what would typify a balanced housing market, it would seem like wishful thinking that we have suddenly achieved a fundamental low in residential real estate values (especially at the high end).

Eminently sensible reason #3: The seven-point jump in consumer confidence in August

With regard to point number three, we welcome any rise in consumer confidence but an honest appraisal of the data would show that 54.1 is still a very depressed level. In fact, the average index level during recessions is 73.0 – August’s reading was nearly 20 points below that. So, if the recession is indeed over and done, somebody forgot to tell this 70% chunk of GDP otherwise known as the consumer.

Far be it for us to call an end to the party. We’ve been warning of the dangers of this rally since it began. And it looks like nobody’s been listening: stocks have continued to climb in the most dizzying Wall Street rally since the infamous bear market bounce of 1929-1930. But that’s what we do here at Notes – we bring you the other side of the economic story. So we figure we’ll plow on.

Legendary short-seller Doug Kass called a bottom in US stocks in March. He was dead on with this call. Now Kass is has turned seriously bearish on the prospect – now almost a matter of dogma in the mainstream financial press – of a V-shaped recovery.

Kass’s reasons for being suspicious of the mainstream’s recovery mantra are eminently sensible… which almost guarantees that nobody will pay any attention to them. They’re even (gasp!) realistic and based on observable facts.

1. Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.

2. Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.

3. The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.

4. The credit aftershock will continue to haunt the economy.

5. The effect of the Fed’s monetarist experiment and its impact on investing and spending still remain uncertain.

6. While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in the prior upturn.

7. Commercial real estate has only begun to enter a cyclical downturn.

8. While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.

9. Municipalities have historically provided economic stability — no more.

10. Federal, state and local taxes will be rising as the deficit must eventually be funded, and high health and energy bills also loom.

(Hat tip, MarketFolly.com)

Reason number 10 scares us, dear reader. Kass is really just stating the blindingly obvious: massive deficits will have to be paid for sooner or later, and when they do, they’ll be paid for by higher taxes.

This hike in taxes isn’t lying somewhere in the distant future, either. It’s happening right now. This from Kass:

We have already witnessed the start of what is likely to become an avalanche of changing tax policy. New York City imposed its first sales tax increase in 35 years (rising from 8.375% to 8.875%), and, on the same day, the state of New Jersey imposed an additional tax hike on wholesale liquor distributors’ sales of liquor and wine, which is sure to be passed on to the consumer. In Oakland, Calif., even the “high life” is being taxed as the city has recently passed a tax on marijuana sales and the state of California appears to be close in following Oakland’s example.

This is just the start of a nascent and broad trend toward much higher taxes, a growth-impeding and P/E-diminishing secular development

Kass not only identifies the obvious when it comes to the future of the US tax regime, but he also hits the nail on the head (in our humble opinion, at least) when it comes to the future of US stocks.

The market optimism that we are now experiencing in the expectation of a clean handoff of the baton of stimulation from the consumer (2000-2006) to the government (2008-???) might be more short-lived than many believe, as the price of stimulation, regardless of whether it’s source is the private or public sector, holds the promise of being more of a growth-retardant. With the debt super-cycle continuing apace (but in a public sector context), the fragility and inherently unstable “balance of financial terror” argues for a not-so-benign and extremely volatile stock market future.

Unquestionably, the animal spirits have been in full force as shorts are scrambling to cover and many more are joining the ever more vocal and growing bullish chorus. But to me, the margin of safety is becoming ever more thin as the enemy of the rational buyer – namely, optimism – reaches new heights.

In summary, since a self-sustaining economic recovery appears doubtful, I do not believe that we have started a new bull market. Rather, it is more than likely that economic growth will disappoint in late 2009/early 2010 as the domestic economy confronts many of the emerging secular challenges discussed above.

*** Here’s Kass’s model portfolio as of June 2009. Interestingly, he recommends holding 29% in cash… a very smart move in our opinion, considering the state of the markets right now.

http://4.bp.blogspot.com/_9MYixPWxtF0/SjbACP6_syI/AAAAAAAAAn0/dG_f2yx8p0I/s1600/doug-kass-model-portfolio.jpg

Yet here at Notes we remain cautiously bearish. Why? Because it is our humble opinion that this remains a bear market rally, impressive as it is. Gluskin Sheff’s David Rosenberg says the rally lacks three key ingredients:

1. Leadership
2. Quality
3. Volume

History is littered with such bursts of euphoria. Probably the most infamous is the bear market rally of 1930. Stocks recovered strongly following the November 13, 1929 low. Wall Street became wildly confident that the worst of the crash was over. And for a time the bulls were dead on. From a low at 199 on November 13 the Dow rallied to a high of 294 in April 1930 – up 48%. By the end of the year, the Dow was down to 158. And by July 1932 it had plunged another 41 points.

Believe it or not, this rally occurred in the absence of an economic recession. Although it is largely overlooked today, the U.S. economy held up following the October crash. The rout in stocks was at the time considered to be an isolated incident – a direct consequence of excessive speculation and nothing more.

It is sobering to consider that few thought during the first half of 1930 – when the business curve of the Harvard barometer was almost horizontal and therefore did not signal a recession – that a devastating depression lay ahead.

The lesson from history is that depressions – or bear market rallies – aren’t avoided simply because they are not predicted. Nor are stocks always a bargain because they are “cheap.” At its November low, the Dow sold for only 10-times earnings; it had peaked at 15-times earnings in early 1929. But try telling investors who bought into the Dow in November 1929 that they’d got a bargain!

We bring this up not because we believe that history is destined to be repeated, but because we believe it often rhymes. And it would be foolish not to revisit the lessons of 1930 at this juncture – one year after our own “great crash.”

The casualties of the bear market rally of 1930 included some of the best investing minds of the era. Legendary investor Jesse Livermore lost all his money in the 1930-32 decline and eventually ended his own life. And a reclusive John D Rockefeller issued a statement that contained these fateful remarks:

In the ninety years of my life, depressions have come and gone. Prosperity has always returned, and will come again… Believing that the fundamental conditions of the country are sound, my son and I have been purchasing sound common stocks for some days.

Call us old fashioned, but we simply don’t believe that a secular bull market can last in a recessionary environment. And we firmly believe that the recovery drum has been banged a little too hard by the mainstream media.

To wit, we strongly recommend that Notes readers spend some time familiarizing themselves with the recent “fact finding” study on the depths of the current recession by two of our favorite underground sources, Tyler Durden of Zero Hedge and David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates.

What follows is a very quick-and-dirty rundown of Durden and Rosenberg’s case.

1. The US consumer makes up 70% of US GDP, yet retail sales and wage-based income are steadily declining. And consumer deleveraging continues despite efforts by the Fed and the Obama administration to stem the tide.
2. The business outlook remains bleak. May business sales decline a hefty 18% year-on-year. This is clearly a recessionary signal. Other key business outlook indicators, such as the Philly Fed’s Business Outlook Index and the MAPI Business Outlook Index, are pointing down.
3. There is no reason to believe that an inventory bounce is in the works. In fact, the decline in UPS package volumes (-4.7 year-on-year in June) show that inventory weakness is accelerating.
4. The recent falloff in jobless claims is due to seasonal factors, not an improvement in the economy. “Official” unemployment is under 10%. But the U-6 data (which includes the so-called “underemployed”) is 16.8% – 6.5% higher than a year ago. A consumer driven recovery in this environment is highly unlikely.
5. Housing is still in the ditch. It will take at least five years to mop up excess inventory. This means house price deflation will be a secular trend. This will continue to act as a drag on the banking sector and impair credit quality.
6. There is no top-line business growth. Better-than-expected earnings in the second quarter were achieved by cost cutting, which will have a negative, not a positive, impact on the economy. Stock holders will eventually want to see revenue growth. When this fails to happen, stock prices will come under pressure.
7. State revenues are imploding. The Rockefeller Institute of Government predicts a slide of 20% in the second quarter. California is the first state to go bust. It won’t be the last.
8. President Reagan’s low-tax lesson has been forgotten. There are no fewer than three tax increases planned for upper-income households by the Obama administration. We are looking at a top marginal rate jump of 10 percentage points by 2011. This will bring the top rate to 45%.
9. Although credit spreads are tightening, S&P downgrades of corporate bonds hit records in June. And credit conditions for small companies remains incredibly tight.
10. The overall inflation rate is currently running at -1.4% year-on-year. This is the lowest rate since 1950. There is no threat of real inflation until the excess slack in the economy is absorbed. [Note: We disagree with Rosenberg and Durden here: we see a clear-and-present threat of inflation down the road.]

This chart blew us away. Stock prices are supposed to move at random. So how do we explain such a seemingly orderly pattern? To answer this question you have to also consider the cyclical movements of commodities prices. Take a look at the chart below. It shows the trend in commodity prices between 1982 and 2000 – an 18-year upswing in equity prices.

As you can see, commodities entered a secular bear market just as equities entered a secular bull market. And vice versa.

The reason for this is actually relatively simple. As costs for raw materials increases corporate profits decrease. Eventually, the decrease in profits causes demand to fall for commodities… and prices fall.

This fall off in prices then reduces investment in the acquirement and production of raw materials, which in turn reduces supply. As supply gets tighter prices begin to rise again. Investment in commodities becomes once again profitable, and the cycle completes itself.

This story gets really interesting when you consider that during the vicious sell off in commodities last year prices bottomed far higher than in previous recessions.

According to Rosenberg:

In the 2001 recession, the oil price bottomed at $19.33/bbl; in 1990, it bottomed at $16.81/bbl; in 1982 at $28.48/bbl; and in 1975 at $10.11/bbl. We bottomed this cycle at levels that were peaks in prior cycles. The same holds true for copper – it hit its trough at $1.39/pound this time around versus $0.630 in 2001 and $1.00 in 1992. Ditto for the ‘softs’ – soybeans bottomed at $8.48/bushel this time, compared with $4.15 in 2001, $5.42 in the recession of the early 1990s and $5.32 in the early 1980s downturn.

What does this mean for your investments? Put simply, this implies that “the floor is in” for commodities. Consider adjusting your portfolios accordingly.

GOLD

LONG TERM

Before getting into the weekly commentary, some comments on the head and shoulder pattern.  I have had several readers who have pointed out reverse head and shoulder patterns in gold, one a long term and one of an intermediate term basis.  I believe there have been some experts that have shown the same pattern recently.  I had shown a long term gold chart in my commentary for the week ending 19 June 2008.  You can find it in the archives of many of these sites and it might better show the patterns discussed.  The long term reverse head and shoulder pattern, as suggested to me, has the shoulders on the left and right sides of this chart with the reverse head in the middle.  As for the intermediate term pattern, the left and right shoulders can be seen on the right side of the chart with the reverse head in the middle.  Unfortunately, I DO NOT subscribe to these being reverse head and shoulder patterns.  They are more legitimately potential double top patterns which I had talked about previously.

Head and shoulder patterns are trend reversal patterns and therefore for a reverse head and shoulder to be present (suggesting an upside break) you would have had to have had a bear market move leading into the pattern.  For a normal head and shoulder the lead in trend would have been a bull market trend.  In neither of these cases do we have a bear market leading into the formation of the pattern and therefore we DO NOT have a reverse head and shoulder pattern.

The long term P&F chart suggests that we are still in a bull market and some distance away from a reversal.  With the existing pattern that reversal would come if the move should go straight down to the $870 level breaking below the blue line and two previous lows.

As for the normal indicators, they too have still not reversed.  Although the price of gold is still some distance above a simple 200 day moving average line I use the weighted method which gives a more aggressive line.  The price of gold is still above this line but only barely.  The moving average line is, however, still in a positive slope.  The long term momentum indicator remains in its positive territory but is moving lower and is below its negative sloping trigger line.  The volume indicator has now crossed below its long term trigger line although the trigger remains in an upward slope.  So, what does all this mean?  It means that the long term rating remains BULLISH but is getting close to being down graded if the negative gold price trend continues much longer.

INTERMEDIATE TERM

In my last commentary the price of gold had just climbed above its intermediate term moving average line.  Unfortunately, it quickly reversed and broke below the line in a decisive manner and is now below its previous recent low and well on its way downward.  The momentum indicator has also moved into its negative zone and below its negative trigger line.  As for the volume indicator, it too is below its negative sloping trigger line.  All in all, the intermediate term rating is BEARISH.

SHORT TERM

The recent trend in the price of gold is easy to see on a short term chart.  Everything here is on the down side.  The action appears to be trapped inside a downward trending channel.  The price is below its negative sloping moving average line and the momentum is in its negative zone below its trigger line.  Both indicators have moved below recent lows.  The very short term moving average line remains below the short term line for confirmation of trend.  Everything points to a still BEARISH short term rating.

As for the immediate direction of least resistance, well the aggressive Stochastic Oscillator is giving us some hope for a reversal of short term trend, at least for a little while.  It is still in its oversold zone but has moved above its trigger line and might be heading to breach its oversold line.  Although this is not necessarily a sign of a reversal of trend it is a sign that the existing trend may be running out of steam and needs a reversal or at least a rest period (such as the period following June 15th).  I will go with the lateral trend as the one with least resistance for now.

What goes up the mostest comes down the fastest.  Silver just can’t seem to get its act together and continues to act a lot worse than gold lately.  While gold lost 1.8% of its price during this past week silver lost 5.5% of its price.  Although it is still acting slightly better than gold over the intermediate and long term, over the past short term the performance of silver puts it in spot 22 out of 24 off the components in the Precious Metals Indices Table.  Only the S&P Gold Index and the Merv’s Qual-Silver Index had a worse short term performance.

Since its recent top in early June the trend in silver price has been almost straight down.  It is heading towards a reasonable support just below the $12 level.  Should it hit $11.50 then most likely it will continue down to test the previous low at the $8.50 to $9.00 level.

Looking through the various indicators silver is now BEARISH for all three time periods.

Most precious metal (gold and silver) stocks took a deep hit this past week.  Average losses, based upon Index declines, were in the order of 6% to 10%.  This has put all stock Indices into the BEARISH camp on the short and intermediate term.  Many Indices have also gone BEARISH on the long term but there still are some hold outs like the Merv’s Gold & Silver 160 Index, the Penny Arcade Index and the Spec-Silver Index which still maintain their BULLISH long term ratings.  The Merv’s new Penny Arcade Index is probably holding up the best, especially when measured relative to its recent gains.  It is still up 402% from its Nov low even after a 21.5% decline from its early June high.

There is no way of knowing when this latest decline in the stocks will end.  We can guess, intelligently or otherwise, but no one REALLY knows.  One must assume that a decline, once established, will continue.  For this reason probably the best policy to protect one’s capital, is to start looking for exits in individual stocks.  When the turn around comes, tomorrow or next year, you will be sitting with cash to take advantage of the new move.  If you don’t exit from your losing stocks, and the decline continues, you do not get a second chance.  You could eventually break even on the next bull move but that may be 100’s of % points from where the stock might bottom out prior to a reversal.

In my view it is always better to err on the side of protecting your capital rather than to err on the side of an ego refusing to see the possibility of any major decline.

Well, that’s it for this week.

Their forecasts on a wide variety of indicators have turned out to be amazingly accurate. They were among the first to predict (back in the late 1980s) the rise of Boomer-driven culture wars and the simultaneous rise of Gen-X-driven free agency and distrust of government. And they were completely alone back then in predicting, for the post-X “Millennial Generation” (a label they coined), a decline in youth crime and risk taking and an increase in youth civic engagement that would first become apparent around the year 2000. Guess what? For the last ten years, everyone has been noticing exactly these trends among teens and 20somethings.

Howe and Strauss also made extensive predictions, based on generational aging, on how America’s entire social mood would likely change, in dramatic fashion, during our current 2000-2010 decade. To quote Doug’s prescient 1997 article, which was reprinted in Outside the Box late last year…

Remember the Sixties?

Bad News, Potentially Good News

What’s Next

What Does This Mean to You?

• Government grows powerful, and sweeping new legislation is enacted. The old 1990s rule was: just compete and stay off the state’s radar screen. The new 2010s rule will be: better have a presence in Washington so you’re not dealt out of the “new” new deal.  One political party tends to dominate. The Democrats under FDR during the last Fourth Turning offer a good example. While Neil Howe doesn’t think it will necessarily be the Democrats this time around, they are certainly in the pole position at this point.
• While public history speeds up, personal life slows down. Families will spend more time together, like in the old Frank Capra movies. Ever more households will be multi-generational, a trend now spurred by Boomers with large, empty McMansions and Millennials without jobs. There will be a blanding of the pop culture, with the entertainment of the young (put Miley Cyrus or “High School Musical” on fast forward) increasingly regarded as tamer than the entertainment of the old.
• Innovation tends to stagnate, while a few new technologies will be chosen to be adopted on a large scale. We will see the equivalent of canals or railroads or interstates being built across America. To borrow from Carlotta Perez’ four-stage description of technological revolutions, we are moving from the “innovation” to the “implementation” stage.
• New laws and regulations will do less to referee a free market and more to pursue one or another national priority. They will increasingly favor the large producer over the retail buyer, investment over consumption, planning over risk, debt over equity. Businesses will hustle to reposition themselves. Anti-trust will weaken.
• The authority and obligations of community will strengthen at all levels, from local to national and possibly beyond (if our alliances prove durable). Personal reputation and membership will matter more. A “new localism” will reshape town and urban planning. A global slide toward national or regional protectionism will loom as a real danger.
• It is too early to tell whether the crisis will ultimately be inflationary or deflationary, though we at Casey Research come down on the side of inflation for the simple reason that the government possesses the means to inflate. Due to the gold standard, that was not the case early in the Great Depression.
• In the past, Fourth Turning periods have always resulted in the nation redefining who we are in some essential way. That was certainly the case during the American Revolution, when we transitioned from a British colony into a collection of independent states — and the Civil War, when those states were hammered into a single nation. And, again, after World War II, when the U.S. went from being a relatively isolated nation to a global empire. A wild card, for instance a terrorist nuke going off in a city anywhere on the planet, could similarly take the country, and the world, into unforeseeable new directions.
• Baby Boomers will continue to be respected for their cultural achievements (it’s not a fluke of history that Boomer music and other entertainments are still wildly popular among the young), but will be increasingly ignored in the political debate. The term “senior citizen,” already in decline, will disappear entirely. And if push comes to shove, Boomer’s financial interests – including Social Security – will be subjugated “for the greater good.”
• There will be a growing push to rebuild the middle class. The wealthy and the impoverished alike will both come under pressure thanks to new pro-middle class initiatives. If you are a high-income earner, it’s a certainty your taxes are going up, and likely by a lot. If you want to make a fortune, don’t pursue the niche or the “long tail.”  Invent the next big brand that will appeal to Everyman.

Don’t Worry, Be Happy