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The 1929 & 2007 Bear Market Race to The Bottom
Week 61 of 149
Prime Interest Rates & CinC Inflation
A Finance System Changed Beyond Recognition
12 December 2008 Color Key to text below
Boiler Plate in Blue Grey
New Weekly Commentary in Black
Here is the BEV chart for the Bear Race.
The weekly closing price BEV (Bear's Eye View) results for week 58 in the Dow Jones' 1929 & 2007 bear market's race to the Bottom are as follows:
1929-32: -51.79% from its all time weekly closing high price of 380.33
2007-08: -38.77% from its all time weekly closing high price of 14,093.08
On 02-Sept-1929, the DJIA hit its BEV Terminal Zero (last all time high) of the "Roaring 20s." Sixty one weeks later, the DJIA 1929-32 bear market was -51.79 below its terminal zero and racing down to its July 1932 bottom of -89% below its 1929 terminal zero. The Red plot above tells the entire 149 week story of the Great Depression Bear Market.
But we are stuck with the DJIA 2007/201? Bear Market's blue plot.
On 15 October 2007, the DJIA hit its BEV Terminal Zero (last all time high) of the 1982 to 2007 Volker/Greenspan/Bernanke bull market. Sixty one weeks later this bear market is down 38.77%. So what happens now? I don't exactly know. But the DJIA chart pattern appears to still be bearish.
I would also caution against expecting this bear market to closely mimic the 1929 bear market. My BEV Chart above shows the similarities, but there are differences too. The biggest differences between the two bear markets are the current actions of the Federal Reserve and US Treasury. The US government is fully committed and heavily armed in their publicly announced war against the bears.
I expect the 2007 bear's BEV chart plot to diverge significantly from the 1929-32 bear as time goes by. Strange are the ways of "policy," we might even hit a new BEV terminal zero (new all time high) before we continue down to the terminal bear market low. When we do hit the bear market's terminal low, the bottom will only become apparent weeks, months or maybe years after it happens.
Patience is a virtue.
Below is my volatility chart comparing 2007's 200-day moving average closing price volatility with 1929 bear market volatility.
Note: 2007 values are actually positive. They were inverted so 1929 would fit on top and 2007 on the bottom. So for 2007, please forget the negative valuations and focus on the percentages.
1929, Wk 61 200 Day Moving Average Volatility: 1.10%
2007, Wk 61 200 Day Moving Average Volatility: 1.75%
(Remember, with the 2007 data up is down and down is up!)
Historically, daily 1% swings from the pervious day's closing price in the DJIA, while not uncommon, should not occur on an almost daily basis. The stock market is running a fever with its "Persistent, Extreme Volatility."
Is there any good news for Wk 61? Two days this week had their volatility fall within the historic range of 0.00% & 1.00%. We haven't seen that for a few weeks. Also the 40 Day M/A is coming down. Bad news is that the 200 Day M/A is still rising fast. But Wk 61 did seem more sedate. But currently I am a committed bear. To see the market calm down may not necessarily be something good for the bulls or bad for the bears.
Bear markets are like a well scripted horror movie. The opening scene always shows happy people totally oblivious to the coming horror that is their destiny. In Bear's Eye View (BEV) terminology, the opening scene of a bear market is called "the terminal zero."
The terminal zero is the * last * new all time high of the bull market. This is a very happy time for the bulls, doomed though they may be. What the bulls don't know, but will discover in due time, is that the coming scenes are directed by the bear.
Bears make superb horror movie directors. They know good market horror, is hope destroyed. But it's a bad movie to have the chainsaw wheeling fiends do what they must do in the first scene. For the bulls to get their money's worth, the movie must move smoothly from one scene to the next. In this process, tensions will build and relax until the final scene's crescendo of bull market hope destruction.
The problem with me turning bullish now is that so far it has not really been much of a horror movie. It seems like something is missing in the plot. I know people's fortunes have been destroyed by this bear. And I am not cheering for the bear. But if there is more to come, who wants to take that too?
So if you're out of the market, don't be in a big hurry to get back in. If you're still in, good luck. Remember that since 1885, the single most bullish thing for the stock market to do was to fall 40% from a BEV terminal zero; except the one time in 1929.
Since 26 November, the Step Sum doesn't know if it is bullish or bearish. It is just sitting in a range between 40 & 43. As we can see in the Red plot above, this is not unusual. Of all my weekly charts, I think the Step Sum plot is the most important.
The Step Sum is an indicator of market sentiment. When the underlying sentiment is bullish the Step Sum will rise. When bearish it falls.
Think of the "Step Sum" as the sum total of all the up and down "steps" in a data series as prices change over time. An Advance - Decline Line for a data series derived from the data series itself. Logically, to have more up days than down days during a bull market makes sense as does having more down days than up days during a bear market. Understanding the Step Sum is no harder than that.
Prime Interest Rates & CinC Inflation
In Wk 60 of my Bear Market Race Report, we saw a chart plotting CinC & CPI yearly inflation with Barron's Best and Medium Grade Bonds Yields. This week I've charted CinC inflation with the Prime Rate and Barron's Best Grade Bond Yield. We shall see that all interest rates are not the same.
Note on the above CinC plot. I removed approximately 30 of the 3,153 week's data points. These spurious data point's single week wild swings would have confused the plot.
Note on CinC in general. I understand that inflation is not just an increase in currency, but of currency and credit. To keep things simple, I prefer to use CinC as my inflation index.
Here is a brief review of the plots charted above.
- CinC inflation is the annual rate of currency creation as dictated by "monetary policy." I believe CinC is a superior measurement of actual inflation than CPI inflation. After all; increases in CinC is inflation.
- The Prime Rate is an interest rate similar to Barron's Best Grade Bond Yield, but there are differences.
- Barron's Best Grade Yield is set by the market forces of buying and selling long duration, good quality corporate bonds. The Prime Rate is a bank set rate for short term business loans.
- Short term interest rates (Prime) are usually lower than long term interest rates such as Barron's Best Grade Bond Yields. So under normal credit market conditions, the blue plot above will always be lower than the green plot of bond yields. It is important to understand that those times when the blue plot is above the green plot the credit market is by definition no longer normal. At such times the Federal Reserve is acting to tightening the money supply. To do that it only has to raise bank-set, short term interest rates like Prime, Fed Funds, and The Discount Rate higher than market-derived longer term bond yields.
The best way to think of both prime and bond yields is this; Prime Rate is set by "monetary policy" while bond yields are the bond market's reaction to "monetary policy."
Examining the blue Prime Rate plot
as it starts at 7.5% in 1921.
- World War One was a source of great credit inflation. After the war, dollars created for the war effort flowed into consumer prices. The Federal Reserve wanted to deflate this inflation and did so with the 7.50% rate we see in the above chart. We can assume that long term bond rates were lower than the 7.5% Prime we see in 1921.
- Around 1924, the Fed's resumed its monetary inflation, but now the "liquidity" flowed into asset valuations such as real estate and stock prices. We can see "monetary policy" pricking the 1929 stock market bubble in the above chart with the rise in the Prime Rate from below 5% to about 7% in 1929. Again, we can assume that long-term bond rates were lower than the 7.00% Prime we see in 1929.
- Interest rates collapsed shortly after the stock bubble deflated. The "policy makers" lowered Prime to 1.00% for most of the 1930s, hoping to create demand for bank loans. If we had data on bond yields from the Great Depression era, it would be safe to assume that they would be much higher than this Prime Rate of 1.00%.
Unfortunately, after the credit binge of the 1920s, businesses were incapable (financially or emotionally) to assume large debt loads. World War Two saw the United States with a quasi-command economy. The Prime rate was set and kept at 0.75% to encourage war production. With government contracts creating strong orders, business activities soon revived. And so did CinC inflation.
After World War Two the world entered into the Bretton Woods Accords (BWA) era of "monetary policy." A key provision of the BWA was that the United States Government would fix the US dollar at $35 paper dollars for every ounce of gold held in the US gold reserves. In other words, the US Government promised it would not print more paper dollars than they had gold dollars to back their paper. As you can see in the chart below, the US "policy makers" did not keep that promise for long.
The DJIA had a good bull market from 1942 to 1966. Bull markets in financial assets has everyone's approval. However for the period shown in the chart above, consumer prices were also rising as a result of CinC inflation.
- By 1980, CinC and CPI inflation were both at double digits.
- The reserve status of the US dollar was at risk.
- Action had to be taken.
Remember, the Prime Rate is a short term rate set by bankers and is usually lower than bond yields. Reviewing the chart containing plots of Prime and Best Grade Bond Yields, we see that from December 1980 to September 1981, the US banking system raised the Prime Rate to 21.5%! That was 10% above Barron's Best Grade Bond Yield. This created an extreme yield curve inversion which caused the worse recession since the 1930s. This recession terminated the double digit increases in consumer prices.
Paul Volker, the Chairman of the Federal Reserve is credited with breaking the back of the 1970s inflation. In regards to consumer prices (CPI), that is true. But CinC inflation continued on from 1981 to 2008. The Chart below tells the story.
Monetary inflation has been incessant in the post World War Two Economy. Looking at the increase in CinC above, it is all too apparent that Paul Volker did not "stop inflation." Mr. Volker's real triumph was in diverting the Federal Reserves' rivers of "liquidity" from consumer goods to financial assets. Alan Greenspan gets all the credit for the stock and real estate bubbles. But Paul Volker's willingness to raise the Prime Rate to 21.5% and keep it there for nine months saved the US dollar's reserve status. His actions also made possible the 1982-2007 parade of inflation generated financial asset bubbles.
Paul Volker is no hero, he's just another "policy maker."
Strange are the ways of monetary inflation. CinC inflation from 1947 to 1981 resulted in an historic rise in interest rates. CinC inflation from 1981 to 2008 then caused interest rates to fall to near historic levels. The only difference between 1947-81 & 1981-08 is where "liquidity" flows to.
When "liquidity" flowed into consumer goods, it became apparent that the dollar bought less than the previous year.
People hate "Consumer Price Inflation."
Bond buyers responded to this CPI inflation by demanding a higher current yield to compensate for the dollar's loss in purchasing power. The same goes for DJIA dividend yields. This is why CinC inflation from 1947 to 1981 caused higher interest rates.
When "liquidity" flows into financial assets such as bonds, stocks and real estate, these asset values rise in price.
People love "Economic Growth."
Capital gains now become the prime objective in investors' minds. Bond and stock investors are willing to buy assets with reduced yield for they expect to receive even greater capital gains from asset appreciation. Stock investors during the Greenspan-era Fed were so fixed on capital gains that DJIA dividend yields went below 1.5% when the market peaked in January 2000. The Greenspan Fed left an indelible mark on the DJIA dividend yield chart.
So inflation is a great idea, if you're a banker or politician. But for those of us who produce or consume items of economic value, CPI inflation or Asset inflation harms us greatly. The losses are always real while the gains of many years eventually pop with the inflationary bubble.
It was no mistake that the banks went to the Congressional feeding trough before everyone else. The banking elite understood the consequences of congress bailing out their pet constituents. The US dollar will lose much value in the years to come. Paulson & Bernanke understanding inflation and being loyal fraternal brothers in the banking guild made sure the banks got their bailout money first while those dollars still had purchasing power. I would not put it past Paulson and the Wall Street banking establishment to have engineered a market crisis just prior to his and Bernanke's appearance before congress.
A Finance System Changed Beyond Recognition
Brilliant people often have friends in high places in the banking system. It's a great combination, much superior to the Greenspan / Bernanke era banking model where "policy makers" found millions of stupid people to loan money to. This combination of brains and banks provided the ways and means of modern economic progress since the earliest days of America. Think of "ways" as new and better ideas to do old things or even new things and the "means" as how best to finance these profitable ideas.
Barron's headline banner on its 1920s issues had it exactly right:
"Finance: The Application of Money to Practical Ends"
- Barron's credo from the 1920's
Government's role was essential in this process. It was essential that government stayed small, inexpensive and limit its influence to enforcement of contract laws. In general, government needed to stay out of the way of the brains and banks. The sub-prime mortgage crisis is a prime example of what happens when politics enters into finance .
In the 1960s, public opinion changed towards big business as a new generation came into its own. Oil fields, smoke stacks and electric utilities were once great public virtues of a proud America. After "Earth Day" in 1970, people who would later gain public office saw industrial production as scars on the face of mother Earth. But I'll admit that industrial environmental abuses before Earth Day 1970 were unacceptable. Pollution is a public nuisance that should not be allowed. What was also unacceptable was the exponential growth of government regulation (environmental and other) that saw private for profit industry as a public evil.
Soon after 1970, lawyers and regulators made it impossible for the brains and banks to construct new petroleum refineries or nuclear power plants within the U.S. If creating a new and modern industrial infrastructure in the U.S. only made money for lawyers, brains would build their modern infrastructure overseas. This did not result in industrial activities ceasing in the US, but who profited from these old industrial companies shifted from share holders to bankers, politicians and lawyers.
Legal theory has it that the shareholders own the company. But today's reality is that corporate ownership is largely an absentee ownership. Thomas Edison is no longer the largest shareholder of GE. The current owners of GE are mutual, pension, trust and hedge funds. They have no vested interest in a strategic long term relationship with any company whose shares they own. These funds' main interest in their investment in GE is in studying its price chart to tell them at what levels they need to dump their positions. I am not making a charge of corporate malfeasants. For the sake of their funds having exit points in a position is a proper concern for them. I am only making the observation that corporate ownership today is not a non-factor in many major industrial concerns. Control is everything.
Today, in a very real sense, the banks think of the existing American industrial infrastructure as something that belongs to them. The American steel industry was built largely by Andrew Carnegie, but only after J.P. Morgan provided the financing. So since the 19th century, banks have had a powerful presence on the American steel industry's corporate boards. This is true for any large company whose shares trade in the stock market.
Politicians and lawyers see industry as targets of opportunity in actions that rarely benefit industry.
Who is looking out for the long term good of corporate America? It has become apparent that no one with de-facto control (politicians, bankers, labor unions & corporate officers) has a long term strategic interest in American industry. The auto industry is an excellent example.
Politicians want increased taxes and business policies that benefit their voting blocks in labor and the environment.
The US auto industry's profitability is at the mercy of politicians whose demands are political, not profitable.
Bankers see companies as sources of interest income, or fees for consulting advice on derivative products.
The US auto industry may be insolvent, but the banks care only that congress is willing to guarantee the auto industry's debts to the Banks.
Corporative officers? They get hired and fired at the pleasure of the board.
I would think that prior to their congressional testimony the auto industry's CEOs would have been given instructions on what to do in front of the cameras. Their first priority would be to do nothing to anger congress.
In this theatre of the absurd, little concern has been shown to the actual owners of the auto companies: the stock owners. But how much respect is owed to people whose time is spent looking for a profitable exit from the companies' shares? The 2008 domestic automobile industry has a business model without much of a future. In the next few years we will see which other industries have similar models.
What is my advice for investors in my Wk 61 Bear Market Report? Ignore all silver linings over the financial markets. Now is the time to concentrate on the dark clouds.
Mark J Lundeen
12 December 2008
Dow Jones -40% Declines From 1885 to 2008 is the article that inspired this race of 1929 & 2007 Bear Markets. You may want to read that article to understand my "BEV Chart."
Dow Jones Industrials Average Market Volatility is the source for my volatility studies.
The Lundeen Bear Box and Step Sum is the source for my Lundeen Bear Box and Step Sum Chart
Note For the Record: Mark Lundeen does not want a devastating bear market in the next two years. However, in full view of Congressional Market Oversight Committees and under the supervision of Government Regulatory Agencies, things were done that I believe will make a historic bear market inevitable. If you have a problem with this bear market, contact Washington, not Mark Lundeen. |
发表于 2008-12-15 22:41:15
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