The 1929 & 2007 Bear Market Race to The Bottom

黄河之水天上来

The 1929 & 2007 Bear Market Race to The Bottom
Week 66 of 149

Short Primer on Dividends, Bond Prices and Yields
Gold as a Leading Indicator for US Treasury Yields
1967 to 2009

Mark J. Lundeen
Mlundeen2@Comcast.net

16 January 2009

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 66 in the Dow Jones' 1929 & 2007 bear market's race to the Bottom are as follows:
1929/32: -52.38% from its weekly closing high price of 380.33
2007/09: -41.24 % from its weekly closing high price of 14,093.08
Nothing new for me to say this week. This market won't go down below the BEV -45% line and can't get above the -35% line. Give the market some time and something will happen.
Below is my volatility chart comparing 2007's 40 & 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.

(Remember, with the 2007 data up is down and down is up!)

1929/32, Wk 66 200 Day Moving Average Volatility: 1.19%
2007/09, Wk 66 200 Day Moving Average Volatility: 1.77%

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."

Volatility is creeping-up again. Last week's 200 Day M/A was at 1.75%, today it closed at 1.77%. Yesterday was going to be a 2% day, but came back from below 8000. The "policy makers" snatched 205 down points from the bear so Thursday closed up 0.15%. Had the DJIA closed down below 8000, the 200 Day M/A would have crept up to 1.79%. As you can see in the table above, the record of 1.78% made on 17 December is still holding, but just not by much.
We are still seeing a 2% day each week. To put that into its proper perspective consider the following facts.
From 02 January 1948, to 12 August 1971 (when the US closed the gold window) there were 6060 NYSE trading days. Only 64, or 1.06% of those days were, 2% days. One day out of one hundred was a 2% day.
For the 200 Day M/A volatility data-point for 16 January 2009, (200 NYSE trading days from 04 April 2008 to 16 January 2009) we have seen 65, or 32.5% of the NYSE's trading days of the last 200 are 2% days. One day in three are 2% days!
That only includes the 2% days from 04 April 2008 to 16 January 2009. The market started to get jumpy in July 2007. From July 2007 to 16 January 2009 there have been 88, 2% days in total. This number was almost 89 had Thursday closed below 8000.
All this and the DJIA won't go below the BEV -45% line and can't get above the BEV -35% line. Is the market venting pressure a little at a time or are we seeing volcanic pre-tremors to a coming huge explosion?

The Lundeen Bear Box and Step Sum is below.

Since last October drop not much has happened. But we see the DJIA is on the Bear's side of the BEV -40% line. That means nothing as long as the "policy maker's" monopoly money can be used to bring up the DJIA like they did on Thursday this week.
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.

Short Primer on Dividends, Bond Prices and Yields

I want to look at gold's relationship with US Treasury Long Bonds. This is important as the price of gold historically is a leading indicator in predicting future interest rate trends. But first I want my readers to understand some bond basics and their abysmal failure in the 20th century as a long term investment before I address gold and US Treasury Long Bond Interest Rates. I might as well touch a little on dividends too, as stocks are competitors to bonds and gold with investors.
Investments in the financial markets are investments in either equity or debt. I exclude derivatives as they are intended to be hedging vehicles or pure speculative positions. In the right hands they are legitimate plays on the market, but most retail investors have low risk levels. Options and future contracts are not appropriate investments for most people.

Dividends

Equity is the fractional ownership in a company through the purchase of its common stock. Decades ago, one of the main objectives of purchasing stocks was for profit-sharing in a successful business via dividend payments. American Telephone and Telegraph (aka "Ma Bell" or AT&T) in the 1940s & 50s would advertise in Barron's that it had maintained a $9.00 per share dividend payout for years. I believe AT&T was called Ma Bell because she took care of her shareholders like a mother even during the Great Depression era.
This was not an unusual ad campaign decades ago, nor was publishing a full page ad displaying only a company's name and its balance sheet with past and projected production information. These ads were intended to show that a company paid dividend that year and would have the financial strength to pay dividends next year. In 1950, only 20 years after the 1929 crash, investors were fully aware that companies in poor financial conditions didn't have to pay dividends, and that capital gains could come and go with the winds outside of Wall Street.
We live in a different world now. Post Bretton Wood's stock market inflationary capital gains (often in common stocks that pay no dividends) had gained great favor over income from dividend paying stocks. But since 2007, where are the capital gains with these companies? The current corporate model on Wall Street does not encourage a good dividend program for its shareholders. And if the truth be told, for the past two decades shareholders have not asked for dividends either. Note that politicians have always insisted upon having their cut in corporate profits via their tax programs.
In 2009, all too many companies whose shares trade on the stock market are going to have problems in the next few years. High debt levels, falling earnings and dividend payouts are not predictors of future higher share prices. Also on a dividend yield basis, to see the DJIA fall 40% and still have a dividend yield below 4%, promises future declines.
So how far can the DJIA fall on a single day?
The two largest DJIA one day drop were on:
12 Dec 1914: -24.39%
19 Oct 1987: -22.61%
Note that neither occurred during a -40% DJIA bear market.
The 1914 drop was due to WW1. It must be noted that the market was shut down (no trading) from 31 July 1914 to 11 Dec 1914. (5 months) This drop occurred on the first day trading resumed. Also the DJIA itself was reconfigured from 12 to 20 companies during this period. So it was not only a different world, but a different DJIA that began trading again in December of 1914. By using the numbers from my source, we see a -24% day from one trading day to the next, five months later, but its not a real number.
The 1987 drop was due to programmed trading. It seems that everyone was using the same black box computer program, and on 19 Oct 1987 all the computers went on a mindless selling binge. That plus the market in October 1987 was due for a correction.
These records are due to abnormal conditions, but if either of these records is taken out in 2009, it would be another notable achievement for Dr. Greenspan's bubble-blowing misadministration of the Fed. And then we also have the current American corporate business model that minimizes a good dividend for the owners of their company's shares. If the day comes when people start to focus on their portfolio's building capital losses with no compensation from dividend income, I expect to see a day when people walk away from Wall Street and never come back. We may see a double digit percentage down day on this selling but I suspect not a record breaking percentage fall. I hope not!

Bond Yields and Prices

Debt is a loan made to a company with the purchasing of its bonds. Like a mortgage payment, a company must pay its interest and principle payments on a set schedule or default. Today, defaulting companies go to Washington for bailouts, but decades ago companies were liquidated for the benefit of its creditors, such as its bond holders. This makes payments from bonds a more secure source of income for investors than dividend payouts will ever be. A good thing in troubled times, but the inflation of the 20th century created a risk of a different nature - inflationary risk.

Note on Bond Prices: From 1938 to April 2002 I used the discontinued DJ 20 Bond Average prices. From April 2002 to Jan 2009 I used the new DJ Corporate Bond Index data.
The chart above shows how badly bonds have underperformed the DJIA since 1938. In markets where "policy" decides who wins and who loses, long-term investors in bonds were the inflation-adjusted, designated losers of the 20th century.
In the chart below, we are looking at the discontinued DJ 10 Bond Utility Average. From 1947 to 2002, we see the weekly data points for these bonds' yields and prices. Note the effects the changing yields have on a bond's price. It is important to understand that as a bond's yield (Red Plot) goes up, the price of the bond (Blue Plot) goes down. Like the stock market, the bond market has its bull and bear markets.
So when we see bond yields going up in the chart below, understand that the bond market is in a bear market with bonds losing value. Holding bonds when interest rates are rising is a very bad investment decision. Bonds in a bear market can see losses as great as common stocks in the stock bear market. However, when bond yields are trending down, bond prices are trending up in a bull market. Bond holders can make good capital gains in a bond bull market.

People who purchased good grade corporate bonds in 1981 when these yields were over 15% saw a 70% increase in capital gains on these bonds only six years later. These investors also earned 15% for six years on their original investment by January 1987. Not many people bought bonds in 1981. After decades of losing money, owning long-term bonds in 1981 had a social stigma attached to its owners. People who bought gold and silver in 2001 know the feeling.
This chart above is for a 10-bond average. A 1947, 20-year bond used above would mature in 1969, but it would have been removed from this average by 1959. Any bond has a shelf life for a bond average or index of only so many years. Dow Jones, in managing their bond averages or indexes, have to "adjust for constant maturity" to keep their average or index a * bond * measurement. Mutual or pension funds who purchase bonds must do the same with their bond portfolios.
To see why rotating bonds out of an average or even a bond mutual fund (like Pimco) is a necessity, let's look at a US Treasury 30-Year Bond called "August 2015 @ 10 5/8%." This bond is a relic from the Volker Fed era when investors trusted gold more than the Federal Government. All US Treasury bonds now listed in the bond tables with double digit coupons are from the Volker period. This bond has been listed each week in Barron's bond tables since August 1985 and the chart below is its yield and price history from September 1992 to the present.

This $1,000 bond was a 30 year bond that paid a 10.63% coupon ($106.25 in interest payments a year) when it was issued in 1985. However, in September of 1992, when I started tracking this bond, interest rates had fallen substantially. By 1992 this bond was yielding only 7.5% to anyone purchasing it. But note the price of the bond. This $1,000 bond was selling for $1,350 seven years after it was issued. Remember, bonds can have capital gains too.
The key thing to understand is that this bond is paying it owner $106.25 a year no matter what any future interest rate may be. If you could have purchased it in 1992 for $1,000, it would yield 10.63%. But no one would have sold it to you for only $1,000 in 1992. Interest rates fell 3% from 1985 to 1992. And that made the price of "August 2015@10 5/8%" rise so its current yield would be no more or less than other US Treasury bond of the same duration. This is how the bond market "discounts" bond prices as interest rates change. But strangely this math has broken down in the current rush into the Treasury market.
If someone is familiar with why this is so, I would appreciate a short reply. I suspect it is due to its $1500 price tag while other similar bonds issued during periods of lower interest rates are much closer to the $1000 face value of US Treasury Bonds.
To understand why Dow Jones or a fund must rotate out older bonds and replace them with newer bonds, look at the red lines I placed at 4% and 5.5% on the chart above. Please note the different prices for this bond at 4% from 2003 and 2008. Five years made a big difference in the price bond buyers were paying for this same bond.
So we see the price sensitivity of this bond to variations in interest rate changes as time moved farther from 1985 and closer to 2015. This is because the longer the duration a bond has until its maturity, the more unexpected and unpleasant surprises can impact the bond market. Under normal conditions, longer-term bonds demand a higher interest rate than short-term debt obligations to compensate bond buyers for an uncertain future. And "bonds" by definition are long-term loans. We see above that long-term loans act much differently than short term loans. So to keep the performance of a long bond in a long term fund or bond index, the old must go to make room for the new.
Key things to have gain in reading up to this point:

• Stock dividends are shared profits, bond interest is debt payment
• Long-term bonds are much more sensitive to interest rate changes than short-term bonds.
• Rising interest rates = bond price falling
  Falling interest rates = bond price rising.

Gold as a Leading Indicator for US Treasury Yields
1967 to 2009

For thousands of years, money was understood in terms of weights of gold or silver - that started to change in 1934. To understand why FDR confiscated the American people's gold in 1934 one only has to understand that gold as money is a limit on credit and currency creation. This means that gold limits government and protects individual empowerment.
Forcing Americans to use Federal Reserve Notes in domestic commerce enabled the Federal Government to extract wealth from one economic group and disburse it to another by means of a printing press. This print it up and pass it out "monetary system" has been a constant fixture in American politics since FDR. But foreign creditors, for obvious reasons, would not accept paper in place of gold in 1934. So exchanging paper dollars for gold remained an option for foreigners until August 1971.
This next fact is an essential concept in understanding why gold and US Treasury Bond Yields have a special relationship. The ending of the Bretton Woods era, and the ability of foreign central banks to exchange their paper dollars for the US Treasury's gold was a unilateral decision by the United States Federal Government. There was no international vote, no UN declaration, no nothing other than US Secretary of the Treasury John Connally's statement to the press that: "Its our currency and your problem" when the link between gold and the paper US dollar was announced.
The charts below show that the dollar, between 1971 to 1981, became everyone's problem as people world-wide sold dollars and purchased gold.
After reading my primer on bonds, we should all understand that raising gold prices is a bull market in gold * BUT * rising US Treasury Yield is a bear market in US Bonds. Now let's look at a critical 4 year period with a 10 Wk M/A of gold and US Treasury Long Bond Yields.
I've looked at this chart for years, but I still find it amazing. Look how tight the relationships were between gold and US interest rates when the world was seriously considering abandoning the US dollar standard. During the heat of the crisis, from 1979 to 1981, the price of gold was predicting US interest rates by only a few months.

This is all very logical. Unhindered by foreign central bank gold redemption, the US greatly inflated CinC from 1971 to 1981. This resulted in double digit CPI inflation rates and made the US dollar a junk currency. Double digit US Treasury Yields made US bonds speculative-grade junk bonds. Was it surprising that only a few years after 1971, the world told the US they didn't want Uncle Sam's fast sinking long-term Treasury bonds and bought gold instead?
The next chart is this same data from 1967 to January 2009. Again I remind you that rising yields = bear market for bonds and falling yields = bull markets for bonds. With that said, we can see that from 1967 to 2001 there was a polite agreement between gold and the US bonds markets. When gold was in a bull market US bonds would be in a bear market and when gold was in a bear market US bonds would be in a bull market.
Again, this is a very logical situation. From 1967 to 1982 the American stock market was going nowhere. The bond market was in a horrible bear market. If someone, foreign or domestic had dollars, what financial instrument could they purchase that would provide a rate of return that was above the late 1970s US, CPI double-digit inflation rate? With the Barron's Stock Group Averages, only the gold mining companies were clear winners after CPI inflation. In a world where money shrinks +10% every year, people were selling bonds and buying gold.

But we see that things changed in the early 1980s.

• double digit treasury yields and superb capital gains prospects on bonds;
• the DJIA had a dividend yield of over 7% plus the stock market was taking off to the moon;
• tax rates were reduced.

Most importantly, Federal Reserve created CinC inflation was now flowing away from consumer goods and into the financial markets. With double digit gains on dollar assets likely, it was not surprising to see people selling gold and buying US Bonds from 1982 to 2001.
But that was a long time ago. Today:

• bond yields are near historic lows with prospects of significant capital losses on bonds;
• the DJIA dividend yield is still less than 4% after a fall of 40%!
• tax rates will increase with the new administration.
• CinC inflation continues unabated but the financial markets seem unable to absorb this new "liquidity."

The polite agreement between the gold and US Treasury markets, that only one of them would be a bull market at any particular time, became null and void in 2001 and continues to this day. This doesn't pass the smell test. In January 2009, there are no reasons for US bonds to be in a bull market.
If you go to the link for John Connally I've provided and skip down to his history as US Sect of Treasury, he was advising massive "liquidity injections" to stimulate the US economy. But in 1971Connally was thinking in terms of billions of dollars. In 2009, the credit addicted economy needs "injections" of trillions of dollars. Should gold be in a bull market? Damn right it should be! Gold has always been in limited supply, but the dollars used in buying gold are inflating to astronomical sums.
But why in 2009 is the US Treasury Bond Market in a bull market? In the chart below for US Treasury Bond of February 2036 @ 4 ?, note the steep decline in yields (and increases in prices) for the US long bonds since the start of the credit crisis. Then, in just the past two months, rates crashed and prices soared during yet one more crisis in the banking sector!

This bond matures in February 2036. A baby born today will be 28 years old in February 2036. This child and the bond market will see many changes in the next two decades. If Connally in 1971 wanted economic "injections" of $Billions, and Paulson in 2009 wants economic "injections" of $Trillions, what will the future Secretary of the Treasury, Mr X in 2036 want to "inject" into the economy? Quadrillions? This is a trend that shows no sign of halting, so the next stop is at quadrillion.
To get a sense of the magnitude of how large one quadrillion is, we need to go intergalactic. There are only 225 billion stars within 500 thousand light years of Earth! On a cosmic scale, 500 thousand light years is our back yard. You really need to go to the link above. Zoom out a few clicks at this site and we include the Virgo galactic super-cluster and two other super-clusters. The number of stars in all of these galaxies is still described in terms of trillions. On planet Earth, there are no units of economic value that can be numbered in trillions unless you start counting atoms. But who purchases just a few dozen atoms of carbon or copper? That the supply of dollars should become larger than all the stars in several spiral galaxies is something I can't find a word to describe! Incompetent? Criminal? Goofy?
Call it what you want, but under this relentless campaign of CinC and credit inflation, bond values should be imploding and yields soaring far above their 1981 highs right now. But look, even the bombed out mortgage market has current interest rates lower now than at the time of the 2007 mortgage crisis. This is really too much to believe! I smell a rat.

So in January of 2009 we find gold and the US Treasury bond markets rising up in bull markets. Both these trends are market opinions upon the US dollar. A gold bull market is a bearish opinion; a bullish bond market is a bullish opinion. They can't both be right.
Considering all the "liquidity" the mad-scientists of "policy making" are "injecting" into their victim, I'm siding with gold. Expect a massive failure coming in the long term US Treasury Bond Market. Don't be surprised if President Obama makes some announcements on prime time TV on the bond market crashing sometime in 2009. No nation can inflate their way out of problems caused by inflation, though history shows that they do try.