2 October 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 DJIA is again turning down, how far is the question. I still believe we have not seen the final low in this Bear Market. If the 2007-09 Bear becomes the #1 DJIA Bear in History, I for one would not be surprised. But the "Policy Makers' supply of paper, ink and hard drive space is unlimited. So if they decide to take this market up, they can print the money to make that happen, and I think that is what is going to happen with the DJIA, after a correction.
Until long & short term interest rates, and stock dividend yields start to rise again, I see the DJIA continuing to trend higher with occasional corrections. But, in Wk 102, I made it clear that I wanted nothing to do with this market. In the last week, I've seen nothing to change my mind on this.
Below is the 8-Count & DJIA BEV Chart
It has been a while, but we now have a 1 in the DJIA's 8-Count. The last time we saw that was on 26 Aug with the DJIA at 9543.52. Will we see a 2 in the 8-Count? We haven't seen a 2 since 24 July, with the DJIA at 9093.24. And the last time we saw 3-DJIA 2% Days in an 8-Day running Count was 04 June with the DJIA at 8750.24.
So, as the 8-Count fell from 3 to 0, the DJIA moved up from 8750.24 on 04 June to 9829.87 on 22 Sept. A nice 12% move.
Seeing an 8-Count of 1 is no big deal, nor would a 2 signal a coming financial panic. But, 109 years of DJIA history tells us when we persistently see 3 or more DJIA 2% days in a running 8-Day Count, that hot breath you feel on the back of your neck is the Bear's!
Two percent up or down days are all the same to the Bear; he loves volatility. Remember, the largest percentage up days, from 1900 to 2009, occurred during the Great Depression's Bear Market.
There are so many massive problems currently being ignored by public officials and the financial media, yet the market is doing okay. But denial is not a river in Egypt. Today, 103 weeks after the 09 Oct 2007 DJIA top, denial is beamed at us from our television sets, and permeates the ink in our newspapers.
So You Betcha! The Bear is coming back to scrub clean America's balance sheets of all that nasty old non-performing debt and over-valued assets. That is the Bear's job, and he does it very well.
When this market starts heading down again in earnest, I'm watching my 8-Count to see if it gives us a heads up as the storm arrives. Since 1900, it always has before.
Nine of the past 12 Trading Days were down days for the DJIA. Since Sept 17, after all was said and done since, the DJIA was only down 3%. I would have more confidence in my Short-Term Bullish stance if the DJIA was down more than that. I expect to see the DJIA below its BEV -35% line and approach its BEV -40% line during this correction. But like all my predictions concerning future market actions, I might be wrong.
Currently, I have zero money in the general stock market, so all of my prognostications are for "Entertainment Purposes Only." If you have a horse in this race, I'm cheering for you, but I think you and your horse are crazy.
The Step Sum is an indicator of market sentiment. When the underlying sentiment is bullish, the Step Sum rises. When bearish, it falls.
Think of the "Step Sum" as the sum total of all the up and down price "steps" in a data series over time; an Advance - Decline Line for a data series derived from the data series itself. Logically, bull markets will have more net up days, while bear markets will have more net down days. Understanding the Step Sum is no harder than that.
* Correction in Arizona's Solar Power Potential *
Last Week, I asked my readers to correct any mistakes I made in the calculations for the table on Solar Power (SP), - and they sure did! I got some great feedback that changed my perceptions on the potential for SP. I don't believe SP will be appropriate for 100% of the energy needs of the Nation, but it could do a heck of a lot towards making America more energy independent.
The biggest difficulty SP has is overcoming the fact that its advocates have made alternative energy a national political issue to justify ever-bigger government. For example, Obama's former "Green Jobs Czar", whose only experience was being a "Community Organizer" with no technical background. Currently in Washington, energy is only a political issue that the Democrats intend to drag out from one election to the next.
If the SP industry were allowed to aggressively market their energy products as a solution to higher energy costs, instead of having their future controlled by bureaucrats who stifle development by endless discussions in Washington committee meetings, the industry today would be at a more mature level of development.
Dr. Tim Ellison, who holds a PhD in Physics and a degree in Electrical Engineering, knows much more about SP than I. He was kind enough to revise & correct my table from Wk102. Thank you Dr. Ellison!
It really irks me that the future of Solar Power in the US, and everything else, is being decided by "Community Organizers" and "Policy Making" Ph.D's in Quackology, instead of people like Dr. Ellison, who would really pick up the ball and run with it. Yes, this makes me angry!
There are still problems with SP; it's not there after the sun goes down. But Solar Power's potential has not been tapped, and that's a political scandal.
Nuff said about Solar Power; its time to move on.
Bond Market Credit Spreads 1962 to 2009
Credit Spreads in the Bond Market are simply the differences between the yields of different categories, or grades of Bonds, such as government bonds and corporate bonds. But why do different bonds have different yields, and why do bond yields change over time?
First, let's look at what a bond is: it's a loan that pays interest. Any time an investor or bank loans money, there is the risk that the money will not be paid back. That's called "Credit Risk." There is also "Inflation Risk." In 1962, $3,000 bought a Cadillac. What if in 1962 someone invested $3,000 in GM Bonds @ 5%, and waited 20 years? The intention was that with the return of the principal, plus 20 years of interest payments, this investment would return a new 1982 Cadillac with $3000 left over from the interest payments. Twenty years of Monetary Inflation made sure that this would not happen. Inflation consumed most of his $3,000 principal and its interest payments' purchasing power by 1982.
So, interest rate changes are much more than variations of the return on principal; they also contain information on credit quality, inflation, and currency risks. As the bond market sees more risk, (credit, inflation and currency exchange), it demands a higher yield for a bond. As the bond market sees less risk, it demands a lower yield for a bond.
The chart below displays the yields for the US Treasury's 10 Year, and Moody's Aaa and Bbb grade corporate bonds. My source is the Federal Reserve; the data is Friday Closing Yields. The chart below displays a 47-year record of the Bond Market reaction to good times and bad.
For your information: bond yields and prices are inversely proportional to each other. The exact same relationship the DJIA has with its Dividend yield.
So rising yields are actually * Bear Markets * in the Bond Market, while falling yields are Bull Markets. Keep that in mind when studying the chart above. Bond Bull and Bear Markets, over the long term, run concurrent with the Stock Market's Bull and Bear Markets. This is to be expected as both Bonds & Stocks are financial assets, so both are sensitive to interest rate trends.
Note the orange oval on the extreme right of the above chart. Previous to the Sub-Prime Mortgage fiasco of 2007, the yields of these bonds may have varied from one to another, but the three yield trends were in agreement with each other. See how for 45-years, they all went up, or down together. However, note after August 2007's Sub-Prime Crisis, the trend in each bond category went its own way! I don't know exactly what this means. But with money issues, when decade-long patterns are broken, prudent people start moving towards the exits. I'm assuming that it's a precursor of bad things to come in the financial markets.
In past Bear Market Reports, I've made my case that Monetary Inflation has been a constant market factor since the creation of the Federal Reserve in 1913. I've shown that there are periods when Monetary Inflation flows into commodities, resulting in CPI Inflation, and other times it flows into financial assets, resulting in Financial Asset Bull Markets. The chart above fits well with this argument.
Let's look a little deeper into Yield Spreads. They are very simple; just subtract the lower grade (higher yield) bond's yield from that of the higher grade (lower yield) bond yield. The Table below shows a few examples from key points in my first chart.
The samples include good and bad times in the Financial Markets. But good times in the market may be bad times to invest in bonds, and bad times in the market may be the exact moment to jump in - head first.
The Credit Spreads of 05 March 1966 indicates a very happy bond market, the smallest spreads from 1962 to 2009. But if we review my first chart, we see that the next 15 years were a massive Bear Market in bonds, peaking in the week of 05 October 1981!
In 1981, US Treasury Bonds, and bonds in general, earned the moniker of "Certificates of Confiscation" by bond traders, and investors. And for good reason! As inflation ravaged the purchasing power of each individual dollar investors held in bonds, the Bond Market's rising interest rates reduced the number of dollars investors were holding in their portfolios. A Bear Market double whammy!
One thing investors must understand: on the whole, financial market commentary gives voice to the hopes and fears of Dumb Money when markets are at their extremes. And it's precisely at the market extremes where Bull Markets become Bears, and Bear Markets become Bulls.
But sometimes, the financial media gets it right. I believe it was H.J. Nelson who made a brilliant call in Barron's & the WSJ in October 1929, just weeks before the crash! I'm sure there are other prescient calls in the history of Dow Jones, but the public isn't always appreciative of the wisdom of financial advisors. Richard Russell, of the Dow Theory Letters, tells how some of his subscribers sent him insulting letters, after he made his brilliant call for the 1973-74 Bear Market bottom, in November of 1974.
But to make a real killing in a market, one has to buy really, really low. To do that, you have to act like one of Napoleon's soldiers, willing to run toward the sound of gunfire as everyone else flees for their financial lives. For social creatures like human beings, it's not easy running against the crowd. Buying long dated US T-Bonds, yielding 15% in October 1981, was one of the hardest, but brilliant, investments of the 20th Century. But 28 years ago, that is not what you would have read in the Financial Media.
With the 20/20 hindsight of history, and the data charted below, we see bonds weren't as risky as the traumatized bond sellers of 1981 thought. Fed Chairman Volcker raised short term interest rates substantially higher than long term T-Bonds. This stopped the credit expansion in its tracks. This also caused a lot of economic pain! Electrical Power Consumption fell by 4.12%.
Also, we see how in 1981 the yield on the US 10-Year Bond was higher than the annual rate of increase of both CPI and CinC. Since 1962, this was a first! These charts on the bond market may be something to remember in the years to come, assuming the US dollar survives.
The above chart is a mess, but it is what it is. The dashed oval to the right is very interesting. Currently we have negative CPI as CinC is near 10%! Since 1962, this is another annoying first that concerns me. CPI is political nonsense, so I ignore it. The 10% year-over-year gain in CinC is a solid indication of future Consumer Price Inflation (if not the government's CPI), as well as higher Bond Yields and lower Bond Prices. Include lower Stock Market too.
No one knows the future, but betting that the Yields on * all * US dollar Bonds will challenge the 1981's highs in the next 5-10 years seems to be one of those "Better than House-Odds" wagers.
Bond Yield Spread Charts
10-Year T-Bond & Moody's Aaa Corporate Bonds
Remember, the plots in my Yield Spreads are only the differences in the yields of higher-yielding (poorer quality) bonds from lower-yielding (higher quality) bonds. These plots do not indicate the actual yields. They only give the Bond Market's risk assessment on one Bond category compared to another. See my table above for these plots' construction.
In the chart below, the first items that jumps out are the 5 times, from 1966 to 1984, where the Bond Market gave high quality US Corporations a better credit rating than it gave the US Treasury during a Bear Market in Bonds! Every time the plot rises above the Green Dashed Line, Moody's Aaa Bonds had a lower yield (higher quality rating) than the 10-Year US T-Bond. This during a Bond Bear Market. In my table above, the first sample date of 07 March 1966 gives the exact yields for the first Red Arrow in the Below Chart.
That speaks of the quality of stewardship US Corporate Management had for their industries' financial health decades ago. But, beginning with Alan Greenspan's Fed Chairmanship (1987-2006), the Bond Market began downgrading Aaa Rated Corp Debt, as these large companies became as addicted to Dr. Greenspan's "Liquidity Injections", as was everyone else.
In the pages of Barron's, from the 1950-80s, Investment Banks would frequently have full page "Tombstone" ads for new issues of corporate bonds. $50,000,000 for a new factory or another capital good was the stated reason for increasing a company's balance sheet's debt-loading. A 100 million dollar deal was almost unheard of! These old Tombstone ads are now things of a forgotten past.
Instead, during the 1990s, all too frequently, we would watch, on CNBC an Investment Bank's analysis recommend a Blue Chip Company, like General Electric, as a buy on CNBC. Why? Because GE announced a debt offering in the Bond Market, with the intent of buying back its shares in the Stock Market. This ill-advised debt still litters the balance sheets of America's largest companies. Its effects in the Yield-Spread Chart above are still apparent.
The above Yield-Spread Plot tells the story of Greenspan's Bubble market well. Since 1989, the credit quality of Aaa Corporate Bonds has fallen significantly, as the spread to the US 10-Year T-Bond slid down between the two Dashed Red Lines.
Who taught this corporate malfeasance to a new generation of bankers and businessmen? I blame our Schools of Economics, which have lionized Greenspan, Bernanke and the Federal Reserve for the past 20 years.
10-Year T-Bond & Moody's Bbb Corporate Bonds
Below, note in 1966, the Bond Market gave Moody's Bbb rated Bonds an almost identical risk assessment as the US 10-Year Bond. That didn't last long. These companies were rated Bbb for a reason. By 1982, with Volcker strangling inflation with Double Digit Interest Rates, the spread expanded to 4%.
As people are discovering today, being in a deep recession, while carrying excessive debt, results in financial difficulties. In the following Boom Years, the spread tightened, which is to be expected. But starting in February of 1998 the plot breaks an established pattern, whose new trend, by 2002 would find Bbb Bond's spread at the old 1982 lows.
This data from the Bond Market proved to be a leading indictor of the 2000 High-Tech Crash.
We see an amazing recovery during the US Housing Bubble years. I'm not surprised. Moody's was rating these bonds Bbb, as it rated US Sub-Prime Mortgages Aaa. Using Moody's, and the other Bond Rating Companies' risk assessments, the Bond Market priced the bonds market accordingly, until the Sub-Prime Bubble cratered, taking these bonds down with them. They may have recovered nicely since January of this year, but I expect the improvement is mostly due to Washington's TARP and Stimulus Programs. I don't expect the current 3% spread to stand when the Bear returns. I expect new lows in this spread in the years to come.
Moody's Aaa & Bbb Corporate Bonds
After reviewing the first two spread charts, I've not much more to say about this one. But personally, I doubt the Bond Market's ability to preserve wealth in the next 10 years. Review my chart on the DJ's 10 Utility Bond Average above. Rising inflation and interest rates will be especially hard on the insurance industry and pension funds.
I've said in the past, that to make a real killing one has to be like Napoleon's soldiers and run towards the sound of gunfire. But what if, when you're reached the top of the hill, you see Godzilla running up the other side? There are some circumstances you just don't want to find yourself in! In my opinion, buying American Bonds at yields lower than 15% (the old record highs) is one of them. When US 10-Year Bonds are approaching a 20% yield, I'd take a look at them. CinC's rate of increase proved to be a key in the last Bond Bear Market; it just might be again.
Potential for Future Interest Rate Increases
From history, we know that the Bond Market is no place to be in when Washington's Politicians have great plans for a better future via "Progressive Legislation", and the Federal Reserve stands ready to finance Congress's delusional policies with inflation.
From 1962 to 1982, bond yields rose to levels thought impossible in the 1950s. But by the early 1980's, after two decades of fiscal and monetary excesses to finance President Johnson's "Great Society", the world was considering abandoning the US dollar as a reserve currency. We hear the same today! To defend the dollar 30 years ago, Fed Chairman Volcker allowed interest rates to rise to double digit levels, making the dollar once again attractive to foreign investors. It also resulted in a huge decrease in Electrical Power Consumption, as seen in Wk102 EP's BEV Chart.
The same excesses in fiscal and monetary "Policy" of the 1960s & 70s, are being repeated by Washington's "Policy Makers", but on an even grander scale. Analyzing this data is not science; rather it's a study of human nature. In the Age of Obama, we should ask ourselves: how much abuse will Global Holders of US Bonds take, before they begin speaking with foul 4-letter words like SELL? When they do start selling, I expect US bond yields to exceed their 1980s peak, by a wide margin. With Washington's commitment to borrow additional trillions in the bond market, and the Fed is bloating its balance sheet again, bonds will once again become known as "Certificates of Confiscation."
Doctor Bernanke promises to keep interest rates low, but he knows the day is coming when he will have to raise the Fed Funds and Discount Rates. For all the damage the "Policy Makers" have done to America's economy, and our financial standing, we should expect new record highs in the Fed Funds and Discount Rate, exceeding the 1981 record highs by a good margin.
So in Wk103 of the 2007-09 Bear Market, Doctor Bernanke dithers. To raise or not to raise US Interest Rates: that is the question.
His keeping Fed Funds and the Discount Rate at 55 year lows, as Congress goes on a spending spree with borrowed money, has caused the world to consider discontinuing the US dollar as a reserve currency. If he raises the Fed Funds and Discount Rate to levels sufficient to protect the US dollar's status as a reserve currency, as Chairman Volcker did from 1979-82, we will enter into the second Great Depression, with all US dollar interest rates go double digit. If he keeps short term rates at current levels, the dollar will at some point cease being an economic asset, and we risk entering into the first Greater Depression.
Our lives rest in the hands of these Ivy League Fools.
2 October 2009
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.
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