This is from a newletter that I get ....this 83 yr old guy is spot on most of the time. (I deleted all of his graphs)
THE DEFLATION BATTLE — Question — Russell, let’s get serious. What do you think “your” bear market signal means?
Answer — I note you call it “your” bear market signal. I assume you put it that way because there’s so much disagreement as to whether it was a bear market signal, or whether the Dow Theory still works at all. So, yes, I believe the Dow Theory still works. And yes, I believe we received a real, bona fide Dow Theory bear signal. And no, the signal wasn’t “my” signal. The signal was the stock market’s signal — I merely identified it.
And in answer to your question — “What does the bear market signal mean or what does it portend?” I want to make my answer clear and simple. I believe the bear market signal portends deflation.
Almost every sector that I examine or study is overpriced — from the US stock market selling at over 18 times earnings to the Shanghai stock market selling at a ridiculous 55 times earnings. Housing is overpriced, commercial real estate is overpriced, land almost everywhere is overpriced, stocks everywhere are overpriced, most currencies are overpriced. You name it today, and it’s probably overpriced.
I believe that the bear market signal is telling us that the great unwinding has arrived. I think we are on the edge, the very edge, of international deflation. Prices of everything will be coming back to earth. It’s going to be a long, slow process. And obviously it’s going to be a painful process. The world’s “punch bowl” has sprung a leak. No, worse than that, the punch bowl is broken.
Question — Russell, if what you say is true, where’s the island of safety?
Answer — This is the question that bothers me more than any other. It bothers me because, honestly, I don’t have the answer. And I don’t know if there is a definitive answer.
Question — No answer? That’s very discouraging — and scary. Then what do you think will happen next?
Answer — I believe it’s already dawned on the Fed and probably central banks around the world that deflation has begun to show its ugly face. The central banks are very afraid of deflation. Their answer to deflation is, and will be, to lower interest rates and try to reliquefy their economies. This will entail stepping up the creation of fiat money. There is no limit to the sheer amount of paper that the central banks can create, and as deflation increases its grip on the economies of the world, I expect a virtual blizzard of fiat currencies to be created.
The forces of deflation will not be defeated any more than a primary bear market can be “reversed.” The increasing flood of paper will, however, diminish the purchasing power of the various currencies. This will result in the paper cost of gold rising. The more fiat paper being created, the more paper will be required to buy an ounce of gold. Thus, what will really be happening is that gold will remain the centerpiece as it always has been, and the value of fiat paper will decline in terms of gold.
Question — Are you saying that once the deflation process starts, it will be unstoppable?
Answer — Yes, deflation will run its course just as every bear market in history has run its course. Bear markets end in exhaustion, and this one will be no different. But the cost of fighting deflation in terms of the creation of fiat currency will be huge.
Question — Russell, again I ask, if your deflation scenario is correct, where do we hide?
Answer — My best answer is that we diversify into “real things.” And most important, we avoid debt, since debt is a merciless killer in deflationary times. Here are a few items that we can diversify into during the bear market ahead. A home free and clear. Gold not on margin. A business that can make a profit during deflation. Diamonds bought at the right price. Conservative positions in top-grade utility stocks. And cash. Why cash? Because you need cash to pay bills, and cash will buy you tangibles.
Question — What about gold stocks or GDX?
Answer — Since 1999 gold shares have enjoyed a phenomenal rise. The initial phase of that rise is over. Gold stocks will move again when gold really takes off on the upside, and that will be (my guess) when gold rises over 900. Thus, gold stocks are only for those who have long horizons. Gold shares are a leveraged bet on the future of gold “going through the roof.” If you own gold shares, you have to shut your eyes and just hold them for a future explosion. At present, as we’ve seen recently, gold stocks tend to move with the broader stock market.
Question — Russell, I know that every bear market presents specific problems. What problems do you see in this bear market?
Answer — The first is that I believe deflation and destruction of debt through bankruptcy lies ahead. The world is inflated and choking on debt. Debt and inflation will be attacked in this bear market.
The second problem is the currency, the dollar in our case. During the great deflation of the 1930s, nobody ever questioned the value of the dollar. The dollar was considered “as good as gold.” The dollar was the island of safety. The only problem was that nobody had dollars. Believe me, I remember those days well.
Today the world doesn’t trust the dollar. The dollar is our currency and the world’s problem. Thus, the dollar is no longer the island of safety. Ultimately, I believe, gold will be seen as the island of safety and perhaps certified gem quality diamonds as well.
On to the Stock Market — Many years ago I observed that when bonds and utilities both move in the same direction — either up or down — these two exert a persistent pressure on the market to move in the same direction.
Yes, I know, there are a lot of mixed forecasts regarding the US economy. It’s almost as if the bull and the bear camps are evenly split, which is the reason for the current erratic, high-volatility action. That sounds reasonable, but there’s another phenomenon that’s now taking place. You see it on the these two daily charts.
The Dow is down over 1400 points from its October high. A slew of stocks have been hit and hit hard. A lot of stock sectors and indices have violated their August lows. But still, there’s a strange counter-force that seems to be at work. I can sense it. I can feel it. And the two charts below reveal the secret of that counter-force.
The first chart, of course, is the bellwether 10 year T-note. Here we see the action of this widely-followed note over the last six months. The direction has been, and is — up.
Matching the action (and few have noticed this) is the D-J Utility Average. Yes, as most of the rest of the market has been declining, the Utility Average has been working its way higher. What we see here is unusual, but unusual or not, it’s been happening. It amounts to a strong counter-trend pressure within the bear trend. The result — confusing action, conflicting action, deceptive action.
The counter-trend action of the bonds and the utilities provides us with an opportunity to lighten our positions in common stocks. Which is what I suggest. Right now the stock market is at cross-purposes. I see it in my PTI studies, I see it in the action of the stock averages, I see it in the Lowry’s figures, I see it in the Fed’s confusion.
WHERE ARE WE? — One advantage of P&F charts is that they simplify the picture. And if a market picture ever needed simplifying, it’s this one. Above we see a P&F chart of the broad Wilshire 5000, an index which takes in almost all the common stocks in the US.
First, note that all the current action is taking place below the bearish trendline. Next, note that the formation on the chart looks very much like a giant head-and-shoulders top formation. But let’s be coldly analytical about this. The most recent action turned the Wilshire short-term bullish when the most recent green column bettered the preceding column of Xs at the 14750 box.
A further bullish confirmation would result if the Wilshire can rally above the 15050 box to the 15100 box. So why guess, why grind our teeth in frustration? If the trend is changing in any important way, we’ll see it as the Wilshire makes its way up to the 15100 box. Meanwhile, all the action continues to take place below the declining trendline.
Conversely, if this is truly a bear market, the Wilshire, in its own good time, will break down to the 14200 box. In the meantime, let’s try not to do anything stupid. It is well to remember that rallies in bear markets (aided by short covering) can be sudden and violent and often appear more convincing then the real thing. I continue to think that what we saw early this week is simply a rally in a bear market.
The chart below shows the percentage of NYSE that are holding above their 50-day moving average. As you can see, this week’s rally took the percentage to 29.9%, which means not even one-third of the stocks on the NYSE were above their 50-day moving averages. This big stock average surged on Tuesday and Wednesday, but the bulk of stocks on the NYSE are still “under water.”
The chart above shows the Dow in terms of percentage moves — each box equals one percent. What we see here looks like a potential top, but the real proof of a top, I believe, would require the percentage to sink to the 12516 box and then break below the rising blue trendline. So far, this has not happened.
COMMENTS — Do seasonals mean anything in the market? I guess we’re going to find out. We’ve now moved into the “good” six months period for the market — these are the months of November through April. And we’re now just a month away for a “good” year in the decennial pattern, which is a year ending in “8”. I have a special feeling for the “8 years” since I started Dow Theory Letters in the year 1958.
