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The stock market’s turn down was confirmed last week, as Primary Wave 3 was finally
unleashed with a high volume break of the long-term uptrend line. The coming decline
should slice more than 50% off stock prices in the year ahead.
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After one of the lengthiest bear market rallies on record, from March 2009 to January 2010, the minor
trend now has reversed to be in accord with the major trend, which is down. For intelligent investors
who are willing to take action, the opportunities for profit have rarely been better – where taking action
means selling now – as opposed to holding and hoping.
The Dow’s 437 point smash in last week’s holiday‐shortened session erased almost 3 months of gains –
emphasizing a typical characteristic of the market – that stocks fall much faster than they rise. This is
not a “dip” or a buying opportunity, but instead the start of a tsunami which will take stocks below the
lows of 2009, as the bear market continues.
The third wave will last through most of 2010, and probably into 2011. As we approach the mid‐point of
the decline selling will vastly accelerate, as the “point of recognition” is reached – that is the point at
which investors realize that the underlying economic fundamentals are dire, and efforts are redoubled
to liquidate assets at any price in order to raise cash.
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A common objection cited to holding cash is the low nominal rate of return. But that very low rate, near
0% today, reflects the very low risk in cash. Furthermore, the value of cash actually rises in a
deflationary environment like that of today, as assets of every nature depreciate. For example, if you
were to sell your house today for $500,000, and buy it back in three years for $250,000, your cash will
have doubled in relative terms. In the coming deflationary depression, the same argument will apply to
all assets, whether it’s your house, stock portfolio, art collection or yacht.
The Canadian dollar took it on the chin with a 2½ cent drop as the latest statistics confirmed that
inflation is quiet. Gold tumbled below $1100 and is on track to break $700. The price of copper topped
at $3.54 seven trading days before the top in the S&P 500 and should drop substantially with stock
prices – ultimately copper should break below $1.25.
The US Dollar Index is in full rally mode and should easily surpass its 2009 high of 89.62 (currently at
78.27). Global investors of all stripes will be seeking a safe haven in greenbacks as defaults multiply and
the world deflates. The Euro is under liquidation, as are the commodity‐linked currencies such as the
Aussie and Canadian dollars.
Cash is king, especially US cash, but make sure your deposits are guaranteed. That rules out most
money market funds containing corporate or municipal paper which are not immune to default.
Treasury Bills and government guaranteed deposits are best.
Speculators may wish to hold longer bonds to benefit from expected lower yields in the years ahead –
this is at direct odds with the consensus view that inflation is about to surge, causing interest rates to
rise by 2 percentage points or more. That view is based on the premise that printing money will stoke
inflation – but printing money alone is not sufficient to ignite the inflation cycle – it is also necessary for
banks to lend and for consumers to borrow, each of which has been unwilling to do so.
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Perhaps the biggest obstacle to inflation is today’s gargantuan level of debt in the US – about $3.70 1 for
every dollar of GDP. Like every previous bubble in history, the recent one will demand that the piper be
paid. We are looking at several tough years to deflate the debt, whether it’s paid down or, in many
cases, eliminated through default. Unfortunately the government’s idea of a solution through wild
spending and tax increases is exacerbating the problem.
Japan is a contemporary case in point, where billions of yen have been spent to prop up their crumbling
financial institutions, which are now disparagingly but accurately known as “zombie” banks. For all their
furious yen‐printing, their economy is stagnant, the stock market remains 75% below its peak of 20
years ago, and their debt has exploded to almost 200% of GDP. The ravages of a 20‐year deflation have
depressed Japan’s interest rates to historically low levels: Treasury Bills earn 0.1% and 10‐year bonds
are yielding 1.325%.
30‐year US Treasury bonds today are yielding 4.51%, and stand to gain considerably if yields fall to
Japan‐like levels. A one‐percentage point decline in yield gives a price gain of about 18% ‐ and you
collect a coupon while you wait. Two notes of caution however: If yields rise, then bond prices will fall
just as quickly. And anything other than the highest quality sovereign debt should be avoided. Do not
be tempted by the higher yields of corporate bonds – their yields may well rise as Treasury yields
decline, reflecting their risk of default.
©2010 Kim Husebye, CFA, CMT
www.kimhusebye.com
Any and all mention of stocks or other securities should not be construed as any kind of investment recommendation or advice. Consult with your own advisor
before making any investment decisions.
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Hoisington Investment Management, Quarterly Review and Outlook, 4th Quarter 2009
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