The Bear Gains His Grip - On Everything. Again!

The trend is your friend

But it's still a bear market

So the trend is down!

Closing in on the 200-Day Moving Average

Last week, I mused that I thought the markets had turned down, but that we'd need to respect the moving average before being 100% sure.

We're not there yet...but we're gaining ground fast:

The S&P looks destined for a date with its 200-day SMA.

Note that the moving average is very good at catching the meat of a move, but is not good at catching turning points.

For example, if you'd have been waiting for the upward break through to get long in 2009, you'd have missed nearly 300 points of the S&P's move up.

Still, you'd be sitting on profits right now, and, perhaps more importantly, you'd have a stop-loss waiting for you that would lock them in.

The markets are oversold right now, but during bear markets, that condition can occur for quite some time.

We'll try to identify a couple of things in particular in the weeks ahead, namely:

1. When the markets have definitively resumed their downtrend, and
2. Identifying appropriate moments to add to short positions

Another Good Short: The Euro

As crazy as the US indices look at these levels, it's hard to see anything attractive about the Euro at these levels.

Fundamentally, it's quite overvalued when compared with the Dollar. It appears to be at the start of a major downtrend, in perfect accordance with the markets throwing up all over themselves.

AND, with the Dollar continuing it's ascent, the Euro looks poised to get trashed in a big way. As big of a mess the US is, Europe is arguably an even bigger basket case. The Euro could easily revisit parity with the dollar at the end of this move.

Bearish Venture Capitalists

On Thursday night I attended a technology startup discussion, featuring three Bay Area venture capitalists on the panel. It was a very good lineup, with one guy in particular that I enjoyed and seemed to identify with (perhaps it was his "get out of our way, government" mantra).

He brought up an interesting point that many stimulus funds will dry up by the end of Q1, at which point the next shoe could drop. I thought that'd be a perfect fundamental backdrop against the technical warnings we're seeing right now.

You know the math - the markets turn down, and then the fundamentals reflect the technicals. Pundits will say that the market is a "forward looking mechanism", hence it discounts improving or deteriorating fundamentals 3-6 months ahead of time.

Personally I find that to be bogus business school logic, as I prefer to think that rising asset prices eventually are reflected in rising fundamentals, which is a more logical sequence of cause and effect than the crystal ball theory.

In any case, with markets starting to circle the bowl, the evaporation of stimulus money in 3-6 months would be the perfect fundamental "reason" for another downturn, that appears to be starting right now.

Not Good When Stocks Drop After Good "News"

Good friend Brian Hunt has been on the Intel beat for the past 16 months - he's been using INTC's stock price (quite successfully) as a leading indicator of where we're heading.

On Tuesday he pointed out in his Market Notes that the "short term circle is now complete." Last April, Intel reported bad news, and the stock shot upwards. Last week, Intel reported great news, and the stock was subsequently hammered.

Interestingly the business fundamentals look great at Intel - perhaps another justification that the fundamentals are often the last ones to go.

Anyway the INTC worm appears to have turned, which is another foreboding short-term sign.

China Starts to Slam on the Breaks

We've wondered before how the global economy would fair if China, the posterchild of world economic activity, faltered.

Quietly, Chinese markets peaked last October. And now, the government is trying to tap the brakes on this economy.

I don't see how this can end well, at least in the short-term. And the folks at Stratfor are raising the same questions:

Fine Dining Turned Cafeteria Comfort Food

Think good times are back? Think again.

Granted my hometown of Sacramento will never be confused with San Francisco or Manhattan, but it does boast a small but impressive lineup of fine dining.

That lineup will soon be reduced by one, as the owner of Mason's New American Restaurant has (wisely, I believe) decided to trade in the silver spoons for Sloppy Joe's.

As this depression unfolds, I'll bet we'll see more fine dining establishments rebrand themselves as cafeteria-type establishments...hopefully without the tasteless steamed vegetables.

Because that's how things roll, here in Lunch Lady Land:

Watch adam sandler lunch lady land in Comedy | View More Free Videos Online at Veoh.com

My Trading Activity - Still Short the S&P

Still looking good on the short S&P trade. This position looks like a keeper.

Short the S&P - this time it's working out, so far.

Would love to add to this, but I'm still not 100% convinced that this turn down is The Big One. I think it is, but am waiting for a breach of the 200-day SMA as the "oh shit" point.

Shorting the Euro, and alternatively going long the Dollar, would also appear to be good trades. They are "all the same trade", after all!

Have a great week in the markets! Comments are always welcome and very much appreciated.

The Market's New Trend: Down?

Fear - have you returned?

The markets forgot 'bout you

Have we hell to pay?

NFL: Both Public Teams Cover

I'm a day late publishing the weekly update this week, partially thanks to the NFL conference championship games. I normally write on Sundays, but instead devoted yesterday to three great American pastimes - gambling, drinking beer, and watching football.

Of note to us speculators, the Colts and Vikings both received a slight edge in public betting percentage (usually a slight contrary indicator in sports betting) - and both teams covered their respective spreads. (The Vikings lost the game, but they were winners in my +3.5 book).

The Market's New Trend: Down?

Has the trend of the market (finally) changed from up to down? We got fooled in November, so I'm hesitant to call a downturn until we see a break of the 200-day moving average to the downside.

We're not there yet, but there are some signs that this could be a resumption of the bear market - a lot of people forgot that we are in a secular bear market - which is exactly what bear market rallies are supposed to do.

At risk of speaking for the rally, I believe it's accomplished everything it could have hoped to do back in March - it's rallied for almost a full year, retracing over 50% of previous losses, and has convinced many "experts" that the worst is behind us.

It'd be a perfect time for the S&P to start a violent drop below it's previous March lows.

Gotta Respect the Simple Moving Average

The red line below represents the 200-day Simple Moving Average of the S&P 500. As you can see, if you'd have simply been long stocks when they are trading above their 200-day moving average, you'd have been in good shape.

And conversely, you'd want to have been out of stocks, or even short, when they are trading below the 200-day SMA.

The S&P is still comfortably perched above it's 200-day SMA - for now.

(Source: Google Finance)

This indicator actually works quite well for most asset classes, and even individual stocks. Here's a neat write up that DailyWealth did on this in the context of Mebane Faber's "Ivy League Portfolio" a few months back.

Bottom line: A downturn may have started, but if you want to be safe, wait for a decisive break of the 200-day SMA.

In Case You Missed Them - Recent Blog Highlights

• James Altucher of Formula Capital calls the American Dream of home ownership a complete scam. Renters, you'll love this one.

• China is flushing the economic turd that is the rest of the world right down the toilet. Few notice that China's rally peaked in August of 2009.

• Finally, you know we're screwed when Fidelity.com is looking for Joe Sixpack's to interview about the end of the financial crisis.

My Trading Activity - Short the S&P

So far so good on the S&P trade, as it fell hard and fast last week. Friday, granted, was on low volume. The push back up today was meager.

Short the S&P - this time it's working out, so far.

Playing devil's advocate, every market correction thus far has been fairly shallow - about 5%. We're in that range now. So if the uptrend is still in place, we'd expect to see a resumption upwards about here.

So I am not in a hurry to add to this short position yet - I'd prefer to see a breach of lower levels, and a confirmation of a downtrend in place. I expect the markets to fall at least 50% from these levels, so I'm not in a particular hurry to get short.

Have a great week in the markets! Comments are always welcome and very much appreciated.

Why Housing and the American Dream are Complete Scams

Fellow renters, you'll love this clip.

James Altucher of Formula Capital rants about the scam that is home ownership in America.

As a renter myself (a renter in California, no less!), I ate this clip up. I still remember feeling REALLY dumb in '03-'05 when everyone was buying property that "never went down" - at least not in Northern California.

Now with unofficial unemployment in Sacramento County pushing 17%, and home prices off their peaks by 50%, the common wisdom has changed a bit!

Still, I don't think we've hit bottom - not as long as we're still in the early stages of a Depression. I'm only interested in buying property if it's for $0.10 or $0.20 on the dollar - which I think there's a chance we could see, if we get the complete fallout that Bob Prechter & Co are calling for.

Further recommended reading:

• An idiotic explanation of inflation from a dumbass real estate agent
• Five contrarian real estate indicators from the same superstar

Inflation and Deflation - What to Consider, and What Indicates We're Wrong?

Stumped about the inflation/deflation debate? Good news - you're not alone!

Hard Asset Investor's Brad Zigler is also somewhat undecided on the subject. Though he leans toward inflation, he acknowledges that very strong deflationary forces are also in play.

Though you know that I'm one of the lonely souls in the deflationary camp (along with many readers!), I also am not 100% sure of which way things are going to unfold.

But that's OK - that's why we follow the trend! Ultimately, the market will be the final arbiter of this debate, and there's nothing we can argue today that will change what the market is going to do.

So, grab your position, but by all means, be flexible and ready to change if we're proven wrong. Personally, I'm watching the stock market, and the dollar...especially the dollar. If it takes out it's old lows, that would indicate a serious flaw in our dollar rally/stock tanking scenario.

That looks unlikely right now, though, as the dollar looks to be at the start of a major rally.

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View the full UUP chart at Wikinvest

Why Doug Casey Sees Market Crash, General Electric Bankruptcy Likely

Doug Casey was a little bit early on his impending disaster call - like a decade or two - but he seems to be on the beat of this unfolding economic disaster right now.

To Doug's credit, Crisis Investing for the Rest of the 90's is a fantastic read, even though the title is not exactly one that stood the test of time! In fact I avoided reading it for awhile because I mistakenly thought it wouldn't be relevant. That was a big mistake - it was one of the best investment books I've ever read.

I am a longtime subscriber and affiliate of Casey Research, so I may be a bit biased, but I devour everything I read from Doug. Enjoy this interview, as he elaborates on the unfolding of what he deems The Greater Depression...

***

Doug Casey: "Stock Market Set to Crash"

(Interviewed by Louis James, Editor, International Speculator)

L: So, what's on your mind this week, Doug? I understand you've had a "guru moment"…

Doug: Well, it's nothing but a gut feeling, but I think the stock market is riding for a big fall this year.

Everyone was afraid the world was going to come to an end a year ago, and it almost did. But governments all around the world stepped in and printed up trillions of their various currency units – it's not just the United States. And still, retail price inflation hasn't blossomed. It seems that governments are bent on keeping asset prices up to avert panic. They focus on controlling perception instead of fixing the problem. It stems from an economic version of the theory that all we need to fear is fear itself. As long as we have the right psychology, everything is going to be okay – total nonsense.

L: That old saw: as long as there's confidence, all is well.

Doug: Yes. It's the Wile E. Coyote theory of economics. As long as you never look down after running off a cliff chasing the roadrunner, you can keep treading air. Unfortunately, although the power of positive thinking may help in many ways, it's of zero use if you continue living above your means and making stupid decisions.

L: Insolvency doesn't seem to matter; as long as everyone has confidence that things will keep going, the experts believe they will. But in the real world, you can't remain insolvent for long, even if "you" are the United States as a whole society.

Doug: Exactly. My thinking about the stock market is this: corporations have done as "well" as they have mainly by cutting expenses. Laying people off, that sort of thing. So the bottom lines have not fallen as far as we might expect – but the top line has been hit. Revenues are falling for corporations across the board.

L: And the market has to notice this reality sooner or later.

Doug: Yes. The world's financial system has to adjust to a new reality, one with lower levels of consumption and differing types of production. The legions of unemployed are not going to go back to work anytime soon, at least not doing anything like what they were doing before the bubble burst. The economy is going to continue deleveraging. There's going to be less debt to allow the purchase of all this stuff people have been buying, resulting in lower corporate earnings. So it's hard to see revenues doing anything but continue to spiral downwards for years to come.

And then there are financial "accidents" waiting to happen.

L: Like the bank failures the government has admitted it expects this year? The FDIC says there will be more bank failures in 2010 than in 2009, with the spin being that 2010 will be the peak of the crisis.

Doug: Sure. But I also expect corporate bond failures. And there are other things out there. As Porter Stansberry (whose style as an analyst I really like) has pointed out, General Electric – which is really just a hedge fund disguised as an industrial concern at this point – is leveraged thirty to one. It's a dead man walking. It's the next AIG. When something like that happens, it really shakes Wall Street to its foundations.

So, I've been bearish on general equities for years, based on fundamentals. Whether they go up is no longer a reflection of prosperity – it's a reflection of how much money the government creates and where it goes. But I am feeling particularly strongly bearish on Wall Street right now. That's my gut. The social mood of the country is going to turn ugly and gloomy; people won't want to call their brokers and "get into the market."

The Greater Depression is going to be really serious. I can't see buying stocks until dividend yields are in the 6-12% range. And people have forgotten the market even exists. Anyway, Baby Boomers, who own most stocks directly and indirectly, are going to be selling them to support themselves in retirement.

L: Would you recommend shorting GE?

Doug: It should be an easy bet, but the government is certain to try to prop it up, as it has other dinosaurs pursuing business models that no longer work, like General Motors – although it didn't help their shareholders. "Too big to fail." That makes shorting riskier. But GE still has a $179 billion market cap, so it should fall quite a bit from here, if not all the way to zero.

L: No way out for the stock market?

Doug: Well, the government has been suppressing interest rates for a long time now, which is exactly the opposite of what they should be doing. These artificially low interest rates discourage people from saving and encourage them to gamble, hoping to outrun inflation. But eventually the market will force interest rates to go higher, and that will kill the stock market, because the stock market does tend to fluctuate inversely with interest rates. High interest rates almost always mean a low stock market, and low interest rates tend to mean a high stock market. So it seems to me that there simply is no good news on the economic front. Interest rates are headed way up, both out of a need for capital and as a reflection of the high price inflation ahead.

L: This doesn't sound like a guru moment – a flash of the famous Casey inspiration. This sounds more like a well-reasoned argument to me.

Doug: Well, when you get a really strong gut feeling, it's usually because you intuit many things that are out there, subconsciously if not analytically. Look, dividends are dropping across the board. Top line earnings are dropping. Where net earnings have been maintained, it's been by expense cutting.

L: Even if margins are maintained, the companies are getting smaller, and people are making less money, on the whole.

Doug: Right. And interest rates are at all-time lows. That's the short sale of the decade, if you want to short something. Bet against bonds. And there's more.

[Doug Casey is one of the few investment visionaries whose forecasts have been spot-on. Don’t miss what Doug predicts for 2010 – to read the rest of this FREE interview, sign up here.]

China Flushes, The Rest of the World Begins its Financial Swirl to the Bottom

Regular readers are aware that we've been watching the Chinese market as a potential leading indicator for US equity markets for some time.

Our astute readers aside, of course, the average financial slob (or pundit, if you will) seems unaware that the Shanghai Composite topped way back in August. When I posted this chart and question about the strength of the Chinese markets just after New Year's, I was greeted with a host of comical comments on Seeking Alpha's syndication of the article (which is typical).

"Wait - isn't that a quadruple candlestick, poised for a jump to the upside?!"

To be honest - I had no clue. And still don't. But I can see that China has still not taken out its October highs.

With that, I was pleased (and not surprised) today to see that The Daily Reckoning is also on the beat of China as a leading indicator. Eric Fry writes:

Taking a slightly longer time frame into consideration, the Dow is zero for the last eight trading days…and not very far from zero for 2010. Most European markets are in negative territory for the New Year, as is the Chinese stock market.

So what gives? Do these disappointing performances point to a bad moon on the rise? Is the great big rally that ignited last March about to extinguish itself?

“Probably,” is the answer provided by Jay Shartsis, Director of Options Trading at R. F. Lafferty in New York.

Jay begins his bearish analysis by pointing out that the world-leading Chinese stock market is now leading to the downside. “The important emerging markets of China , Russia and Brazil have topped out already and have been trending lower,” he observes. “They have leading tendencies to our market, having bottomed out before ours did last March. The chart below shows that Chinese stocks (as represented by FXI, an ETF that holds Chinese stocks) [have] traced out a head and shoulder top, and is now rolling over to the downside.”

With China breaking down, global markets may not be far behind.

Ed. note: If you're not a regular reader of the Daily Reckoning, I'd highly recommend you peruse their site here.

Also, regular DR and Agora readers may enjoy a review we posted a few months ago of Financial Reckoning Day Fallout.

We're Officially Screwed - Fidelity.com Doing Stories on End of Financial Crisis

Speaking of contrarian investment indicators, they don't get much better than this.

Fidelity.com posted a listing in a prominent public relations newsletter today:

Summary: Buying stocks again?
Name: Chris Taylor (Fidelity.com)
Category: Business and Finance
Email: query-100@helpareporter.com
Media Outlet: Fidelity.com
Deadline: 07:00 PM EST - 20 January
Query: Looking for investors who are shifting some of their cash holdings back into stocks and bonds, now that the financial crisis has ebbed.

That last line says it all. Get ready for the next shoe to drop, baby!

Lowest Levels of Bearishness in 22 Years Indicate Downturn May Be Imminent

Regular readers know that I'm a big fan of Bob Prechter's investment analysis. One of my favorite aspects of his work is the use of sentiment indicators as a market timing mechanism - that is, when everyone is bearish, you should be greedy, and when everyone is bullish, you should run for the hills.

In this guest piece, Prechter's colleague Nico Isaac analyzes current investor sentiment...read on, and think about whether you should hop on the investment train leaving the station, or run for the hills!

***

New Year: New Economic Boom? Why 2010 Should Be One to Remember
January 19, 2010

Elliott Wave International's latest free report puts 2010 into perspective like no other. The Most Important Investment Report You'll Read in 2010 is a must-read for all independent-minded investors. The 13-page report is available for free download now. Learn more here.

By Nico Isaac

In the realm of market psychology, there's a big difference between optimism and extreme optimism. The first is seeing the glass half full. The second is seeing the glass half full deep in the heart of a bone-dry desert. In finance, it's what we call "Buying the Dip" mentality -- when all outcomes, even losses, are cause for celebration.

We are there now.

To wit: With a new year upon us, the mainstream has already come up with a fresh tagline to define the next 360-or so days. It even rhymes: The Bull Runs Again In 2010. This projection is in no way "in spite of" the fact that the U.S. stock market just finished its first decade of negative returns since the Great Depression; it's because of that fact.

See, according to the mainstream experts, this "Lost Decade" of abysmal stock performance (in which the Dow ended 9% in the red, the S&P 500 - 24%, and the NASDAQ Composite - 44%) is the very foundation on which a new bull market will apparently be born. One economic scholar recently coined the phenomenon the "Slingshot Effect" -- the more severe the downturn, the faster the recovery. (Associated Press)

Adding to the upbeat chorus are these recent news items:

"The horrible decade has wiped out all the excesses of the previous two decades and put us back on track for more normal returns." (USA Today) -- AND -- "It may be the best of all possible worlds." (Business News)

Back in the late 1990s, when the "unstoppable" NASDAQ began to experience regular days of double-digit drops, it was "Buy-the-Dip." Now, it's "buy the entire lost decade." And, as the Dec.31, 2009 Elliott Wave Financial Forecast Short Term Update reveals -- current sentiment readings "continue to show that stock market bears have packed up and moved to Florida for the winter."

The Dec. 31 Short Term Update also reveals two mind-blowing charts of the S&P 500 versus Investor Intelligence Advisors Survey Percentage of Bears -- AND, the S&P 500 versus the percentage of "Fully Committed" bullish advisors since 2000. The current reading is the lowest bearish percentage in 22 years.

Take one look at the evidence, and you'll see that a defining pattern emerges: Low levels of bearishness have consistently coincided with one kind of market move. Combine this picture with the other measures of investor sentiment like momentum, volume and Elliott wave structure, and the evidence tilts overwhelmingly in favor of an unforgettable year.

Elliott Wave International's latest free report puts 2010 into perspective like no other. The Most Important Investment Report You'll Read in 2010 is a must-read for all independent-minded investors. The 13-page report is available for free download now. Learn more here.

Nico Isaac writes for Elliott Wave International, a market forecasting and technical analysis firm.

Ed. note: I am both a subscriber and affiliate of Elliott Wave International, and highly recommend their work.

This Chart Says It All - US Household Continues Deleveraging at Record Pace

US households continue to shed debt at a record pace - this graph says it all...

US households are finally "just saying no" to debt.

To put this breakdown in perspective - the Fed's data on this goes back to 1976, and household debt grew every single year until 2009.

In fact, we're looking at two straight years of deleveraging in terms of both mortgage debt and consumer credit - another record.

Yikes!

Hat tip to friend and reader Carson for the tip on this data.

Related reading: Are Deflationist Arguments Still On Track?

Are Deflationist Arguments Still On Track? A Checkpoint in the Debate

Whither deflation...

Chased away by reflation?

Or eye of the storm?

Revisiting the Deflationist Arguments of 2009

Earlier this week I revisited two of my favorite inflation/deflation interviews of 2009, both courtesy of Jim Puplava at the Financial Sense Newshour. Being sympathetic to the deflationist arguments, I was interested in seeing if their forecasts were still on track, despite the relentlessness of the reflation trade.

Puplava's interview with Bob Prechter was a classic. Prechter argues that the Fed cannot do anything to stop the powers of deflation, because most of the outstanding debt in the world is going to go unpaid. And that deleveraging process will occur faster than the fed can reflate the system.

In the September interview, Prechter correctly forecasted gold's late year push, while expressing his belief that 2010 will be a banner year for deflation. In terms of timing, his thesis is still on track...he thought the shoe would drop late last year, or early this year.

As a subscriber and affiliate of his, it's clear to me that he believes a turndown is imminent, as he's aggressively laying his reputation out there right now, basically calling the top right here, right now.

In summary, the winner of the Puplava/Prechter inflation/deflation debate is still too early to call, though I anticipate the next few months will tip the scales one way or the other. I love Prechter's bravado in trying to cement his legacy - we'll see if it pays off for him!

Demographer Harry Dent was then interviewed by Puplava in October, where he shared his demographic research, and what he thought that meant for the financial markets. Dent made an extremely prescient call on gold, which was trading around $1,000 at the time of the interview. He said it'd be the last market to roll over, and that it could go quite high - even above $1,200.

When asked what could disprove his thesis, Dent mentioned the timing of the markets topping - he expects them to tank in the 1st half of 2010. If things are still humming midway through the year, Dent said he would need to re-examine their hypothesis, to see what they were missing.

So thus far from Dent's side, things are also still inconclusive, but so far roughly mapping to his forecast from a few months ago.

Revisiting these two interviews was an instructive exercise. Because us market junkies follow things every day, and every week, it's easy for us to grow impatient when things don't turn our way quickly. And that's often a big mistake, as you can go from being early, to being wrong, if you give up too early on a position.

So in summary, if you are a deflationist, as I am, I don't yet see anything that doesn't jive with the deflationist argument. Let's hold tight, and see what the next month or two has in store for us. Nothing has been proven yet, either way.

But Aren't We Missing Something?

Both sides of the inflation/deflation debate love to argue that the other side is missing one or more critical points.

I try to read as many opposing points of view as I can, to balance my thinking, though I have to admit that I find many inflation arguments to be a bit too simplistic.

But I just posted a solid guest inflation article today from Casey Research's David Galland, appropriately titled What the Deflationists are Missing - and while I am a subscriber of David's and think the world of his analysis, I thought it'd be fun to raise some counterpoints on "what we're missing".

While I don't fully agree with all of David's points, all of my counterpoints are merely academic at this point as well. As usual, the markets will be the final arbiter of who's right, and who's wrong!

So here are some excerpts from David's piece in italics, with my deflationary counterpoints beneath:

Galland writes: For starters, there is already a massive inflation operation being run by the Fed, evidenced in a historic spike in the monetary base over the last two years.

Yes, true, the Fed has increased the monetary base by a trillion or two over the last two years. BUT, a larger amount of credit was destroyed during the last market crash - 10 or 15 trillion dollars worth, depending on the source.

In that light, the Fed appears relatively powerless in their efforts to goose the money supply. It just can't print fast enough when credit is being destroyed at a breakneck clip.

If you believe the global economy has stabilized, then perhaps the inflation argument holds water. But I think the real doom and gloom is yet to come, and that we've only seen the tip of the iceberg in terms of credit destruction!

In a deflation, the value of the money increases – which is actually a pretty desirable thing, if you ask me. Inflation, by contrast, means that pretty much everything you own in the local currency steadily loses value – forcing investors into a perpetual game of catch-up. It’s hard for me to calculate how the government can dramatically increase the money supply and yet have each of the currency units become increasingly more valuable over a sustained period of time.

Arguing against that point, Evans-Pritchard makes the case that the U.S. government is making much the same mistakes that were made in the first part of the Great Depression, i.e., being overly tight with the money. And that the velocity of money is falling.

There are a couple of key differences between now and then, however. First, the Fed didn’t actually know what the money supply was back then. They literally had no monitoring tools in place, mostly because no one thought it was important enough to track. Second, they didn’t have fiat monetary powers. Today, neither of those factors apply.

During the Great Depression, FDR was able to devalue the dollar overnight by 50% by confiscating gold, and resetting it's price in dollars. This is not possible now, precisely because we have a fiat monetary system. The value of the US dollar is determined by the market everyday.

So while the Fed does have fiat monetary powers, and the theoretical ability to put as many dollars into circulation as it would like to, it is merely pushing on a string, because we have a credit based monetary system. Creating a trillion or two dollars out of thin air is not net inflationary when credit is being destroyed at a faster rate.

In fact, if the Fed swapped out all credit outstanding today, that wouldn't even be net inflationary...it would be a break-even.

The Fed will eventually have the ability to inflate, but only after most of the outstanding credit has been destroyed. At that point, the Fed may not even exist - but that's a speculation for another day.

There is something else that I think the deflationists are missing, and that has to do with confidence in the currency. If the U.S.’s many creditors come to agree with our point of view – that the dollar is being led to the altar as a sacrificial lamb to political expediency – then they’ll further reduce their purchases of our Treasuries and start trading their dollars for stronger currencies and tangible assets, including precious metals.

I agree that at some point, the bond markets are going to start rebelling against the fiscal profligacy in the US. But, I also don't see how that is an inflationary event. If long term interest rates were to spike tomorrow, that would severely hamper the Fed's ability to swap out bad debt. So instead of being propped up, that debt gets marked down to its true value - which is likely much lower than the value it's being carried at on the books today - which is deflationary.

Much of the inflation argument hinges upon the Fed's supposed unlimited ability to create new money out of thin air. But that type of activity can go on only as long as the bond market permits. And when the bond market screams "no mas", the party is over.

My Trading Activity - Shorted the S&P (Again)

On Thursday night, I shorted the S&P again, after being alerted of a favorable technical setup for a pullback. So far so good, as stocks got routed on Friday, despite the "good news" being reported in terms of earnings.

Puts expired worthless, but the new short is off to a good early start.

I've got a stop at recent highs, so not much downside on the trade. If stocks have finally tipped over, I'll look to hold this position all the way down...that being below the March '09 lows, in my estimation.

And the dollar still looks like a screaming "buy" here, as even the most optimistic projections have the dollar rallying another 10-15%. I like it to rally above it's previous highs, and will continue to look for an appropriate re-entry point in this trade.

The S&P got slammed Friday, despite good earnings news...great example of why trading on news can be unreliable at best!

(Source: Barchart.com)

Meanwhile the dollar is gearing up for it's next leg up.

(Source: Barchart.com)

Another way of playing the dollar rally would be to short currencies primed for a fall, such as the Euro or the Australian dollar. Both have started to turn down sharply.

Have a great week in the markets! Comments are always welcome and very much appreciated.

Latest Inflation Insights From Casey's David Galland

Many - including me - think that 2010 will be a pivotal year in the inflation/deflation saga. And while I hopped over to the deflationist "dark side" almost a year ago, I try to stay very tuned into the inflation scenario, to continually check my thinking on the subject. It's OK to be wrong...I just want to recognize that as soon as I can, and adjust my outlook accordingly.

David Galland always puts together some thought provoking points, and his piece here is tough to argue with. I'll let you read and absorb, and I'll be back with some thoughts from the deflationist point of view later today in our weekly update column. Enjoy!

***

What the Deflationists Are Missing

by David Galland, Managing Editor, The Casey Report

An interesting article by Ambrose Evans-Pritchard came my way the other day. It’s worth a read, if for no other reason than that he paints an appropriately dark picture of the current state of the U.S. economy. You can read it here.

While I very much share Mr. Evans-Pritchard’s view that the global economy is far from out of the woods, our views diverge in that he sees devastating deflation speeding our way down the tunnel. Casey Research readers of any duration know that we see devastating inflation.

While we could both be right, with deflation first and inflation later, I’m not so convinced.

For starters, there is already a massive inflation operation being run by the Fed, evidenced in a historic spike in the monetary base over the last two years.

And the Obama administration is far from done.

The Democrats’ reinvigorated focus on jobs – the single most important factor in this November’s elections – will soon translate into a flurry of new initiatives designed to put people back to work, most of it funded at taxpayer expense.

To believe in the deflationary case would seem to require believing that Obama and his minions are ready to forgo any further political aspirations by collectively putting their feet up on their desks for the balance of their sole term at the apex of global power.

Given Obama’s meteoric rise to power – evidence that he possesses a certain drive and competence in the game of politics – that seems highly unlikely. And so it seems safe to assume we’ll soon witness a redoubling of his efforts to keep interest rates down… to make it easy and cheap for strapped consumers and businesses to keep borrowing… and to otherwise flood the economy with money.

In a deflation, the value of the money increases – which is actually a pretty desirable thing, if you ask me. Inflation, by contrast, means that pretty much everything you own in the local currency steadily loses value – forcing investors into a perpetual game of catch-up. It’s hard for me to calculate how the government can dramatically increase the money supply and yet have each of the currency units become increasingly more valuable over a sustained period of time.

Arguing against that point, Evans-Pritchard makes the case that the U.S. government is making much the same mistakes that were made in the first part of the Great Depression, i.e., being overly tight with the money. And that the velocity of money is falling.

There are a couple of key differences between now and then, however. First, the Fed didn’t actually know what the money supply was back then. They literally had no monitoring tools in place, mostly because no one thought it was important enough to track. Second, they didn’t have fiat monetary powers. Today, neither of those factors apply.

Everyone knows what the money supply of the U.S. is and watches it keenly. Including our foreign creditors. And so it is not surprising to see the Fed publicly talking about tightening up a bit. But it’s just talk at this point.

With the economy continuing to struggle, the only reasonable assumption that can be made is that the Fed – in cahoots with the entirely politicized Treasury – will keep shoveling money onto the economic embers, and continue to do so until economic activity again flares up.

That will, of course, require increasing the quantity of money that actually makes it into the economy – but that should be child’s play for Team Obama – with direct hiring and spending, continuing to buy mortgages and other loans to suppress interest rates, forgiving the bad debts of banks, or changing accounting rules so that banks can postpone reckoning day. And that’s just for starters, all of it packaged nicely in the name of the public good.

And once the money starts to flow, there will be a pick-up in economic activity, which will beget yet more money moving around. At first, this money will be a palliative for the economic worries, but then comes the inflation – a small trade-off, the politicians will decide, if it buys them enough of a recovery to make it through the November elections and get the president the second term you know he so strongly desires.

There is something else that I think the deflationists are missing, and that has to do with confidence in the currency. If the U.S.’s many creditors come to agree with our point of view – that the dollar is being led to the altar as a sacrificial lamb to political expediency – then they’ll further reduce their purchases of our Treasuries and start trading their dollars for stronger currencies and tangible assets, including precious metals.

At that point, interest rates will have to begin rising to attract new buyers. As you can see in the chart of long-term Treasury bond rates, a significant move off recent lows has already occurred, and rates are looking poised for a breakout to the upside.

Of course, the higher those rates ratchet, the more it will cost the U.S. government to carry its massive debt. While rising rates will continue to drive demand to the short end, suppressing those rates, in time the sheer quantity of paper that will have to be rolled over, and the rising tide of inflation, assures that short-term rates will have to rise too.

At that point, the train begins to leave the track.

As the train wreck approaches, the government is going to have to find creative new ways to fund its social contract with impatient voters. Perhaps, for instance, pegging everyday fines and assessments to the amount of income a person makes. Executed brashly, such policies might even allow the government to charge a person of means, say, $290,000 for a speeding violation.

I know what you’re thinking: C’mon, let’s be realistic – that could never happen. Think again…

Europe slapping rich with massive traffic fines

By FRANK JORDANS

The Associated Press

Sunday, January 10, 2010; 11:30 AM
GENEVA -- European countries are increasingly pegging speeding fines to income as a way to punish wealthy scofflaws who would otherwise ignore tickets.

Advocates say a $290,000 (euro203,180.83) speeding ticket slapped on a millionaire Ferrari driver in Switzerland was a fair and well-deserved example of the trend.

Germany, France, Austria and the Nordic countries also issue punishments based on a person's wealth. In Germany the maximum fine can be as much as $16 million compared to only $1 million in Switzerland. Only Finland regularly hands out similarly hefty fines to speeding drivers, with the current record believed to be a euro170,000 (then about $190,000) ticket in 2004.

The Swiss court appeared to set a world record when it levied the fine in November on a man identified in the Swiss media only as "Roland S." Judges in the eastern canton of St. Gallen described him as a "traffic thug" in their verdict, which only recently came to light.

"As far as we're concerned this is very good," Sabine Jurisch, a road safety campaigner with the Swiss group Road Cross.

Full story here.

Or maybe the government will force you to convert some or all of your IRA or 401(k) into Treasuries, perhaps packaged up in an annuity. You’d be given the choice of making the switch or making a withdrawal and paying all outstanding taxes at that point. This is something that Doug Casey has warned about for several years now.

The seeds of that possibility may be headed for the soil: the following article from BusinessWeek reveals that the Treasury is now looking very hard at the trillions in retirement accounts and trying to figure out new ways to “help” the owners of those accounts.

In my view, what’s important in this little dissertation can be summed up as follows:

1. The current administration and its congressional allies have powerful political motives to soak the economic soil with fresh dollars. The Christmas Eve announcement that the Treasury is removing the $400 billion cap on losses it will cover for Freddie and Fannie is a classic example of how far they are willing to go to keep the money moving.

2. Unlike the Great Depression, the U.S. is now on a fiat money system – which is purpose-built for the current scenario. Open the taps, and if that doesn’t work, open them even wider. Failing to do so would be political suicide, and Obama and his team are just not into the idea of serving a single term.

3. Given the size of foreign holdings of U.S. dollars, the nation is faced with a “rock and a hard place” situation, where a sharp loss in confidence on the part of our creditors would likely lead to a currency crisis that drives the value of the dollar quickly lower, at the same time that it drives interest rates higher.

Something will have to give. We think that something will ultimately be the U.S. dollar, as it’s politically more acceptable to have a failing dollar than a smoking hole where the economy used to be.

Before this thing is over, I would not be surprised to see a new currency regime adopted that introduces exchange controls and a different category of dollar to be issued for the purpose of paying back foreign creditors. Such a dual-track currency system is nothing new but has been used by desperate regimes numerous times throughout history.

Forecasting the future is actually impossible, as there are just too many variables. But that doesn’t mean that we can’t step back and make certain logical assumptions about the policies the politicians are most likely to deploy in their efforts to retain power.

In the case of today’s world, the only politically logical decision will be to keep on spending until that spending itself becomes a pressing problem, at which point the politicians will turn their attention to “solving” the newest in a long list of problems they have created.

At which point they will no doubt find some creative way to blame the inflation on speculators, profiteers, and the free market.

The economy is now so manipulated by politicians, big bankers, and special-interest groups that making sense of the markets has become an almost impossible feat. In the spirit of “making the trend your friend,” no matter how dire it is, the editors of The Casey Report are experts in analyzing budding mega-trends and seizing the profit opportunities hidden in them. Learn to do the same – click here for more information.

Ed. note: I am a Casey affiliate, and have been a subscriber of theirs for over 3 years now. The Casey Report gets my highest recommendation for its excellent analysis.

Tax Receipts Down, Government Jobs Up...This Won't End Well

Bernanke - man of

the year. Did he earn it? Or

pushing on a string?

Markets Strong Out of the Gates...But How Much Conviction is Left?

The broader indices continued to climb higher in the first week of trading in 2010. But how much buying power is behind these moves?

Moves straight up usually don't end well.

(Source: Barchart.com)

Since the correct in early November, stocks have climbed just about everyday, without much of a blip of a correction. Meanwhile, upward momentum and volume continue to look anemic, indicating that the rally may finally be running out of gas.

But thus far, warnings of a potential turndown have either been early, or wrong. So which is it?

While I am not a huge chartist in terms of reading into patterns (head and shoulders, etc), I do notice that the chart of the S&P above is tracing out an ascending, contracting triangle. These are usually proceeded by sharp moves either up or down. Obviously a move down would appear to be the more likely scenario, so it will be interesting to see what the S&P does over the next couple of weeks.

It very well could continue to move higher, so I am going to hold off on shorting until we see a definite break in the uptrend. The mistake I make in early November was shorting too early, under the (incorrect) assumption that the uptrend HAD been broken.

So we'll chalk that up to a learning experience, and try to be a little more patient on pulling the trigger.

Tax Receipts Continue to Decline

It's hard to get excited about this "economic turnaround" when tax receipts continue to fall across the board. Tax receipts may be the least manipulated of all economic stats, so are worth paying attention to.

Here's a smattering of tax receipt data from around the nation...and little to none of it is positive. For a fun exercise, type "tax receipts" into Google News, and see what comes up!

• Texas sales tax receipts fell 11.6% year over year
• Kansas is projecting a 5.1% drop in tax receipts this year
• Federal revenues dropped 16.6% from 2008 to 2009

It seems that a lot of the "news" about the economy bottoming is nothing more than pundits projecting the bounces in the DOW and the S&P onto Main Street. In reality, that hasn't happen.

The markets have bounced since last March because that's what markets do. They never travel up or down in straight lines. All we've done thus far is mirrored 1930's stock market retracement - nothing more, nothing less.

From a technical standpoint - wake us up when we've surpassed the usual Fibonacci retracement levels.

From a fundamental standpoint - wake us up when tax receipts start to turn around...because we know there's only one reason for people to pay more taxes, and that's because they are making more money!

Now as to the ethics of taxation in the first place...we'll leave that libertarian rant for another day.

Evans-Pritchard Sees Japanese Hyperinflation

If you think this column is a ball of sunshine, you'll love Ambrose Evans-Pritchard's take on the 2010 financial markets:

The contraction of M3 money in the US and Europe over the last six months will slowly puncture economic recovery as 2010 unfolds, with the time-honoured lag of a year or so. Ben Bernanke will be caught off guard, just as he was in mid-2008 when the Fed drove straight through a red warning light with talk of imminent rate rises – the final error that triggered the implosion of Lehman, AIG, and the Western banking system.

As the great bear rally of 2009 runs into the greater Chinese Wall of excess global capacity, it will become clear that we are in the grip of a 21st Century Depression – more akin to Japan's Lost Decade than the 1840s or 1930s, but nothing like the normal cycles of the post-War era. The surplus regions (China, Japan, Germania, Gulf ) have not increased demand enough to compensate for belt-tightening in the deficit bloc (Anglo-sphere, Club Med, East Europe), and fiscal adrenalin is already fading in Europe. The vast East-West imbalances that caused the credit crisis are no better a year later, and perhaps worse. Household debt as a share of GDP sits near record levels in two-fifths of the world economy. Our long purge has barely begun. That is the elephant in the global tent.

As if this wasn't enough, he also sees quantitative easing in Japan as finally getting "over the hump" in terms of deflation, and achieving what so far has been an elusive goal - hyperinflation!

Finally, Evans-Pritchard also pokes some good fun at Europe's economic prospects.

The Worst Trend of Them All

Take a look at this chart of public vs. private sector employment, and tell me this chart isn't the most damning of them all!

This is the type of "breakout", or rather "breakdown", that you short 100 times out of 100.

(Hat tip to friend and fellow Austrian economic believer Carson for sharing this link).

Diversifying Your Life

Earlier this week, our local Casey Research "phyle" met up to discuss our usual cheery topics, including what to do if the US completely melts down.

Doug Casey recommends having your whole self diversified - ie. citizenship in one country, your business in another, real estate in a third, and even some savings in a forth. So, if it really hits the fan in your homeland, you're not completely screwed!

So our group chatted about the logistics of moving savings, including bullion itself, abroad. If you are interested in pursuing these types of options, here's a good interview conducted by the "Sovereign Man" Simon Black about storing gold in Panama.

Gold storage in Panama is a hot item. Banks have long waiting lists for safety deposit boxes, and as I’ve discussed before, many Panamanian banks are even starting to eliminate this service, reducing the available supply of boxes on the market.

Personally if I had meaningful investment capital, I'd probably be inclined to get some bullion stashed in another country...just in case. But as is, I've got most of my hopes, dreams, and prospects tied up in our small time tracking software company.

What it Means to "Turn Japanese" Economically

Stratfor, a "personal CIA" service of sorts, released some engaging forecasts for regions around the world in 2010. Here's Stratfor CEO George Friedman discussing Japan's economic outlook:

I find his take on Japan very interesting. If the US is indeed "turning Japanese" economically, you would expect to see an increased emphasis on full employment, rather than return on capital, for the economy.

While I'm sure our politicians have the same DNA as their Japanese counterparts, I'm not yet convinced that American citizens do. Are the characteristics Friedman identifies cultural? Or, will we see Americans follow in the footsteps of their Eastern counterparts?

The next couple of elections in this country should be VERY interesting, as we'll see how asleep the citizens of this nation really are. I'm not yet sure if the tea parties and "libertarian roots" are the tip of a larger iceberg, or one-off types of events.

Trading Positions - Looking for Dollar Re-Entry

My January S&P puts are going to expire worthless - as mentioned earlier, I jumped into that trade too early.

I am looking for a re-entry point into a long US dollar position, and I'll probably look at picking up some UUP for my equity accounts as well. I think we'll see a further pullback in the dollar here, before it resumes it's march above it's previous highs from 2008-09.

We've got small, but top notch, company in the short-term long dollar trade. First we saw our hero, Jim Rogers, take a short term position in the buck. And earlier this week, Tom Dyson wrote that a major uptrend is just getting started in this hated asset.

The buck, everyone's least favorite asset, quietly bottomed in November.

(Source: Barchart.com)

Another way of playing the dollar rally would be to short currencies primed for a fall, such as the Euro or the Australian dollar. Both have started to turn down sharply.

Have a great week in the markets! Comments are always welcome and very much appreciated.

The Top Three Investment Themes to Watch in 2010

Happy New Year...and New Decade! Let's dive into some of the top investment themes to keep an eye on in 2010...but first, a haiku:

09 Reflation

Can it continue for long?

Dollar may foil!

1. The US Dollar: The Linchpin

The dollar, which topped out in early March roughly around the time the stock market bottomed, has been looking frisky of late. It's not above it's 200-day moving average yet, so there is some potential resistance in the short-term, but it's looking stronger by the day.

Can the re-flation trade continue to motor along if the dollar mounts a sustained rally? If the first wave of the global meltdown was any indication, then probably not. We haven't yet seen any evidence to invalidate the "all the same markets" hypothesis.

Is the dollar's recent upturn tipping off an impending markets downturn? In my opinion, this is THE theme to keep an eye on in the first quarter of 2010.

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View the full NYSE:UUP chart at Wikinvest

I do get a kick out of the financial media's explanations for the dollar's recent strength - leave it to them to justify the charts with "news"!

2. China: The Global Economic Savior

China has been billed as the posterchild of the global economic bounceback. Which seems appropriate, as it was also the star of the 2003-2007 credit fueled equity liftoff globally.

"China is fine," pundits say. Well, perhaps. But rather than rely on various analysis and opinions on China, I'll stick with the lazy man's approach - watching the stock market itself.

In late November, we pointed to a potential downturn in Chinese equities as some dark clouds on the financial horizon.

How's China done since then? While still perched above it's 200-day SMA, the Shanghai Composite appears to be embarking upon a third attempt to take out its early August highs.

China's rally stalls.

(Source: Yahoo Finance)

A third failure would increase the likelihood of a Chinese breakdown, and a breach of the 200-day SMA (red line above) definitely would. And if that happens, look out! I'm not sure the re-flation trade could withstand this.

3. The Banks: Still Not Lending, and Breaking Down Too

I was tempted to stop the list at #2, because we know that all the markets are still correlated...but then I pulled up this foreboding chart of the bank stocks:

Bank stocks breaking down.

(Source: Yahoo Finance)

The bank stocks are trading right around their 200-day moving average, since making their rally highs in October. So while the blue chip indices have continued to rally and make new highs, many secondary indices have failed to confirm, especially "crap" like the banks.

Summing It Up: Deflation Likely to Return (Again)

To sum it up, it looks like the re-flation trade may be running out of gas...in which case, it would be time for the dollar to rally, and for deflation to once again take the upper hand.

A couple of months ago, I reviewed my favorite inflation and deflation arguments. Since then, I don't think anything has changed. We remain at a key inflection point in the inflation/deflation battle, at least as far as 2010 is concerned.

I personally think the odds favor the scales tipping once again in the favor of deflation. Then it will get really interesting, as we'll see our heroes at the Fed again swing into action. I'm skeptical they'll be able to do much of anything useful, as I don't think they "saved" us from anything the first time around either. The markets were oversold, and set for a huge rally - and rally they did. Where they go from here will be the true litmus test.

My 2009 Trading Review: Ouch, I Suck

Usually at the end of each year, I pat myself on the back for a year well done. Well this year, unfortunately, I got rocked. So rather than dwell on it too much, I'd rather focus on learning something from my mistakes - and hopefully you can too!

In no particular order, I made a few key ones:

1. Taking position sizes that are too large. You really shouldn't risk more than 2% of your overall capital on any given trade. Because, if the trade goes against you, the most important thing is to live to see another day.

This is the top way that traders go "bust" and lose all of their capital. Something I'll try to (finally) accept in 2010!

2. Not catching market turns properly. Since 2007 or 2008 I've predominantly traded with the trend, which I believe is the right thing to do. BUT, I've gotten burned on trends switching on me. My solution? Use a more robust system for catching turns, including investor sentiment that may indicate when a move is close to bottoming, or topping.

3. Lacking a set plan for exiting a trade - whether a winner, or a loser. Stops are life savers - it's important to honor them, and again, live to see another trade!

Overall no complaints, investing and trading is often an expensive tuition, and the only way to learn it is to do it. So I'm grateful to still have a fair amount of capital intact (off of a small initial stake), and look forward to continuing to improve in 2010!

Thanks for reading!