Deflation's Return by Bill Bonner Buenos Aires, Argentina The Dow rose 47 points yesterday...and is up around 180 points this morning. Not too much...but the rally is still on. More or less. But don't trust it...keep moving up those stops. The state of the economy can be summed up this way, according to our friend Barry Ritholtz, author of The Big Picture blog and the forthcoming book Bailout Nation. "Imagine you jump from a airplane - for a while, you are free falling - accelerating downwards at increasing speeds," he begins. "After a few thousand feet, you pull the rip cord and your parachute opens up. In terms of direction, you are still heading down; In terms of speed, however, even though you are falling, you are falling at a much slower rate." "As the parachute deploys, you are decelerating - the rate of your fall is slowing," Barry concludes. In other words, no matter the speed of the fall, the law of gravity still applies. The economy still must eventually hit the ground...and it will. Though in Los Angeles, where we just came from, the economy seems to still be floating along, unfazed. It turns out that the worst financial crisis since the '30s wasn't affecting the City of Angels...or so it seems. The restaurants were full. In the streets, people ambled around, apparently buying things. The freeways were clogged with expensive autos. What has changed? Nothing we could see. But California recently joined the 10% Club - states with greater than 10% unemployment. Maybe they are mostly outside LA's old neighborhoods. And, the rate is probably much higher than 1 in 10. This from MSN Money: "The official US jobless rate, now 8.5%, excludes millions of people - among them those who have given up on finding work and those forced into working fewer hours than they'd like. "An 8.5% unemployment rate is unmistakably bad. It's the highest rate since 1983 - a year that saw double-digit unemployment, nearly 30 commercial bank failures and more than 15% of Americans living below the poverty line. "But the real national unemployment rate is far worse than the U.S. Department of Labor's March figure, announced today, shows. That's because the official rate doesn't include the 3.7 million-plus people who are reluctantly working only part time because of the poor labor market. And it doesn't include the workers who have given up scouring want ads for seemingly nonexistent jobs. "When those folks are added to the numbers, the unemployment rate rises to 15.6%. In March 2008, that number was 9.3%. The Bureau of Labor Statistics began tracking this alternative measure in 1995." People who have no jobs, or fear losing their jobs, are poor consumers. They hesitate. They procrastinate. They make do. That's why retail shop vacancies are at a 10-year high. If people aren't buying, you don't need space to store merchandise that you won't sell them. And you don't need shop clerks either. Which causes unemployment to increase further. And it causes prices to fall. About which more below... But first, we'll turn to Addison in Baltimore, with surprising news about home prices in The City that Never Sleeps: "Looks like the Manhattan housing bubble is finally cracking under the strain of the credit crisis," says Addison today, taking a break from our marathon editorial meetings. "Preliminary first quarter data released today show a 60% annual crash in sales of Manhattan co-op ands condos. Average co-op prices fell as much as 24% in the same timeframe, but condo and apartment prices are still relatively firm...for now. "Despite a contraction in housing prices all over the U.S., apartment prices in New York City are still too good to be true. While the NYC housing market bellied up to the bar at the great U.S. housing party, the inevitable hangover never fully set in:
"Home prices in Manhattan are still outrageous - there are currently 350 apartments for sale there with asking prices over $10 million. If the first quarter rate of sales continues, that's a six-year supply of eight-figure pads. So what's more likely: sellers hold out, or lower prices? Considering the wave of layoffs on Wall Street, coming super- sized budget cuts in state and city government, and the chart above...we know what we'd do." How can the average investor take advantage? The Lifetime Income Report's Jim Nelson made a great contrarian case for investing in certain housing sectors during the first day of our editorial meetings. He's looking at pools of home mortgages backed by the government through Fannie Mae and Freddie Mac. Since their "receivership" and subsequent propping by the Fed and Treasury, many of their mortgages are practically guaranteed to yield income. For more details, be sure to check out Lifetime Income Report. And back to Bill in Argentina: In our book, Financial Reckoning Day, which we wrote with Addison Wiggin, we argued that the United States was following Japan into a long, on-again, off-again slump. We wrote the book in the early 2000s and were proven wrong almost immediately. Instead of a long, Japan- like slump, the U.S. economy took off and soon turned itself into the biggest bubble the world had ever seen. Now, that bubble has burst. Everything is beginning to turn Japanese. The financial crisis is straightening our hair. It's taking inches off our height. And it's causing us to like raw fish! Japan never got out of its slump. Instead, asset prices in Japan are lower than ever. And the Japanese economy is contracting faster than any economy did during the Great Depression. And to make matters worse, deflation is back. Consumer prices are now falling...again. The difference between this bout of deflation, and other periods of deflation in Japanese economic history over the last 18 years, is that now they no longer alone. Switzerland is already in deflation too. And so is China. China has lost 20 million jobs since the beginning of the crisis. Asset prices have collapsed. And now, consumer prices are going down too. Like Japan, China and Switzerland are exporters. When Americans don't buy, China, Switzerland and Japan don't sell. And soon, their factories go quiet...and their workforce is idled. Will the United States soon have falling consumer prices too? Will it finally follow Japan into a long slump? Yes...and maybe no. There is a big difference between the United States on one side and Japan and China on the other. The United States is not an exporter; it's an importer. Nor is it a creditor; it's a debtor. When the Japanese economy fell off the truck in the early '90s, its people had savings. They could wait out the correction. They didn't have to cut spending and increase savings; they were saving enough already. In fact, when consumer prices fell, Japan's savers got richer; they could buy more things with less money. But the United States can't wait out a correction in comfort. Its people have debts, not savings. Deflation doesn't make them richer; it makes them poorer. And in order to pay their bills, they have to cut spending and increase saving. This puts further downward pressure on the economy and creates a very uncomfortable situation for Americans. The more they save to pay their debts, the more the economy contracts. The more it contracts, the less revenue they have available to save. Oh, wicked world! But wait. Isn't there a way out? Isn't there some magic the Fed can perform...some abracadabra, perhaps, from Tim Geithner? What if we get a lot of smart people together in a room, as Thomas Friedman suggests? Won't they be able to figure something out? We don't know...but we wouldn't bet on it. Tomorrow...what we can learn from Argentina... Until then, Bill Bonner The Daily Reckoning P.S. At this year's annual Agora Financial Investment Symposium in Vancouver, we will be unveiling our updated version of Financial Reckoning Day...and that's just one of many reasons you'll want to join us there. We will be celebrating the 10th anniversary of The Daily Reckoning, so the theme of this year's conference is 'A Decade of Reckoning.' Join all of your favorite DR editors, as well as a few special guests, in Vancouver, British Columbia for the most critical four days of the year. And if you secure your spot now, you can still get the early bird special: $300 off the regular admission price: Agora Financial Investment Symposium - July 21-24 --------------------- Special Offer --------------------------- A Secret Way to Multiply a 39% Gain... Into Nearly 314% Stop paying full price for stock gains... This secret can pay without buying a single share...with much less risk and much less work...for anybody who's finally ready to get started... --------------------------------------------------------------- | ||
| The Daily Reckoning PRESENTS: Do you think of yourself as an investor or a trader? Yes, there is a difference...a pretty significant one, in fact. In the following excerpt from his book, Trend Following: Learn to Make Millions in Up or Down Markets, Michael Covel explores this important distinction, as well as (his particularly) successful trading approach. Read on... How to Survive in This Economy by Michael Covel San Diego, California Do you consider yourself an investor or a trader? Most people think of themselves as investors. However, if you knew that the biggest winners in the markets call themselves traders, wouldn't you want to know why? Simply put, they don't invest; they trade. Investors put their money, or capital, into a market, such as stocks or real estate, under the assumption that the value will always increase over time. As the value increases, so does the person's "investment." Investors typically do not have a plan for when their investment value decreases. They usually hold on to their investment, hoping that the value will reverse itself and go back up. Investors typically succeed in bull markets and lose in bear markets. This is because investors anticipate bear markets with fear and trepidation, and therefore, they are unable to plan how to respond when they start to lose. They choose to "hang tight," and they continue to lose. They have an idea that a different approach to their losing involves more complicated trading techniques such as "selling short," of which they know little and don't care to learn. If the mainstream press continually positions investing as "good" or "safe" and trading as "bad" or "risky," people are reluctant to align themselves with traders or even seek to understand what trading is about. A trader has a defined plan or strategy to put capital into a market to achieve a single goal: profit. Traders don't care what they own or what they sell as long as they end up with more money than they started with. They are not investing in anything. They are trading. It is a critical distinction. Tom Basso, a longtime trader, has said that a person is a trader whether or not he is actually trading. Some people think they must be in and out of the markets every day to call themselves traders. What makes someone a trader has more to do with his perspective on life more so than making a given trade. For example, a great trader's perspective includes extreme patience. Like the African lion waiting for days for the right moment to strike its unsuspecting prey, a trend follower can wait weeks or months for the right trade that puts the odds on his side. Additionally, and ideally, traders go short as often as they go long, enabling them to make money in both up and down markets. However, a majority of traders won't or can't go short. They struggle with the concept of making money when a market declines. I hope that after reading Trend Following, the confusion and hesitation associated with making money in down markets, markets that are dropping or crashing, will dissipate.
There are two basic theories that are used to trade in the markets. The first theory is fundamental analysis. It is the study of external factors that affect the supply and demand of a particular market. Fundamental analysis uses factors such as weather, government policy, domestic and foreign political and economic events, price-earnings ratios, and balance sheets to make buy and sell decisions. By monitoring "fundamentals" for a particular market, one can supposedly predict a change in market direction before that change has been reflected in the price of the market with the belief that you can then make money from that knowledge. The vast majority of Wall Street uses fundamental analysis alone. They are the academics, brokers, and analysts who spoke highly of the new economy during the dot-com craze. These same Wall Street players brought millions of players into the real estate and credit bubbles of 2008. Millions bought into their rosy fundamental projections and rode bubbles straight up with no clue how to exit when those bubbles finally burst. Consider an exchange between a questioner and President Bush at a December 17, 2007 press conference: Questioner: "I wanted to ask you [Mr. President] - I'm a financial advisor here in Fredericksburg [Virginia], and I wanted to ask you what your thoughts are on the market going forward for '08, and if any of your policies would make any difference?"The President's view is a typical fundamental view shared by the vast majority of market participants. Consider further an excerpt found in Yahoo! Finance's commentary; it outlines a single market day: "It started off decent, but ended up the fourth straight down day for stocks early on, the indices were in the green, mostly as a continuation from the bounce Monday afternoon, but as the day wore on and the markets failed to show any upward momentum, the breakdown finally occurred. The impetus this time was attributed to the weakness in the dollar, even though the dollar was down early in the day while stocks were up also, oil prices popped higher on wishful thinking statements from a Venezuelan official about OPEC cutting production whether or not these factors were simply excuses for selling, or truly perceived as fundamental factors hardly matters."Millions of readers read this type of drivel every day. Worse, thousands watch Jim Cramer of Mad Money fame promote similar nonsensical beliefs every day. Predictions based off of fundamental analysis don't work for the vast majority of market participants. Great example? Not many predicted the October/November 2008 market crash! On top of not being able to predict, fundamental analysis leaves many with trying to pick bottoms or trust that conditions will always improve. One of the great traders of the twentieth century, Ed Seykota, nailed the problem with fundamental analysis: "One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air, as it came to rest with the pointed end sticking into his shoe. 'Why didn't you move your foot?' I exclaimed. 'I was waiting for it to come back up,' he replied."Don't we all know an investor who is waiting for "his" market to come back? The financial website marketer Motley Fool has a back-story, a narrative behind how it started, that reflects the folly of literally banking on fundamental analysis as a solution for making money: "It all started with chocolate pudding. When they were young, brothers David and Tom Gardner learned about stocks and the business world from their father at the supermarket. Dad, a lawyer and economist, would tell them, 'See that pudding? We own the company that makes it! Every time someone buys that pudding, it's good for our company. So go get some more!' The lesson stuck."The Motley Fools' David and Tom Gardner's pudding story might be cute, but it is Forrest Gump-like simplistic (and wrong). Their plan gets you in, but it doesn't tell you when to get out or how much of the pudding stock you must buy. Unfortunately, many people believe that simple story is a good strategy for making money. That is a sad state of affairs. A second market theory, technical analysis, operates in stark contrast to fundamental analysis. This approach is based on the belief that at any given point in time market prices reflect all known factors affecting supply and demand for that particular market. Instead of evaluating fundamental factors, technical analysis looks at the market prices themselves. Technical traders believe that a careful analysis of daily price action is an effective means of trading for profit. Now here is where an understanding of technical analysis becomes complicated. There are essentially two forms of technical analysis. One form is based on an ability to "read" charts and use "indicators" to predict market direction. Here is an example of the mentality behind a predictive view of technical analysis: "I often hear people swear they make money with technical analysis. Do they really? The answer, of course, is that they do. People make money using all sorts of strategies, including some involving tea leaves and sunspots. The real question is: Do they make more money than they would investing in a blind index fund that mimics the performance of the market as a whole? Most academic financial experts believe in some form of the random-walk theory and consider technical analysis almost indistinguishable from a pseudoscience whose predictions are either worthless or, at best, so barely discernibly better than chance as to be unexploitable because of transaction costs."This is the view of technical analysis held by most people who know of technical analysis that it is some form of mysterious chart reading technique, such as astrology. Equity research from a major bank furthers my prediction distinction point: "The question of whether technical analysis works has been a topic of contention for over three decades. Can past prices forecast future performance?"However, there is another type of technical analysis that neither tries to predict or forecast. This type is based on reacting to price action. Trend followers are the group of technical traders who use reactive technical analysis. Instead of trying to predict a market direction, their strategy is to react to the market's movements whenever they occur. This enables them to focus on the market's actual moves and not get emotionally involved with trying to predict direction or duration. That said, this type of price analysis never allows trend followers to enter at the exact bottom of a trend or exit at the exact top of the trend. Second, with price analysis, they don't necessarily trade every day. Instead, trend followers wait patiently for the right market conditions instead of forcing the market. Third, there should be no performance goals with price analysis. Some traders might embrace a strategy that dictates, for example, "I must make $400 dollars a day." Trend followers would counter with, "Sure, but what if the markets don't move on a given day?" One trend follower summarized the conundrum: "I could not analyze 20 markets fundamentally and make money. One of the reasons [trend following] works is because you don't try to outthink it. You are a trend follower, not a trend predictor."To be continued... Regards, Michael Covel for The Daily Reckoning |
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