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The changing course of the stock, bond, and economic landscape

The last few months in the financial markets have provided an array of cross currents to bubble up and potentially change the course of the stock, bond, and economic landscape. I would like to start off by talking about the stock market first and then I will move on to talk about interest rates, the housing market, oil, and the precious metals

As I talked about in my last essay it looks like wave 2 of this bear market rally had topped back in Feb/March 04. The DJIA hit a high of 10750 and is now around the 9900 area, down over 700 points. All three indexes, the DJIA, NASDAQ and the S&P 500 have topped and are now in a 3rd wave decline going into 2005 and probably bottoming in the fall of 2006, which seems to correspond to the 4 year cycle and the presidential cycle.

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There are many reasons to believe the bear is back, to seek vengeance on the naïve and undereducated market participants, who have been fooled and brainwashed by the perma bulls, CNBC and other sources paid by wall street firms to help the firms bring in more trading commissions by getting the public excited to buy and more specifically to trade stocks all the time 24/7.

Obviously the first reason for a bear market resurrection is valuation. As of may 1, 2004 the DJIA had a P.E OF 24.7 and a dividend yield of 1.99%. The S&P 500 had a P.E of 24.9 and a yield of 1.68%. And the NASDAQ 100 had a P.E of 38.7 and no yield because most of the stocks in the NASDAQ 100 do not pay any dividends. These are bubble like valuations to say the least, these numbers are more indicative of a top and NOT of a bottom or the start of a new secular bull in general stocks.

Every bear market bottom of the last 100 years has ended with a P.E under 10 and a dividend yield over 6%. We are definitely a long way away from those types of numbers! Even if you give the DJIA a P.E of 14 which is the historical fair value for that index you come up with a price level of 5796 which is well below the Oct 2002 bottom and a very long way away from where we are today.

The VIX and the VXN are a measure of investor sentiment. Both of these indicators are at multi year lows. This shows that investors are willing to take risks in the market and it also show's little if any fear. Readings this low have always been the precursor to a new bear.

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The 4 Year Cycle

I love studying market cycles, they simply fascinate me! Going back 100 years the DJIA seems to put in a bottom on average every 4 years (62,66,70,74,78,82,86,90,94,98,02,06,ect) it's never exactly 4 years to the day but if you average it all out, it comes out to 4.08 years according to the chart in my book "The encyclopedia of Technical Market Indicators" page 182.

So the Oct 2002 low was the last 4 year cycle bottom as predicted and the next major bottom should occur in the fall of 2006. The rallies off the 4 year cycle bottoms seem to last about 18 months or so, so the Feb/Mar 2004 highs in the 3 major index's in my opinion were the highs in this current cycle and we will see a decline with small bear rallies all the way until the next 4 year cycle bottom in 2006.

The Presidential Cycle

This cycle is very similar to the above mentioned 4 year cycle in that each president's terms are only 4 years long. This cycle has importance and is not very hard to understand. The theory of this cycle is that the current president will always put forth the most painful and economically unhealthy monetary and fiscal policies early on in the first 2 years of his new term, and then come right back an try to get re-elected by putting forth the most helpful and stimulated policies in the last 2 years leading up to the election.

This was certainly true this time around as Bush JR has pulled out all the stops both fiscally and monetarily in the last year and a half to help him push up the economy just in time for the Nov 2004 election.

The closer we get to the Nov elections the more tense it will get in all markets. Especially as some political watchers are looking for some type of Spain event occurring sometime around election time. If you would have followed this cycle in 2000 you would have sold all of your stocks once Bush was sworn in, and bought back in just after the Oct 2002 bottom, which seems to correlate with the 4 year cycle above.

So as of today you would want to start selling all of your general stocks (like DJIA ETF's) if you have not already, and wait 2 years after the fall 2004 elections which coincidentally would give you a fall 2006 buy signal matching the 4 year cycle above.

Rising Interests Rates

As most people in the markets watch the FED and Alan Greenspan for magical answers to when rates will rise, I simply look at the yield on the 10 year bond; this tells me all I need to know. As you can see from the chart below, the yield on the 10 year has created a text book perfect head and shoulders reversal pattern on the P&F chart, one of the most reliable patterns in the world of technical analysis.

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As you can see from the chart the downtrend line from 2000 has been broken and the era of decades low interest rates are over. This is not at all bullish for the overall stock market as rising rates will hurt companies profits and there ability to handle there debt payments as more money from there smaller profits has to service the rising cost of there outstanding debt.

All an investor needs to look at when it comes to the fed and there record in rising rate environments is to look at what happened in the 1990's " the peso crisis, Asia meltdown, Russian collapse, LTCM, 2000 tech implosion, etc. With the historical amount of debt in all aspects of the U.S economy, from the man on the street, to the companies that sell the goods and provide the services, to the government itself, the level of debt and of derivatives is simply frightening.

There is no way this is going to end peacefully as simply to much debt has been taken on by everybody, so even a small increase in rates will bring to the forefront problems that most investors and economists can not even imagine today.

As Ike Iossif said on a recent radio show with Jim Puplava and Alan M. Newman:

"It will only take a rise in rates of 1% to destroy the bond carry trade"

(Borrow short Buy long) This one incident, the destruction of the bond carry trade will be enough in my own opinion to really destabilize the whole financial system, and believe me, the fed knows it!

The battle over inflation or deflation is hardly over but as of today it seems that the bond traders can see inflation coming and don't really believe the words coming from the likes of Greenspan and his cronies at the Fed. The bond vigilantes are demanding higher rates to compensate for the inflation they see coming by way of the Feds printing press and helicopter drops.

I am in the camp of investors that believes the Fed will do everything in its power to stop deflation, even if it means printing dollar bills and dropping them from helicopters. To the Fed and the White House a repeat of the 1930's is simply out of the question, it is down right unacceptable.

But the policy of printing unlimited dollars instead of raising taxes or cutting government spending will only bring about rapid inflation, and so the Fed in there own horror trying to stop a repeat of the 1930's may well create a situation similar to what Germany experienced in the 1920's "Hyperinflation". Either way, rising rates and the current Fed policies are not good for the general stock market going into 2005.

To quote John Myers a contributor to the Daily Reckoning, he says so eloquently that:

"The long and short of it is that credit will continue to be expanded in this country until no more borrowers can be found. Then, when borrowing dries up, the government will become the borrower-of-last-resort, the Fed monetizing all the government's excess borrowing or budget deficits. This monetary inflation virtually guarantees a bull market in gold, silver and commodities"

Keep printing Dr. Greenspan, keep printing!


Rising Oil Prices

As most investors know oil just closed above $41 a barrel for the first time since the first gulf war. This is very bad for the stock market and the economy (except oil and gas stocks). There are a lot of people that think this rise in oil is only temporary and that this short term phenomenon will fall back to the low 30's. But I would like to share with you some charts that would tell a different story, a story of much higher prices for oil going into 05/06.

On the first chart you can see a very nice upward sloping head and shoulders pattern that started to form in 1993. The recent breakout over $40 was an extremely bullish event from a technical sense.

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The next chart is a point and figure chart of the oil price over the last few years; you can clearly see the breakout on this chart. The price target on the P&F chart is $57 which if achieved would simply rock the markets worldwide.

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It will be very important to keep an eye on the price of oil because any shock like a terrorist attack or a massive oil spill will cause the price to sky rocket. The situation in the Middle East is akin to a bunch of crazy zealots running around the world's biggest gas station tossing around lit matches. The whole situation of rising oil and rising rates and yields brings a close parallel to the 1970's when rising oil prices and rising bond yields (falling bond prices) caused gold and silver to explode into record prices.


Gold and Silver

As anyone who invests in gold and silver knows the last few months have been tough. The bull market in both metals has definitely taken a breather, but was the pull back a surprise? I don't think so! And I will tell you why. First everyone knows that bull markets ebb and flow, they go up and down, but if you follow the charts and you can recognize the pattern it makes investing much more fun and rewarding not to mention less stressful.

The recent top in the HUI and the XAU gold indexes were nothing more than the wave (1) top of a (5) wave pattern. (For a full detailed analysis of the Elliott Wave Theory please read the classic and most recognized book on EWT "The Elliot Wave Principal" by Frost and Prechter.

As you can see from the chart below there is a clear 5 wave pattern in both the XAU and the HUI. As anyone who is familiar with EWT knows, the wave patterns are fractal in nature, meaning that one set of Elliott waves are just a pattern in a much larger wave at a higher degree of trend.

So as I have been seeing panic selling in the last few weeks/months, I just sit back and smile as I wait for the wave (2) bottom and the glorious wave (3) rally to new highs going into 2005 and 2006. (A break of 113 on the XAU and a break of 256 on the HUI would signal the start of wave (3).

I believe the final 5th wave in gold and gold shares (which will be the frothy mania) won't occur until later this decade, when gold hits $1000 and silver is over $50. I don't trade in and out everyday and let my precious capital get killed by commissions and slippage, I just look for clear long term wave or classical technical patterns to develop and then invest in those sectors with those patterns and sit tight and wait for the patterns to complete themselves.

As you can see from the long term chart of the XAU, this massive ultra bullish head and shoulders reversal pattern has the 150 level written all over it! I will personally just wait and let this pattern complete it's self and then SELL and take my profits (which is the most important aspect of investing), please read the two books "It's When You Sell That Counts" by Donald L. Cassidy and "When to Sell: Inside Strategies for Stock-Market Profits" by Justin Mamis  to get a good handle and when to sell, and why it is the most important skill to acquire in investing and trading.

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So for all you fellow gold and silver investors out there that are getting stressed out I say to you, calm down, relax and just let the patterns do what they will do, and in the case of the XAU what they will do is go to the 150 level in 2005 or 2006.

Before I finish up this part on gold and silver I want to clear something up for the new gold and silver investors out there. Please don't be fooled and believe the lies spewed out of CNBC and the people trying to get you to sell your gold and silver and gold and silver stocks to them at a wave (2) bottom so they themselves and take them from you, leaving you naked, so they themselves can enjoy the bounty of a magical wave (3) rally.

Don't listen to people who say that rising rates will hurt gold and silver, because all you have to do is look at this chart below of the yield on the 10 year bond going back to 1960. This chart tells you all you need to know, when yields rose throughout the 1970's so did gold and silver and when yields fell for 20 years from around 1982 to present gold and silver have been down. It has only been since 2001 that gold and silver have really rallied probably anticipating higher rates into the future, and here we are in that future and all you hear about is higher bond yields and higher fed funds rates.

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So please look at this chart and notice that when the yield on the 10 year bond was over 10% in 1980 where was the price of gold and silver? $850 gold and $50 silver, and what is the yield on the 10 year bond toady? it is only 4.76%. So in my own analysis, rising rates and bond yields are very bullish for gold and silver, so the coming rate increases by the fed to fight inflation and the bond vigilantes is only the beginning of the bull market in the precious metals.


Stalking the Housing Bubble

I am a ferocious reader of books, newspapers, and many financial newsletters. In the past few months while I have been reading my financial newspapers I have been cutting out and keeping all the articles about the big housing boom. I have studied and read about most of the financial manias of the past 500 years from the John Law scandal of 1720 to the crash of 1929 to the bubble of the late 1960's to the gold and silver bubble of the 1970's and most recently, the tech bubble of the late 1990's.

Most manias (and it does not matter which time frame you are using, because all manias have the same underlying characteristics) that are talked about in the financial media have a few choice words that are used over and over again to describe what is going on in the market that has all the attention of the mass public, be it gold, tech stocks, nifty fifty stocks, real estate, baseball cards, fine art, or radio stocks.

Below I will list some of the most recent headlines from my local newspapers around my home town of Vancouver Canada (The most expensive place to live in all of Canada!)

In all the manias I have studied, the words most used in the press are MANIA, BOOM, HOT, FEVER, RECORD, HIGH, and SKYROCKET. In the biggest manias some of the words are put together!

Here are some of the headlines from my local papers, you be the judge and ask yourself, is this a real mania? because it sure looks and sounds like one to me, this will only end badly in the coming years as rates on mortgages rise:

    Vancouver Province, Sunday, Feb 29, 2004. Front page story!

    The Vancouver Sun, Wednesday, May 5, 2004

    The Richmond Review, Weekend edition, May 15-16, 2004

    The Richmond Review, Weekend edition, May 15-16, 2004

    The Vancouver Sun, Saturday, April 3, 2004.

    The Vancouver Sun, Saturday, April 3, 2004

    Vancouver Province, Monday, April 5, 2004

I will close this part of my essay with a small article that just recently came out and was totally under the radar screen of most homeowners and investors. If you have decided that this is a full blown mania and that home prices will fall over the coming decade, what will the implications of this article mean for most investors and the economy when rates rise much higher over the next decade? I will leave it up to you!

IN HOME EQUITY" The Real Estate Weekly

"Canadian homeowners refinancing there mortgages, mostly as home equity loans and lines of credit, are creating an annual impact equal to the creation of one million new jobs, according to a study by CIBC World Markets.

Canadians took $29 billion from home equity from 2002 to 2003, the report states."Canadians have been refinancing their mortgages at a pace never seen before."said Benjamin Tal, senior economist, CIBC World Markets. The CIBC says refinancing put $36 billion of extra purchasing power in the hands of mortgage holders. "This is equivalent to the annual income from one million new jobs being created."When mortgage holders refinance, about one in three increases their mortgage amount by $28,000, leading to an $18 billion increase in total mortgages outstanding in the economy, according to Tal.

Given current mortgage rates, the report estimates that almost a quarter of mortgage holders can still benefit from refinancing their mortgage, adding to the 50 per cent whom already have.
Homeowners draw equity from their homes for home renovations, other real estate investments, education and a myriad of other reasons."


Final Comments

  1. In closing this essay I would like to summarize that when you put all of these pieces of the financial puzzle together, it is very bearish for the general stock market, bearish for bonds, bearish for real estate, bullish for precious metals and bullish for oil.

  2. There is simply too much risk in this market for anyone to be fully invested. I would highly recommend that investors of all ages start to raise there cash positions and start to buy some deeply over sold gold and silver stocks before the wave (3) rally going into 05/06 in the HUI and the XAU.

  3. Get ready for a very violent return of the bear in the DJIA, NASDAQ, and S&P 500, I am sure the bear did not appreciate getting tied up and tossed off the boat by the bull a few weeks ago! (Reference to the front cover of barron's soon to be remembered as one of the most historical sell signals of all time!) So I can imagine that he is a little ticked off, the bear will come back and slaughter all those who disrespected and mocked him over the next 2 years into 2006 in a all you can eat perma-bull massacre.

  4. The last thing that I want to share with all of you is this very important message.
    I love studying Elliott wave patterns, classical technical patterns, cycles, gold and silver, call and put options and many other sophisticated ways of investing or trying to predict the future trends of price action in the markets.

  5. But I strongly encourage all of you not to forget the most basic laws of financial planning. I encourage all of you to always have a solid financial plan and to always follow some basic but very important rules about how to get rich slowly.

  6. Everyone today wants to get rich quickly, like buying a tech stock at $1 and riding it to glorious profits and selling out at $50. That's great and all, but these types of investments should only be implemented after a solid financial base has been built.

  7. I have been studying financial planning since I was 17 and I really like to consider that my specialty. So before I go today I want to share some very basic strategies for building a solid financial base for a secure future.

  8. Self Education: Anyone who wants to do well in the financial markets needs to do a lot of reading. Every investor needs to make it a priority to teach themselves the fine art of financial planning and proper money management.

  9. I advise people to not watch CNBC because they are paid by Wall Street to only talk about buying stocks and how great the economy is, you get a biased opinion in other words. Every investor needs to think independently.

  10. Owning your own home: Paying off your mortgage every month is a great way for saving and asset building.

  11. Start saving and investing as early as possible, so you build the habit and take advantage of the compounding of your money.

  12. If your goal is to become wealthy, you must make some important choices such as, deferral and doing without, and putting money away with considerable frequency.

  13. You must put at least a small portion of you savings into investments that can not be printed up by the printing press. Buy physical gold and silver coins and bars.

  14. Stay out of debt: Only own 1 credit card.

  15. Live well below your annual income.

  16. Create multiple streams of income (earned income, passive income, portfolio income)

  17. You must live by the commandment of living modestly and saving regularly.

  18. You must be a saver and not a spender.

  19. Keep consumption to a minimum.

  20. Read all the books by author Napoleon Hill, he has written some of the best books ever on how to use your brain to attract things and people towards you, mainly money and financial well being. I highly recommend his first book "Think and Grow Rich" it just might change you life!

  21. Every investor needs to tailor a financial plan for their own individual circumstances, but anyone can follow a few of the above strategies.

  22. Building a solid financial foundation is the best thing any investor can do for themselves.
Edward Gofsky
I welcome all comments and views on my essay. Contact me to discuss this posting.
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