By
May 4, 2002
Back in November, I sent out an advisory titled "Extreme Vulnerability" noting that the bear market rally was "either over or half over." Since that time the markets have gone exactly nowhere. Which is a problem. We went through bullish short term cycles and could not create a bull. Slowly but surely, the cycles will now turn bearish and the fun will begin.
A couple of weeks ago I called a top in the gold market and it looks like I was a week or two early.
My thesis is that the bear market will not be over until:
Instead of commenting on all markets at one time, I will take one or two at a time and go a little more in depth. This commentary will focus on the CRB index. In the next weeks I will look at US long term bonds, the US stock market, gold, the US dollar and oil
The CRB index consists of a basket of commodities and is one proxy for inflation. Back in 1995 I noted that the coming financial climate would be one of disinflation and deflation. I noted that the CRB index was coming out of a decades-long triangle (wave B) and would soon begin a 5-wave downward move in wave C. In later commentaries I noted the end of wave 3 of C and noted that wave 4 would look a lot like inflation and would bring a great deal of inflation fear, but that it would be a bear market rally. At the end of wave 4, I sent out a commentary saying that the CRB was now heading for new lows.
Here is where we have been:
In the category of, you can’t lose ‘em all, my calls for the CRB (as opposed to some others we will discuss later) have been excellent.
Assuming that the down move in the CRB is not part of a larger structure (which would really be devastating), wave iv should now be over and we should be heading into wave v of 5 of C and actually, the deflation thing should be over fairly quickly.
Let’s take a closer look:
We should see the deflationary trend end in the months ahead. Since the decades-long ABC move down was in 3 waves, it will likely be completely retraced, which means that inflation of a greater magnitude than in the 1970s is in the cards some time in the decades ahead.
I have 3 criteria for the bear market to be over. If this 5-wave sequence in the CRB is all there is, then criterion number 3 will be satisfied, likely but not certainly, this year. If this 5-wave sequence is only wave 1 or A of a larger structure, deflation could become severe. At the moment there is no way to tell. The target shown in the chart, above, places the CRB at a value equal to the lower end of its range in the early ‘70s, before the oil crisis. There is plenty of room lower.
Having said that, the chart is in historical dollars, not constant dollars. Since the dollar has depreciated significantly since the early ‘70s, a constant dollar chart, would show a much lower low. The low in 1975, which is about as far back as my data go, was about 175 in 1975 dollars or about 577 in 2002 dollars. My target is about 177 in 2002 dollars or about 583 in 1975 dollars. So, even if we stop at 5 waves, in constant dollars we will be far below the lows of the ‘70s.
It is now time to talk about the Fed and the manipulation of interest rates and money supply, and the balance of payments deficit. These subjects are important to inflation, the dollar, and interest rates, so it will come up again in commentaries over the next few weeks.
You will recall that in late 1999 I said that the Fed would increase interest rates until the Nasdaq gave up. The Nasdaq bubble was creating significant distortions in the economy. The Fed had tried to talk it down and to wait it out, but neither strategy worked. It slowly squeezed the economy until the Nasdaq broke. Since the Nasdaq was a bubble, it burst as all bubbles do.
Greenspan is not an idiot – he is a very smart, savvy guy. I have not read many of his writings from before he became Fed chairman, but from the bits and pieces I have read, he understands the economy and was an ardent student of the Great Depression and of the mistakes the Fed has made, essentially since its inception. I am not sure he follows Kondratiev, but he knew that deflation comes next. So, since early 2000 he has aggressively lowered interest rates and increased the money supply, trying to manage deflation as best he can.
In earlier commentaries I noted that interest rate decreases are sometimes good for the stock market and that they are sometimes bad for the stock market, depending on the macroeconomic environment. I said that these interest rate decreases are a bad sign, because the Fed is fighting recession and depression the only ways it knows how.
So far, so good. Many interest rate decreases later and much money into the economy later, and we have dodged a bullet, with a short, mild recession (or was there even a recession?). Or have we?
One of life’s profound lessons is that you cannot do just one thing. You cannot just fight recession with interest rate decreases and increases in money supply. There will be unintended consequences.
The first consequence is that the Fed is almost out of bullets. Interest rates are so low that they cannot go much lower. If we are going into a tough time, it will be increasingly tougher for the Fed to help us get out.
The second consequence is that recessions are meant to clean out excesses to provide a clean basis for the next run up. The continuing amount of debt in the economy, the excess capacity in many sectors of the economy, particularly telcom, astronomical p/e rations, and the low savings rate / high balance of payments deficit indicate that excesses have not yet been cleaned out. It seems that we have a couple of choices: recession or a prolonged period of no growth while the excesses are slowly worked off.
Finally, there is inflation. All of that increased money in circulation can fuel a mighty inflation, once the underlying economy is straightened out. I have long been forecasting a decline in the dollar, and it does not seem like we are there, yet, however, a decline in the dollar will increase the cost of foreign-made goods and exacerbate the effects of monetary-based inflation.
Which brings me back to the CRB. The CRB will have a wave 5 which goes below wave 3. If anything, my target is too high and the CRB will wind up lower. Once wave 5 is completed, we will have to wait for the next waves up and down to see whether a rally, leading to inflation, or another down leg, signaling more disinflation/deflation, is at hand. We are months if not more than a year from that time.
More next week.
Copyright © Kit Webster 2002