Rescuing the Mainstream from The New Economy
by J. R. Fibonacci. December 17, 2005
First, who is the mainstream? Do you think primarily in terms centered on your home nation, the currency of that single nation, and markets specific to that nation? If you answered yes to all of these, then you are definitely among those I mean by "mainstream." Further, if you think that the 90+ year deterioration of the US currency is a challenge you can address in your life simply by purchasing some gold or silver, this article is also for you, even if you do not think of yourself as "mainstream." (In fact, those commodity-oriented folks might skip to the article linked here.)
If you think of "the New Economy" as the eternal global dominance of the United States, in which US real estate is the best, US stock markets are the best, US currency is the best, and everything US is the best because the US is the best, then this article is especially for you. Of course, you will need to be willing to recognize that there is life beyond the borders of the "Yankees."
By looking "across the border," you may find evidence that the US (or a specific US market) is indeed the best. Or, you may find that the US is not the best in everything- at least not always.
If so, finding an opportunity that is better than the ones you previously recognized may be something you would like to foster. You may also witness a change in perception about certain US markets or the US itself. Since my perceptions have changed over the years, I suggest that there are some common (mainstream) misperceptions or assumptions that may not fit our best interests. Perhaps we can "rescue" ourselves from any such misperceptions simply by carefully exploring a bit of evidence.
I'm going to get right to the primary point now. The mainstream- and not just in the US apparently- is in danger. The extent of this danger is in proportion to the complacency or numbness of the mainstream. Precisely because the mainstream does not perceive the situation realistically, the situation is dangerous for them.
The same circumstances might be an immense opportunity. If clearly witnessed and understood, reality is like a partner. We either collaborate with reality or we neglect to do so (and then perhaps complain about how uncooperative reality has been towards us).
Those who are responsible- as in responsive- accept any confusion as a sign to simplify, to clarify. Many people I know seem confused, especially about financial matters. Most people I know do not seem to me to understand the primary economic developments of their lifetimes in the US much less elsewhere. Some do not even seem interested.
If you know that you do not understand the economic changes of the last several generations, but are interested in first understanding and then responsiveness- even prudence and relevance- than please continue. I will address some very simple principles below, though here's a little "pop quiz" to start. If you don't know the answers to these, but would like to, my most recent prior publication answers most of these and it is linked at the conclusion of this article. To me, the questions below are not in themselves so important, but studying the past can be a valuable tool in preparing for the future, which may be rather important to you.
What is the origin of the phrase "that used to be a lot of money?" What is a financial instrument? What is the difference between tangibles and financial instruments? What is a financial market? In major international and national financial markets, what has changed in recent years? Why do price trends begin and why do they end? What does "price" measure?
When there was a major national shift in Japan in the 1990s (and still ongoing), why- and what consequences did this have in the US, especially for the high tech industry, which had been booming in Japan through the 1980s? When there was major national economic shifting in the US in the 1970s, why?
When there was a major international shift around the early 1930s, why- and what consequences did this have in the US? When there was a major international shift around the late 1850s, as in the late 1830s, why- and what consequences did those have in the US? When, in the 1780s, there was a major divergence from a 60+ year trend, why- and what effect did this have on the recently independent former British colonies in "the new world?"
Divergence and Convergence
Actually, I'm not going to focus on macro-economics of those prior centuries, but I will reference "timeless" principles and related patterns that have endured for many centuries or more. For instance, a "megatrend" that goes back to at least the 1780s may be reversing now. What effect could this have on less established trends, like the 90+ year deterioration of the market value of the US currency?
If the currency trend is merely a "branch" or "ripple" or "domino" in the larger trend, then the end or reversal of the parent would be the end or reversal of the subsidiary. On the other hand, when dealing with multi-century trends, a trend of a single century might be like "undertow," like an emerging challenge to the prior trend . Sometimes the inertia of these counter-balancing patterns can resolve in a rather sudden shift.
Again, I consider recent developments to be very dangerous for the trend-following mainstream. By recent developments, I mean not only things like 90+ year divergences from much longer trends, but changes within the last 7 years or potentials.
I am also concerned about the possible intersections of trendlines that have not yet occurred, but are predictable- at least to some extent. Often, when two trends are converging on a critical limit, one ends. An example of this would be within a single market; when a certain short-term trend diverges from a long-term trend, one or the other must prevail.
For instance, consider 1932 after a new 3-year trend in the US stock market. Either the 90% decline in stock prices would continue or the prior long-term trend of rising stock prices would resume.
Or, consider the biggest financial news of 1999. After centuries of a wide variety of multi-century trends in the various currencies of Europe, those currencies were practically retired and superseded by the Euro. This may seem like a breach of trend to a German or a Spaniard, but that "retiring" of several national currencies actually corresponds to the multi-millenia trend of the centralizing of banking.
Similarly, with the NAFTA bloc countries fostering regional conformity, the "Amero" currency project of [those DBA] the IMF and associates seems like a natural culmination, yes? Was it so long ago that 13 independent governments united under uniform weights and measures as the USA? Are we so far away from regional currencies such as Euro, Amero and Pacifico uniting into a single international currency? Indeed, are not the Federal Reserve's "US Dollar" instruments already a virtual global currency, especially with their prominence in internet commerce?
Of course, how much further could banking centralize after a global unit of accounting? Every trend that begins... ends- whether that takes centuries or hours.
Some will say of a trend (or it's ending): "that is very good" or "this is very bad." I will simply say "trend" or "countertrend," and perhaps "poised to reverse" or "solid and sustainable."
The importance of confidence
("sentiment") and discounting
I make personal selections based on my perception of circumstances and also based on a particular purpose or value. While my personal values (and purposes) will be somewhat evident throughout this writing, the primary target is simply to offer perspective on circumstances common to you and I, within the US or without.
If there is a single lesson that I would present with this piece, it is the relationship of changes of trend to confidence. Most simply, public confidence or investor confidence tends to extend beyond reversals of trend. In other words, if you have a choice between following the mainstream's confidence in the market or the market itself, choose the market.
But there is more and it is also quite simple. If you want the best value- the very best investment- would you look among the investments garnering the most confidence from the mainstream... or would you look among what they are generally discounting? Remember, discounts may be very high quality and very useful- but the mainstream is just reducing their demand for that investment for a while.
Consider that you can generally get firewood in summer at a discount compared to winter. This is no reflection whatsoever on the utility of the firewood. In a few months, there is a reasonable possibility that the same people who are selling it to you in the summer might then buy it back for a higher price. The demand changes seasonally, which then effects reserve supplies, but the firewood itself may be exactly the same in terms of heating capacity.
So, would you prefer to invest in trends that may already be over or in trends that may be about to begin? Of course, some of each might be appropriate, but if we know that the confidence and buying activity of the mainstream follows consistent patterns and are thus relatively predictable, then we can invest ahead of trend, instead of only following trend.
Forecasting reversals of trend
Let's consider that we have identified a pattern in confidence (sentiment): when confidence is very high, the possibility of a sudden or prolonged loss of confidence is highest, and when confidence is very low, the possibility of a sudden or prolonged increase in confidence is highest. These reversals in confidence correspond to reversals of trends in buying and selling. When confidence is rising, folks tend to buy more- which generally pushes prices higher. When confidence is dropping, increased selling generally pushes prices down.
For instance, let's consider the commodity silver. In the decades following 1979, silver prices declined about 90% in nominal dollar price (before adjusting for inflation). The market confidence in silver was near record lows several years ago.
In one of my first public forecasts a few years ago, I suggested to a small group that silver had enormous potential to rise from it's price of $4.50. I forecast that silver would very likely continue to produce appealing returns even if purchased at $5.
A few months ago, when silver was rising but just a bit under $8, I saw that confidence in silver had reached rather high levels. In other words, most silver investors were discounting the possibility that silver would drop. I warned many people against buying silver when confidence was at such extremes.
Prices immediately dropped sharply by several percent, enough that many silver investors discounted the possibility that silver would resume it's rally. That is one factor in my then returning to favor a rally in silver, which has recently approached $9 as already mentioned.
Now, after several years of rally in silver, how might we identify the longer-term potential of silver- looking only at confidence and price data? This perspective, by the way, is known as contrarian investing, that is, counter to the confidence of the mainstream.
One research method would be to look at the longer-term patterns in confidence and compare it to the longer-term patterns in prices. If the surge in confidence of the last few years seems to exceed the surge in price and volume, then we might speculate that there is over-confidence driving silver prices up and thus a long-term decline is likely. This would mean that the rally trend of the last few years might reverse- back to resuming the decline trend of the last few decades.
What would indicate a long-term change of trend in silver prices? If confidence levels fall below the prior lows in confidence while the prices are still higher than the prior lows in price, that would indicate capitulation or despair. That would mean that the potential for a rally was extremely discounted- and thus might be a very good risk. If, on the other hand, confidence in silver was now near the levels in 1979 when the dollar exchange rate for silver was nearly $50/oz, what would that mean?
If you want to know confidence levels in a wide variety of investments, check MarketVane.net, SentimenTrader.com and AAII. Note that different methods of measuring sentiment for the same investments will vary. The following data is compiled from InvestorsIntelligence.com.
The light blue line is the dollar price of a broad stock index of the 500 biggest companies in the US. The yellow line is a confidence or sentiment rating concerning that stock index. What does this chart tell you?
The most obvious thing might be that this confidence rating is higher in 2003, 2004 , & 2005 than in prior years. This is despite the fact that the price of the stock index remains down considerably from prior years.
On a few occasions, sentiment has fallen to near 0 or neutral (the number of advisors reporting optimism equaling the number reporting pessimism about the broad US stock market). Look at spring '01, fall '01, fall '02 and spring '03. What happened next in each case?
I've added some thick white lines to highlight the reality that the periods of unusually low confidence were the periods followed by the biggest price rallies. The big surges in price followed brief drops in overall sentiment to neutral (.02 in the first and last ) or slightly pessimistic (-.09, -.15).
For the first three drops, confidence and prices got lower each time. Then, the confidence levels faltered before reaching .3, a key level in prior rallies. The price rally was the weakest yet off a low. Confidence had turned from generally optimistic to neutral. This of course, was the sign that there were enough folks discounting the possibility of a rally that there was enough pessimism to create the potential for a significant increase in confidence, which then produced a major rebound.
Next, despite the 46% percent decline in the dollar price of the broad US stock market, sentiment turned even more overwhelmingly confident. Considering that confidence in the US stock market has recently been far higher than when prices were much higher, what does that divergence mean?
Prices are significantly down over several years while confidence is significantly up. One might think this to be evidence that investors are discounting the possibility of a decline in stock prices- even despite a recent 46% decline of 2.5 years which barely brought confidence levels below neutral. Would you favor following the confidence ratings or the classic correlation suggesting that confidence surging high, far ahead of lagging prices, is a signal to sell?
The amazing fact is that confidence remained quite high even after such a decline- and then surged to even higher levels than before. This is a recipe for a major shift.
Another question for those who are still feeling optimistic about US stocks: if an unprecedented portion of investors (or advisors) are confident about stocks rising, where exactly is the next surge of investment into the stock market going to come from? Since those who invest are already overwhelmingly optimistic, the reality is that there may not be many pessimists left to convert to optimism. How can another rally develop... unless pessimists are converting to optimism and acting on that optimism by changing their market activity?
Remember, it is a trend of pessimists converting to optimism that produces years like 2003. Right now, there are many more optimists than pessimists and that means the potential for a decline is generally discounted and trading for a decline is thus a very reasonable risk.
Most mainstream investors are not familiar with how to benefit from declines in price, despite the prominence in recent years of bearish mutual funds like URPIX and BEARX. With moderate leverage such as 4:1 or 5:1 using ETFs, a 46% price change can produce some rather notable gains (and with much more flexibility than mutual funds).
Relax; the Professional Experts are extremely confident
So, if we clearly understand the basics of how confidence and pricing correlate, let's move on to an even more clear indication of the present danger: the amazing confidence of a particular advisor. This content may not represent all mainstream advisors in general, yet the nature of the commentary is quite revealing about the consciousness of at least some elements of the mainstream who are so (blindly?) confident about US stocks and so forth.
It is rare that I see something that is so misleading. That may be because I generally ignore mainstream advisors. When I saw this, I thought: "that's a great example of disinformation- an opportunity to have some fun at least." My latest study is from a PhD investment advisor of a major Western US Banking Syndicate.
I find the following amusing, though it is also presented to reinforce the danger of what I call mainstream irrationality or denial. Then, I will expose even more about the reality of markets in recent years.
DO NOT WORRY- EVER
While I don't recommend worry, I prefer recognizing what is most probable, then acting in accord with that. If the choices are responsibility and neglect, what would you choose?
Again, note that there is nothing distinctive about this forecaster (in my opinion). His comments may simply reflect the desperate logic common throughout the mainstream. But don't let all my comments bias your interpretation of his words.
Briefly, he points to certain statistics as allegedly indicating the strength of markets. However, he admits that those are the same statistical patterns that preceded the economic contraction from 2000-2002 as measured in US Dollars.
Is such similarity proof of strength- or only proof that folks didn't learn their lesson with the 46% drop in the dollar pricing of the US S&P 500 stock index? That little tap on the shoulder from the markets may be a followed by a few sharp slaps in the face to snap the mainstream out of their stupor (of socialist imperialist consumerism?).
Quick question: in early 2000, just before the first major 3 year global stock market decline (in dollar pricing) since 1929, didn't "Professional Experts" almost universally agree that "everything is fine?" Why? Well, because of the "tremendous strength" in these same statistics, of course! Ah, now you are either sweating or laughing or both, right?
1) Real Compensation rates (wage levels) are nearing the levels in 2000. So relax. Sure, every time this statistic has reached this level in the 35 years charted, it has dropped dramatically within a few years, but relax! Why? Relax because our accounts at the bank "credit laundering service" are insured by the Federal Government- which means that if anything unexpected happens, the American people will pay for it, not the banks!
2) Accountings of household net worth are at all-time highs, just like 2000. So relax- just like you did in 2000.
3) Total Employee figures are at all-time highs, like in 2000. Of course, if the US population has grown more than 3% over the last few years, which would not surprise me, then the employment RATE would be... down. So relax- just like you did in the early 1970s.
4) There is renewed growth in retail sales, again, just like in 2000. So relax- just like in 1929. In case you missed that: relax- just like in 1929.
5) Consumer Confidence- my favorite- is back up to "normal" levels. Well, it was up prior to that Professional Expert's September 2005 publication. Here is updated data.
I'll diverge briefly to note that I actually expect the "retail" holiday boom of the next few months to correspond to renewed confidence at a new bear market high- before reality sets in sharply. [This comment of mine was first published on November 12, 2005- along with almost all of this "DO NOT WORRY" section.] Another seasonally popular topic has been energy prices. Many folks have been afraid of high natural gas prices and such and I think that the recent 10% 1-day increase was an over-reaction (i.e. panic), not to be confused with the 600% steady increase in oil prices over the last 6-7 years.
What if both "over-reactions" and long-term changes are predictable? What if we can generally distinguish- in advance- between long-term changes and short-term excess in confidence (or pessimism)? Even if we do not recognize such distinctions in advance, merely being alert for such things may differentiate us from the mainstream as it is.
If nothing else, the one-day 10% leap in a relatively prominent market like natural gas shows that there is panic in our midst. However, the inertia of mainstream denial/imprudence has to be exhausted before capitulation and panic in primary markets like stocks, currency, or the speculator's prize: real estate.
Of course, you should relax just as if it is now March 2000. Why? Because this Professional Expert insists the financial markets are booming... again (still):
Hmmm. Where to start?
Here's something; were you expecting a "trendless" stock market? I wasn't and I am not. This "trading range" of the last few years (in dollar pricing) is a normal, predictable counter-trend bounce (in dollar pricing) off the 3-year decline of 46% (in dollar pricing). As for the "trendless" stock market (and "recovery"), I imagine he hasn't seen the stock chart below- adjusted by the market value of US Dollars. That "accounting" shows a rather solid decline in tangible purchasing power for stocks over the last several years.
I see he also just stated that "after mortgage yields have been higher for a period," the consumer would be more "likely [to] FAIL." Oh, you mean that the holders of Adjustable Rate Mortgages will default as rates rise? If that is what he is implying, I agree. But I don't know if he even knows what he is saying....
He titles one piece "what do global stock markets know that bond markets don't?" In other words, he notes a divergence, then picks one data set that fits his bias and dismisses the other, right? (AGAIN, THIS IS A REAL MAINSTREAM PUBLICATION- NOT A JOKE!) Sure, bond markets may be much bigger than stock markets, why not just dismiss bond markets anyway?
Otherwise, we'd need a headline like this: "what do stock market investors ASSUME that bond investors don't?" Of course, that might not fit the interests of the publishers of his article, so who can blame him?
Next, he references Price to Earnings ratios, noting that they are far above historical norms, but lower than in 2000, so in this case, is it suddenly GOOD news that things are not as they were in 2000. Of course, he doesn't emphasize that reduced excess is still excess. The somewhat reduced P:E ratio in US stocks (which means improved valuations as in more discounted) still have a long way to go down to reach normal levels.
Again, it's not like these folks have any direct stake in the accuracy of their advice, right? Do they earn a decent percentage of your profits... or just commissions? (And, remember, their debt to you is FDIC-insured!)
Yes, the piece continues, world stocks markets are recovering, and some small markets are at all-time highs. Doesn't that mean that there is more interest in developing markets than ever before- relative to major markets like US and UK and Japan? (The Nikkei is still down, hmmm, about 70% since it's all time high in 1989. About 70% down reminds me of the US NASDAQ from 2000-2002 as well as the US S&P 500 over the last 6 years... in terms of tangible purchasing power- more on that later.)
Yes, borrowing is up. Now who would consider that a sign of strength? If you are thinking "a bank" (or "an employee of a bank"), you may be right.
Again, business lending is back up to near 2000 levels: a clear sign of positive things to come just like in 2000 and 1929, right? More borrowing is a sign of strength, huh? Maybe that is why your spouse keeps buying more and more things on credit- to put you deeper in debt... so you are financially stronger!
So, the mainstream advertisements and speculations are worth just as much today as they were in 2000. Do you understand what I am saying? Can you "handle the truth?" If not, that's fine. Why get caught up in the flurry of worries?
Instead, repeat this constantly: "investors should be focusing away from such issues towards the many positive things... yet to occur." That's right- just focus exclusively on what is not actually happening.
And by the way, here is an emerging trend that is poised to explode soon: a big boom in a very specialized real estate market. (I tell you this because it is only fair to disclose the investments owned by the author of the above piece, right?) Your favorite Professional Expert has recently purchased some desert property and is selling holes in the sand... just the right size in which for you to stick your head.
I'll let you draw your own conclusions. Here is one question that you may find relevant:
Consider that when there are 100 people in a locked room, and 90 are sitting down, how long will it take for 11 more people to sit down? Well, since there are only 10 other people, first someone who is already sitting will have to get up to make 11!
No, markets are not locked rooms, and if folks can afford to participate in a given trend, they can pile in even when sentiment percentage are in the 90s. But if there was a big surge in new investment, such things would be measured in volume trends (thus volume is basically the simplest sentiment indicator). If folks are piling in to buy, but in decreasing volume day after day, what does that mean? That may be a hint that the rally will be relatively short. This happened in US stocks around the end of November (though typical of holiday weeks).
So, before I end, let's look at stock performance from a different perspective. Normally, folks look at stocks only in terms of the local currency. What if we look at US stocks in terms of Euro or Yen pricing? Will the chart look the same? Because currencies fluctuate in value, pricing an investment in a different currency could show a different pattern- some very different.
Therefore, I suggest to you that the mainstream pattern of looking at long-term investment charts in your local currency is not the most revealing choice. Indeed, charting the prices of an investment in terms of any currency is not the most revealing choice.
Those who price an investment in any the ratio of exchange for any single other investment are still using the same basic idea. In other words, all the charts like stocks in terms of gold or silver in terms of gold only illustrate the divergence of the different methods. They do not resolve the basic issue.
I have used dollar charts corrected by a basket of currency forex rates. That is a reasonable idea, but for long-term charts, this doesn't get around the issue that all popular modern currencies are subject to wild fluctuations, like many currencies in the 1990s (in Mexico, Brazil, Russia, and across Asia), like the German DeutschMark in the mid-20th century, or like the 41% overnight devaluation of the US currency on January 31, 1934.
If you want to measure something's actual real-world tangible purchasing power, why not use a basket of commodities? The US government uses a certain index of real goods to measure the US currency's purchasing power. However, for traders concerned with long-term international trends, as well as interested in correcting for mainstream miscalculations, I note the CRB index.
According to CRBTrader.com, the CRB or Commodity Research Bureau first published in New York City, USA on February 3, 1934 in response to the devaluation of the US Currency. The CRB Index has naturally been adjusted since then, including for the enormous emergence of a certain commodity called oil.
This commodity index is really an indicator of the value of the US currency. CRB simply measures how much the US currency can buy of various commodities, generally a fixed set of commodities of a certain weight. While prices all over the world of course may not match prices at the New York Board of Trade, I ask you to consider that the CRB is simply a tool made by investors for investors (measuring the actual behavior of huge numbers of investors in relation to the buying and selling of a wide range of major commodities).
So, in terms of something tangible like the CRB, how do stocks look? Again, this chart simply shows the relative performance of stocks to a wide range of standard commodities (instead of relative to the fluctuating US Dollar).
Simply, there has been no US stock rally for 2003-2005, but a rather consistent trendline of decline for nearly 6 years. Note that there isn't much outside of the black trendline for the S & P 500 index of the 500 biggest publicly-traded US companies (blue) and the (green) global DJW index of a balanced group of international stocks. The Dow Jones World index may look so much like the S&P 500 because in the US is indeed a sizable concentration of all the wealth (or at least stock trading) in the world today.
So, what is the point of all this? If stocks were about to make a huge long-term rally, sentiment would be at a major low (which it is not). Neutral sentiment or slightly negative sentiment for a few days is not a major low. In other words, the vast majority of folks would have to be discounting stocks for there to be the significant possibility of a major long-term rally (like that of 1975-2000, for instance).
What about the "discounting" of October 2002? According to the CRB-adjusted chart to above, that was just another step in the middle of a very long stairway. Because the vast majority of investors may focus on dollar pricing and neglect to consider the tangible returns of their investments (like stocks), most got even more optimistic during the dollar pricing rally of 2003- setting things up for a severe panic in the near future.
Please be very clear on my implication. What you see on the chart above is not indication of a major panic by the mainstream, but only a catalyst for a shift in the very near future from complacency to capitulation (outright panic). When this panic is over, you won't need a chart to tell you there was shift- even if you are a mainstream American. You will know when the vast majority of people have greatly reduced access to tangibles, commodities, real goods- which is already evident in Japan and many less developed places. People may have more access to hyperinflated units of fiat currency credit, but when you are hungry or cold, that is little consolation.
you know the Biblical and Constitutional principle of using fixed measures and weights, you will recognize that the US currency of the last 92 years is not it, as the CRB index specifically shows. Nevertheless, the US Currency is virtually unchallenged as the most popular investment in the world today, at least for the modern mainstream.
Below are two images of US currency from times past, a Federal Reserve Note from 1934 and US currency pre-Federal Reserve. Notice the difference between these two bills, then compare them to the ones that may be in your pocket. Do you notice any words on the below images that are not on your bills?
Here, I am not going to tell you any more on the good news as I see it, nor of the various adjustments that I consider appropriate at this time. I remind you that when the mainstream discounts something, this may present an enormous opportunity. For investors in particular, I also remind you that you can profit from price declines in many ways, including of course buying (or keeping) a deflating currency. Of course, all trends that begin also end.
© 2005 J. R. Fibonacci
J. R. Fibonacci | Horizons Unlimited Investing | Snowflake, AZ USA | (602) 334-4705