Sunday, August 7, 2011

The Global Equity Bear Market Is Back

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The global cyclical bull market in equities is over. What we saw last week isn't a correction in an ongoing bull market. This bear market is likely to be nasty and protracted. Before it is over, the early 2009 lows are at risk of being breached for just about every stock market in the world (excluding Greece, which is already far below the March, 2009 lows). Forget peripheral Europe, the core is now in big trouble. Ditto for the United States and United Kingdom. And did Japan ever really get out of trouble? China is toast for the intermediate term and so are the rest of the BRIC emerging markets.

Short-term, we are way oversold and due to find a bottom and bounce. Intermediate and longer term, it is time to get very defensive. I think Gold, the U.S. Dollar and short-term U.S. debt will continue to function as safe havens for the time being. Longer-term, the U.S. is in trouble and they will likely do the wrong thing - the deflation bogey man can quickly turn into the heavy to hyperinflation bogey man with one more major misstep. I like the U.S. Dollar around these levels for those that like to trade currencies, but I'll stick with physical Gold held outside the banking system and will sleep very well at night. Even if we do get another 2008-like correction in the Gold price (if you can't handle a 25% correction, you will be shaken off this secular Gold bull long before it is over), this would only provide another stellar buying opportunity. Physical Gold is an investment for me, not a trade.

The Dow broke its 2009 lows on a weekly closing basis when priced in Gold. This is a big deal and portends a further major loss of purchasing power for those remaining in common equities. Here's a log scale weekly chart of the Dow to Gold ratio (i.e. $INDU:$GOLD) over the past 5 years to show you what I mean:

The "real" bear market for the Dow Jones Industrial Average started in August of 2009 as the above chart shows, but the herd doesn't recognize the pernicious inflationary effects of trying to reflate that which cannot be reflated at this point in the cycle until it is too late. Much like the 1970s, attempting to keep the stock market afloat will require inflation to be high enough that the actual retail investor loss for a buy and hold strategy during the secular bear market of the 1970s in the U.S. was as great as the 1930s on an inflation-adjusted basis. We are facing a crisis that is at least an order of magnitude greater for the US this time around, so the amount of inflation that will be needed this time around to maintain some semblance of the illusion of prosperity makes a 5 digit Gold price a reasonable proposition if policy makers do the wrong/expected thing.

If you thought the last bear market in 2007-2009 was nasty, what happens when whole countries are going under instead of just big banks? The amount of paper that will have to be emitted to "fix" this problem is mind-boggling. If a massive and unprecedented policy response isn't forthcoming, a deflationary-type crash where the Dow may well go to less than 5,000 will be the outcome. I think the political and popular will will favor massive inflation as the only palatable policy response. That doesn't mean it will stop the cyclical global equity bear market that has begun, but it may mean that the 2009 lows will hold or be only slightly breached in some countries.

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