How Long Will Deflation Last and Then What?

Question:

Real quick, the last time we spoke you mentioned to put our money in cash because of deflation and the banking collapse, but if we hit inflation in a few years would we need to then move it out of cash. I thought I remember us talking about inflation taking place closer the six year mark.

Let me know what you think.


Answer:

When it comes to predicting when scoundrels will be outed and then pull out all the stops to screw everyone regardless of whether it's obvious or not, it becomes a very difficult prediction indeed. There is no substitute for watching and being vigilant. Having said that, my guess would be 2-3 years but perhaps as long as six. The markets should hit bottom in about six years.

In answer to your question, yes at some point it will be appropriate to move out of cash. A likely sign will be that everyone will think you're crazy for doing so because everyone will be in agreement that deflation is the future and that there is no way inflation could re-emerge. Just the opposite of what it is now. Right now everyone knows that inflation is the future and thinks its crazy to be in cash. The only thing consistent about everyone following the crowd is that they always end up being wrong when it comes to investing.

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Market Update - July 15th, 2010 - Investor X

MARKET UPDATE 

July 15th, 2010 

Investor X 

Yesterday I ended the Market Update with the following statement: 

“If aluminum is a proxy for the overall health of the economy going foreword, what is the real message being broadcast here? In my opinion, it is showing weakness in the overall economy and that will become apparent by other numbers and statistics as they are reported. Stay tuned; we may be watching a whip saw unfolding here.” 

Today some of those conflicting numbers were reported, which are indicating deflation and a slowing economy ahead: 

NEW YORK (Dow Jones)--U.S. stocks skidded Thursday after a barrage of largely negative economic data stunted enthusiasm over the recent spate of strong corporate earnings. 

NEW YORK (MarketWatch) -- U.S. stocks dropped sharply on Thursday after another economic report, this one on manufacturing in the Philadelphia region, dimmed views of the recovery.... 

Producer prices fell for a third straight month in June...U.S. stock markets headed lower Thursday morning after the Labor Department said producer prices fell 0.5 percent June, signaling a slow economy. 

BEIJING (Dow Jones)--Steel product prices in China are falling close to cost price for producers and only some of the biggest domestic steelmakers will be able to squeeze out a profit on their goods, a senior Chinese steel official said Thursday. 

The above news indicates deflation and a double dip (depression). Lowering estimates before companies report bad earnings is an old trick that has been used by Wall Street for years. It works quite well in a growing economy and a bull market. However, we are in a shrinking economy and a bear market and so my expectation is that these old tricks will not work in this environment, because there are too many statistical tracks that must be covered in order for it to work. We will see – stay tuned for more economic data in the coming weeks. 

Regards,

Investor X

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Market Update - July 14, 2010 - Investor X

MARKET UPDATE 

July 14th, 2010 

Investor X 

The earnings season started off with a big bang yesterday as good news from Alcoa sent the markets rallying. Aluminum and copper use is so widespread and spans so many industries, especially the construction industry, many analysts view Alcoa’s performance as being indicative of the overall health of the economy. So, what was the good news reported from Alcoa? 

Alcoa cut 37,000 jobs, aluminum prices have dropped 20% in just the past three months as demand has dropped off a cliff, China has significantly reduced its purchases of aluminum and analysts estimated that Alcoa’s earnings would be 20 cents a share. Alcoa reported earnings of 13 cents per share or 35% below analyst’s expectations. As a result of this good news, Alcoa’s stock price charged ahead by nearly 4.5% at yesterdays opening. 

You say, “What is so good about that news?” Oh, I forgot to mention that the 20-cent analyst expectation was the expectation reported last month. During the past month however, analysts have been busy reducing their expectations by 40% so by the time Alcoa reported its earnings of 13 cents per share, analysts expectations were 12 cents. This beat analyst’s expectations by a penny and that is the good news that was the catalyst for yesterday’s rally in the markets. This just goes to prove that if you lower the bar far enough, any bad news can become really good news. 

The reduction of analyst expectations before earnings are reported is a game that has been played on Wall Street for years. However, a 40% reduction in one month is a tad much wouldn't you say? If aluminum is a proxy for the overall health of the economy going foreword, what is the real message being broadcast here? In my opinion, it is showing weakness in the overall economy and that will become apparent by other numbers and statistics as they are reported. Stay tuned; we may be watching a whip saw unfolding here. 

Regards, 

Investor X

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Market Update - July 7, 2010 - Investor X

MARKET UPDATE
July 7, 2010
Investor X 

The market appears to be much closer to the end of the current upward correction than it is to the beginning of the correction. In my opinion an attempt to sell out short positions at the beginning of the correction would have been problematic because, as I mentioned in my previous update, that would have necessitated being right on the sell decision and then being right again on the buy decision for such a strategy to work out. The best way to take advantage of these minor upward corrections, in my opinion, is to add to existing short positions toward the upper end of the rebounds. This requires that you be correct only one time.

I am currently taking some classes that are consuming most of my daytime hours. This will continue through most of August and therefore I will not have the time to be as active in sending market updates unless it appears that the market action warrants an explanation or when the markets get close to the end of the current decline. At that point a multi month rebound should occur prior to the major decline resuming (By the way, when you begin seeing a lot of Market Updates, that is probably indicative that a transition is underway. I typically do not write as many updates once the transition has occurred and a new trend is underway). I plan to sell my trading positions and perhaps a portion of the core holdings in my conservative portfolio and all of my short positions in my aggressive portfolio during that transition. The current downward trend should last for another month or more and erase another 1,300 to 2,000 points before it is complete. Then I would expect the next major rebound to begin. For the most part I have bought in the majority of my short positions and therefore, there is nothing to do over the course of the next month or so but patiently wait for the market to do its thing.

Regards,

Investor X

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Market Update - June 24, 2010 - Investor X

MARKET UPDATE
June 24, 2010
Investor X

The decline today should complete the current wave down. In my June 14, 2010 update I made the following statement:

“Once that high is in place, one of two patterns should follow:…

2) A down up down up down pattern (three downs) that brings the markets significantly below the low of last Thursday, which again was 10,061 on the DOW. This would indicate that the short-term advance is likely over and that the next phase of the decline is underway. 

The target for the current decline remains at about the same level, which is 10,061 on the DOW. Additionally, the current decline has exhibited three down waves, which confirms the major trend as being down. Given the stronger than expected rise before the current decline began, I do not anticipate that the current decline will bring the DOW significantly below the above cited level.

What to expect from here: The current decline should come within 100 points + or – of the above cited target (This may have already occurred this morning at the markets low of 10,185). Subsequently we should expect an upward correction that could last from a few days to possibly a week or so that will bring the DOW back up towards yesterday’s high, which was 10,367 and could rebound as high as 10,475. This should be the set up for the beginning of the next major plunge. For those of us who are short the market, it should be quite impressive. This should begin sometime towards the end of the month or perhaps the immediate days following the 4th of July weekend. Interestingly July 1st is when the states are required to fund their budgets. Many of the states are unable to do so and therefore, this might become a big item in the press following the holiday weekend.

Have a nice day,

Investor X

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Market Update - June 16, 2010 - Investor X

MARKET UPDATE
June 16, 2010
Investor X 


The DOW is getting close to the target I cited in yesterday's Market Update. The advance so far has been anemic with extremely low volume. This indicates that the bears are sitting on the sidelines for now and there is not much enthusiasm among the bulls to plow more money into this rally. So, the best way to describe the markets action so far this week is that it has been drifting slowly higher. Before I discuss my strategy to deal with this market, I would first like to take this opportunity to bring some perspective to the current situation in the markets.


What makes bear markets so difficult for most investors is the fact that upward corrections are typically slow and the topping and reversal process is time consuming. By contrast declines are powerful and fast. Wave bottoms, rather than being a slow process, tend to be a quick event. What this means is that during a bear market, in terms of time watching the markets, most of the time is spent watching the markets go up. Yet, overall the markets are declining. Another way of putting it is for the bears, the majority of the time is spent watching the markets advance and listening to the commentators explain why the markets have bottomed and why a new bull market has begun. Most investors cannot handle the cognitive dissonance this entails. It all seems too confusing and so it becomes much easier to simply follow the crowd while the crowd gets fleeced. Most investors simply do not have the tenacity necessary to stay the course in the face of the majority consensus hammering them with constant messages that they are wrong. Unfortunately, that’s the rules of the game, I didn’t make them but I do understand them.


That is why I mentioned in earlier updates that I instituted a core position of single short ETF’s that I plan to hold for a year or more and that I do not intend to trade these positions. In order to win the game this is the reality: In terms of time, one will be wrong 80% of the Time in exchange for ending up with a winning score. In my opinion, those who do not have time to follow the markets or those who find it difficult to psychologically deal with the above reality, it would be much better to buy in a core short position and then walk away from the markets for about a year. That will help to eliminate most of the confusion. Those who want to attempt to augment their returns and who enjoy playing the game can do so by adding to their core positions a few trading positions as well. The best advice I can give on this point is “To thine own self be true”. In other words make an honest assessment of your temperament and your comfort with risk and then invest accordingly.


As you know I have some trading positions in my conservative portfolio, that are double short ETF’s. I enjoy the game and so attempt to use them to augment my overall returns but I use them sparingly knowing that I am trading at a disadvantage. This is because, as I mentioned above, when a wave is topping it can be a long, slow, drawn out process but when a wave bottoms out, it is usually an event that may last for as little as a few minutes. For example on May 6th, the day of the so called flash crash, if an investor wanted to sell his short positions within 250 points of the bottom of the 1,000 point plunge, he had about 2-3 minutes to do so. If he sold just an hour or so late, the market would have advanced 650 points above the lows and he would have missed his opportunity. On the other hand, if a bull wanted to sell his stock within 250 points from when the market topped on April 26th, he could have done so anytime between April 5th and May 4th. So the bullish investor had about a month to sell out in order to have made “The right call” whereas the bear had only a few minutes. Additionally, that assumes he could have gotten his order executed at all during a period when most of the trading desks were frozen up.


If however one was not trading this market and was simply holding core positions, he would have found that three weeks later the market had dropped below the lows experienced by the flash crash. This is why for many investors it’s better to simply buy in a core position and forget trying to trade and time this market. This especially holds true for those who beat themselves up if they do not short at the exact high and sell their shorts at the exact lows. This is akin to a golfer getting depressed, upset and angry every time he doesn’t shoot a perfect 18. No one, not even Tiger Woods, expects to go out and shoot 18 consecutive holes in one. A more realistic goal is to do better than your competition and at the end of the game, when the final scores are tallied, to end up with a winning score.


This “game” we call the “Bear Market” began in late 2007 and will probably not hit its final lows for another five to seven years. So, it’s important to keep in mind that the score will not be tallied until the game is over. By then, many investors will have lost most of their assets and those who actually end up with a positive score, over that decade, will be rare. The media likes to cut the game into small pieces and act as if each small piece is a separate game and unrelated to the other pieces. I don’t know if that is because they are really that stupid or if it is because they try to keep their viewers confused and dependent upon their “sage” advice. As an example, we hear a lot these days about the risk of a “double dip recession” as if it were totally unrelated to the 2008 recession. Here’s a news flash, it’s going to happen and its not unrelated to 2008, rather it’s a continuation of the decline that began in 2007. So, don’t be surprised when you hear such things as “The economy has entered a Double Dip Recession” and “No one could have seen this coming”. Wasting time “hoping” that a “double dip recession” doesn’t occur is not a good use of ones time. Rather, knowing that the process that began in 2007 will continue until all the excess debt has been wiped clean, recognizing that their will be up phases as well as down phases during the process and actively preparing strategies to not be devastated by the declines when they do arrive is a much more valuable and productive use of ones time.


With the above perspective in mind, I’d like to discuss the current market in relation to my trading positions, which by the way, are only about 20% of the value of my core positions (which are single short ETF's being held long term and not being traded). As I mentioned above, this week’s rally has been anemic and unimpressive and therefore could stall out at any time. On the other hand, it could muster enough “Animal Spirits” to perhaps advance another couple of hundred points from current levels. Either way, it really doesn’t matter in my opinion because the probabilities are that a month from now the markets are going to be significantly lower than current levels. Therefore I am holding my double short trading positions through whatever short term advances the market may make from here. The reason is that if I sell to avoid any short term pain, if the market does advance a couple of hundred points, I will then have to buy them back in again when the rally is over. So, if I do nothing I don’t have to make any decisions but if I decide to sell, that will force me into making two decisions correctly, that is, 1) decide the best level to sell and then 2) decide the best level to buy back in. If I am wrong on either of those two decisions, I can end up much worse off than if I simply do nothing and let this short term rally do its slow and boring process of making a top.


That’s my thoughts on the current market. Have a nice day,


Regards,


Investor X

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