The recent 8 week rally in the broad stock market has come to an end. The bear market rally from an intraday low of 768 on October 10th to the intraday high of 954 on December 2 represents a sweet 24% gain if you managed to catch it, but still nothing more than a counter trend bull rally in the larger unfolding bear market. If you are still holding equities of any kind, in any of your accounts, now is the time to sell!
Pop Goes the Bubble - Part I
Sell Stocks Now!
9 December 2002 * M.A. Nystrom
I am often dismayed when my less financially inclined friends and relatives look at my website only to report back to me, "I don't really get it." These are not, mind you, stupid people. It simply appears that they find the subject of money, markets and investments to be too complicated for them to understand, thus they do not even attempt it. This is where the herd mentality of humanity becomes most apparent - not knowing what to do, many people choose to look around at their peers and do what they see others doing. While this can be a safe and profitable strategy at times, now is not one of those times.
Market Cycle Has Shifted
In the years from 1995 - 1999 the stock market was the place to be, rising every year like clockwork, close to 20% per year. During those years it was easy, fun and profitable to practice the monkey-see monkey-do strategy of investment. With buy and hold, it was nearly impossible to go wrong, and many fortunes were made, and many investors made to feel very, very smart. But while times can change quickly, the change is often nearly imperceptible at the time and it is only much after the fact that the realization hits that things are no longer what they seem to be.
Though the world did not come to an end with Y2K, a fundamental shift did occur in the financial markets with the passing of the millennium, and in many respects, the world will never be the same again. The fundamental forces of peace, prosperity and growth that drove the bull market of the 1990's have given way to war, financial insecurity, over capacity and contraction in the new century. This fundamental shift demands a new way of looking at the world, and a new way of thinking about investing and wealth preservation. Everything in the world around us operates in cycles - the sun rises and sets, the seasons change, individuals are born and they die. The stock market is no different. No more wise would it be to attempt to practice the investment strategies of the 1990s than it would be for a farmer to attempt to plant his crop in the dead of winter. Both shall meet with failure.
Growth vs. Preservation
The high growth experience of the 1990s has unfortunately trained people to expect to be able to achieve high levels of growth under any circumstances. This is a fallacy. The three years of the new century have seen but three years of declines. The speculative Nasdaq has fallen over 75% from its ultimate Y2K peak to its low so far. The broader S&P 500 fell 7% in 2000, 15% in 2001 and approximately 22% year to date in 2000. What many people thought of as "money" in their brokerage accounts has simply evaporated with those declines. If you are one of the millions of investors who dread looking at your investment statements because the value of your assets have been cut in half or worse, then you are aware of this phenomenon.
The perma-bulls, those who believe that stocks will only ever advance, are happy to delude themselves that a new bull market has begun with the latest 20% rally. But markets do not go straight up or straight down. In stairstep fashion, they find their way to their true value. The market has had many impressive rallies since its peak, and each time it fools millions of investors into thinking that the bull is back, it gets them to commit their hard earned money on a speculative whim, and proceeds to demolish and destroy it. Chasing growth in this environment can be treacherous.
Make no mistake about it, money can, has, does, and will continue to disappear into thin air. The most recent and salient example of this is the case of UAL, which recently declared bankruptcy. If you had subscribed to the "buy and hold" investment philosophy with this stock, you would have seen the value of your investment fall from $90.00 to $00.90 in the span of 5 years, a negative 99% return. Last year at this time the big bankruptcy in the news was Enron. This year we have seen Kmart, WorldCom, and Global Crossing, among the largest bankruptcies ever. In addition to size, the volume of bankruptcies is increasing. More publicly held companies -- 257 -- filed for bankruptcy last year than ever before. In this developing environment, it becomes much more important to preserve your money than to chase growth.
We believe that the dawning depression will be deflationary in nature. Deflation, by definition, means that the money supply is decreasing. As the money supply decreases, prices for a range of goods and services fall. But what causes the money supply to decrease?
The definition of "money" is quite tricky. Investors will often say, "I've got money in the market," meaning that they own stocks. Or they may refer to "money" in their retirement account that is invested in bonds. Or even money at the bank which in truth is sitting in a money market account of short term debt.
If you imagine that said investor's "money" was invested in UAL stock, UAL bonds, and UAL commercial paper via the money market account, you can imagine his utter shock when he discovers that nearly all his money is gone! With less money, he is less willing to spend. Employees of UAL who find themselves unemployed may be forced to sell assets to pay off debts of their own. This means they bring to market stocks, bonds, possibly their homes, automobiles, books and cd collections…anything to raise cash. Amazon.com does a thriving business of used books that sell for a fraction of the price of new books. Ebay is another thriving marketplace for discounted goods. The result of the rush to raise cash is deflation, as sellers undercut one another in order to cash in.
As prices fall, companies find that they must lower prices in order to remain competitive. Mitsubishi is still offering the 0/0/0 promotion - zero down, zero interest, and zero payments until 2004 for a brand new car! It is similar to the promotions for young borrowers wishing to purchase new homes - little down, low interest, and low payments for anyone with a job. But as the economy continues to grind down, and these buyers find themselves unable to make these payments in the future, the assets will come to market at vastly discounted prices, contributing further to the deflationary cycle. With little or no equity invested in a house or an automobile, it will be easy for an individual to simply toss the keys back to the bank and say, "Thanks for the ride - you can have your worthless asset back!"
Preservation is Growth During Periods of Deflation
Finally, we arrive at the main point of this article: Sell stocks now! If you have not done so already, this is the time. Even after its historic declines, the majority of stocks remain massively overvalued by historic standards. From our perspective, the intermediate top in the market is in. The stock market is unlikely to see these heights for years to come. In this environment of falling prices of assets, goods and services, simply holding onto cash is an intelligent investment decision. As prices fall, the value of your money increases. This is a simple no brain strategy for the time being. Preservation is growth during periods of deflation.
But just as buy and hold did not work forever, this strategy will not either. At the end of the day, all money, including the cash in your wallet, is simply an illusion. It is accepted by other individuals, banks and businesses because we share the same collective illusion. At one time, we shared the illusion that Enron was the 3rd largest company in America, and that the Nasdaq was fairly valued at 5,000. Just as those illusions were shattered, the day will come when the U.S. dollar is sneered at with derision. When that day comes, you will no more want to be a holder of the USD any more than you want to be a holder of UAL today.
But that story is for another time.
Popping the Bubble is a Process
When I first became aware of the stock market bubble, and the fact that it was going to pop, my assumption was that it would happen much more quickly than it did. The financial system has proven to be much more resilient than I expected, and fiscal and monetary policy have apparently acted to mitigate the destruction. Over the last several years, I have come to understand that the popping is a process, and one which will take several years to unravel and complete. This process is less than half over, and some of the most spectacular and destructive declines in the market are yet to come.
Many investors cannot bear to part with securities with which they have a loss. They somehow feel that until they sell, the loss is not real, and as long as they hold the stock there is the opportunity, however remote, to recoup the loss. This is a fallacy. Money is fungible, meaning if you lose it one place, you can make it back somewhere else and the money is exactly the same. Problems with selling losers have more to do with the ego and admitting fault than anything else.
It is important to note that in every case of financial excess - i.e. a bubble - the final bottom comes below the original starting point. Which means that by the time the process of this bursting of the bubble finally comes to an end, the Dow will rest at or below 2000, the SPX at or below 200, and the Nasdaq at or below 500, as rough guidelines. This means that we're still less - far less - than half way to the bottom, so there is still plenty of time to get out while the getting is still good.
This is Part I of a three part series examining the steps to take to position for the coming second great depression. Part II examines the housing bubble, and Part III looks at the U.S. Dollar. For Parts II and III, click below.