Issue 801 October 28, 2008
THE CRASH IS COMING
If you have been short the stock market since November 5,
2007, you are sitting pretty. That was the day I told my
Website's subscribers to sell their stocks and short the S&P 500.
Last Friday, the Dow Jones Industrial Average fell over 300
points. This was considered a good day. It had been down over
600 points in the first hour.
Yesterday, it fell 200 points. That was considered a not-
too-bad day. How it got there was typical these days: wildly.
It opened down 200, rose through mid-day by over 200, and fell in
the last hour to where it had been that morning.
Volatility is constant. The experts do not know whether
this market is ready to soar or not.
My guess: it's not.
Alan Abelson, who has been writing a wry weekly column for
"Barron's" for over 30 years, cited the work of John Harris.
Harris says that in the years since 1928, whenever a Presidential
election is accompanied by a bear stock market, the market
continued down to year's end after the election in four out of
four cases: 1932, 1948, 1952, and 2000. The average loss on the
S&P 500 was 5.9%, but on average the low was 10%.
Past is not necessarily prologue, but it surely is
The experts say that the traditional sign of a bear market
climax is a panic sell-off of shares. This is called exhaustion.
Exhaustion can produce a bottom. It also creates a sucker's
In October 2002 the S&P 500 bottomed at 777. That was one
of the strangest oddities in stock market history. On Friday the
13th, August 1982, the Dow bottomed at 777.
The S&P 500 arrived at 777 in a most intriguing way. It
closed below 800 in mid-2002. Then it soared back to about 950.
Then it fell back to 777. Then it soared again to about 950.
Then it fell back below 800. Only in the first quarter of 2003
did it begin its long trek back up. It peaked in late October
2007. Then the rout began.
The bulls are waiting for the final sell-off. They tell
people to stay in this market, yet they also predict a final
It seems to me that it is better to sell your shares -- all
of them -- and short the market. This way, you profit from the
final sell-off. But the analysts never mention this strategy,
let alone recommend it.
Despite the fact that exhaustion has not happened, the
analysts also assure us that the stock market is still
fundamentally sound -- Herbert Hoover's famous phrase from 1930
to 1932. There is bad economic news on all fronts, but somehow
the stock market is sound. Yet the economy is in recession --
something the analysts have denied until recent weeks.
The stock market's bottom is supposed to send a message: the
economy is going to recover in six months. Or nine months. Yet
the experts are now talking about a recession that lasts longer
than the traditional 11 months. Then why should the stock market
be close to the bottom?
"IS IT CRASH YET?"
The economy is slowly sagging. Thus has not been like a
fall off a cliff. It has been more like a stroll down a hill.
The overleveraged behemoths of finance have taken huge hits, as
have the taxpayers, but the economy is not showing signs of
anything remotely catastrophic.
There seems to be a disconnect between the stock markets of
the world and the world economy. The Hang Seng index of Hong
Kong is down by two-thirds over the last year. Yet the Chinese
economy, while slowing, still seems to be growing above 7%.
These are government-supplied figures. We should not take them
too seriously. But the trend is still positive.
Are the Asian stock markets not forecasting really bad news
to come in 2009? This is what bullish analysts ought to argue.
We are told that the Hang Seng index is selling off because
profit projections had been wildly optimistic a year ago. Maybe
so, but the question remains: Why?
The answer is the Austrian theory of the trade cycle. The
economic boom is created by rising monetary inflation. The bust
occurs when the rate of monetary expansion slows.
The Chinese central bank is slowing the rate of monetary
inflation. It had pumped in money (M1) at a rate of close to 20%
per annum for several years. Year to year in September, M1 rose
at less than 10%.
In June of 2007, I predicted what I thought was going to
happen in China.
The bubble in China resembles the bubble 1995-2000
NASDAQ in the United States. The Chinese stock market
is trading at a price/earnings ratio above 50. Some
stocks are trading at 80. In a speech on June 12, Alan
Greenspan commented, "Some of these price-earnings
ratios are discounting Nirvana." But let us not forget
that the NASDAQ reached a p/e ratio of more than 200 in
In late January, I wrote this:
At some point, China's central bank will be successful
in slowing price inflation. The economic boom requires
ever-larger percentage increases of the money supply.
By merely following the policies of the previous year,
the central bank will produce a recession. If the
central bank is serious about slowing inflation through
interest rate increases, it will see its goal achieved.
Price inflation will in fact slow. The cause of the
slowdown will be a recession in China.
What could trigger this? A recession in the United
States could. Falling demand for the goods produced by
China's export sector will produce bankruptcies in
China. They will order no more goods and services.
These effects will ripple through the Chinese economy.
In the absence of the recessionary efforts of central
bank policy, these ripples could be contained by growth
in the other sectors. But a reduction of Chinese
economic growth is already in the pipeline. The central
bank's policy of letting interest rates rise is
sufficient to create a domestic recession.
China is now where I thought it would be. China is cutting
jobs in the export sector. The government is intervening to save
jobs -- the standard approach of governments all over the world.
In short, the recession is spreading fast. The crash in
Asian stock markets is not a random event.
We have not had a crash in American stocks comparable to the
fall in Asian stocks, but the trend is relentless. The stock
market does not reverse for long.
Optimism is fading. But it still remains. The average
pension fund investor has not called the fund to tell it to stop
buying stocks. He does not have to tell the fund to sell -- just
Because companies match investments in 401(k) programs,
investors stay in. They are told endlessly that American stocks
will return to their tradition of producing 7% per annum returns,
despite the fact that the Dow is down sharply from its peak in
2000 of 11,700, even without the 22% loss to price inflation.
The bulk of retirement investors still believe the mantra,
despite the evidence.
The falling economy will push down profits. This will push
down the denominator of the price/earnings ratio. Prices will
The stock market has obviously reversed its momentum. It
heads lower, week by week. The public cannot seem to come to
grips with what I have been predicting ever since last November:
the end of the boom in stocks and the coming of a long recession.
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I think the market will get exhaustion. There will be a
sharp move downward. But I also expect to see a repeat of 2002
and 2003: spiked upward moves followed by spikes downward.
When will this happen? I don't know. The market is
grinding away investors' optimism. This psychology has not yet
moved to real pessimism -- when investors abandon the constant
slogan, "Don't sell in a panic."
They should have sold calmly a year ago.
The Federal debt:
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