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September 30, 2002

Indifference Spells Opportunity
by Ed Bugos

I don't remember the last time the Dow declined six months in a row
- Bruce Stratton, Safehaven.com

Bear Talk
September's 1000+ point decline in September in the Dow makes it the sixth month in a row. Our guess is the final bottom in this bear market will come when nobody cares. If one were to correctly deduce how far we are from that prospect today (it would still have to be a good distance I think) we'd argue they'd be in a better position to estimate a bottom.

How many investors, for instance, would you guess cared that the market bottomed in 1933, after falling nearly 90% over four miserable years from its peak in 1929? It's a question I don't think the empirical evidence could answer directly. What I mean is where investors, after watching their investments shrink to near nothing, choose a sitcom over the financial news channel; where they don't return their broker's calls; where they rarely open up their statements, or when they do, look for a cheque with hopeful but knowingly wasted anticipation; where investors simply give up expending any energy either looking, or willing a bottom.

This day hasn't arrived yet, or at least such symptoms have not been evident broadly enough to resemble a major market bottom. Richard Russell (Dow Theory) said in his Sept 27th letter that the number of US households that own stocks has grown between 1999 and 2002 by 7.1% (to more than half), according to the Investment Company Institute. And this despite the 2-½ year bear market. We have the Fed to thank for keeping them all long. In the same letter, which illustrates our point on bottoms:

Bear markets end with people "hating" the stock market, bemoaning their losses, and swearing that they'll never have anything to do with Wall Street again. Bear markets end with heads-of-households boasting that they have nothing to do with stocks. Bear markets end on low volume and battered blue-chips and low P/E ratios and fat dividend returns - Dow Theory Letters 27/09/02

From anecdotal accounts as well as the literature of the day we can surmise that by the time the Dow put in a bottom during 1974, investors had already given up hope. The average fell only 45% from its peak bull market value, but the damage was much worse in the broader market, which continued to decline until gold and oil stocks picked up the slack in the midst of the greatest dollar devalution since 1933 - 1947 (where the dollar fell by 40% against gold and about 80% against most commodities after FDR delinked it from gold).

If anyone called a bottom in either 1974 or 1933 nobody today remembers. At real bear market bottoms, almost nobody has the guts to call one, and if they do, nobody is listening, because people don't want to own stocks, they want to sell them. At a real bottom the vast majority of stock holdings have more value in their potential for tax claims, or tax losses, than for capital gains. It's far more popular to show humility than it is to display arrogance, the camp believing such bottoms no longer occur vanishes from influence, skirts get longer, etc., etc., you get the drift.

Today, the bulls still argue the economy is strong, that it's going to avoid another recessionary dip, and that stocks will bottom soon. They still argue that profits will rise from here on in, led by consumption. All of this nonsense has been financed by the Fed's monetary policy in that if it weren't possible to slash rates from over 6% to under 2%, none of these arguments would hold any water for long, never mind exist.

Indeed, that hot air is about spent. We feel that the real bottom has yet to arrive. The day that nobody cares about stocks also has yet to arrive.

So far, our market adage has held up with respect to gold's bottom in 1999. I was there, and it's true, nobody cared.

The British government announced at the time it planned to auction the remainder of its gold. The announcement was taken very bearishly. It knocked gold prices down to fresh post-82 lows, unintentionally of course. The bank wouldn't have intended it to happen that way. Bankers like to play dumb when it's convenient. But that's not our point. Our point is that the bottom gold bulls had been waiting for finally arrived, but nobody cared in 1999. They were all long stocks, and evidently still are. I do not remember if we thought it was the ultimate bottom, at the time, but I do remember that we're on record for saying it was during 2000. The verdict is still obviously out. We could be wrong.

Only markets and history can prove our hypothesis right or wrong, and I don't think the world's banking elite has any interest rate leverage left to alter either.

Certainly, nobody cared when oil prices bottomed in 1998. Oil was seen as no longer essential to the economy, relatively speaking of course. That's simply the way it is.

At market bottoms nobody cares for stocks, at market tops they love 'em, for the umpteenth time. We might not be able to tell exactly how extreme these swings will play out, but perhaps we're able to tell that the public's infatuation with stocks has yet to turn into indifference, or even hate. I think hate comes first, but who knows today.

Market Update
At any rate, several Dow components over the past two weeks have issued earnings warnings for the third quarter. The warning by Wal-Mart on Monday, from Philip Morris on Friday, and the bearish Wall Street research issued on GE were only the latest in a long line of third quarter frights that have resulted in new bear market lows for the stock in question. 13 Dow components are now below their low in July (before Monday). Philip Morris, SBC, and GM fell through this low just last week. Morris and SBC just on Friday. And several others appear to be telegraphing bearish technical behaviors. Here are two examples.

JP Morgan landed right at its July low on Friday, and could be ready to take the average lower. Most of the main US stock market averages are holding their July lows at the moment. But they are weakening technically from the inside. Important leaders are giving in to the bearish chart arguments, one at a time. I think an important selling climax lies just ahead, which will turn into a rout for the dollar. It could be this week or the third week in October, but our radar says it's close.

Bears should be mindful, however, of two facts. First, the bond bubble during the past few months will have boosted profits for those banks with large dealings in fixed income operations. Goldman Sachs revealed that in its third quarter report, which ended in August. Citigroup and JP Morgan's quarter end in September. I'm no expert in the specifics of their business, but I doubt they were short T-bonds.

The second factor to consider is Citigroup's settlement (or plea bargain), which involves groundbreaking guidelines that promise to separate its research from its investment banking activities. That's all subject to Spitzer's approval apparently. He's been reviewing the offer since Friday we understand.

There's always the chance that if it were a good enough plan to get approval, stocks would rally on the news. For although GE is still a leading Dow component, any relief in the bank sector could force a brief correction in bearish sentiment. Whether it's ignited by a bullish outcome in the Spitzer offer, or by the prospect for not as bad as expected profits for the bank stocks' third quarter, or strictly technical arguments for a bounce, the rally wouldn't have much substance either way.

With respect to a postive settlement with Spitzer, it would probably involve a greater cost burden to the industry one way or another (even if it might settle some investor's minds about near term liability issues). With respect to earnings, the bond rally is just a temporary offsetting factor... one of those stabilization things Greenspan has received credit for recently.

Moreover, we are skeptical Citigroup is able to come up with a way to do what is impossible, and we're skeptical that Spitzer will be happy with whatever settlement the bank is offering at this point. Isn't it too early in the fact-finding process?

Furthermore, the negative contributions to earnings from rising default rates, collapsing investment values (which the bank is exposed to), and a shrinking investment-banking business are more than likely to ultimately overpower any temporary good news. Though the bulls probably hope otherwise.

Undoubtedly, the bulls hope this is the worst of it and that "all the kids with the good report cards" are going to announce bullish earnings news from here on in!

We don't think so. It would be sound to bet on a few bearish surprises in light of events and indications I think. And it is unlikely that bulls can persuade anyone to bet on bullish earnings reports this time around. The best bullish argument is the fact that the averages have yet to pierce July's lows, and are trading at critical bullish chart support on Monday. The case can be made that a short term victory for the bank sector could postpone the break down for a few more weeks.

But beyond that, we think Dow 6000 is closer than ever. There's still a lot of riff-raff to weed out in this market's healing process… speaking of which…

Greenspan's Royal Charter?
I guess the Queen doesn't agree with our assessment and charge that it's the central bank's monetary policies, which are responsible for the biggest bull market in history followed by the longest bear market in at least 3 decades… and counting. Either that or we've hit the nail so square on the head they figure a Royal stamp of approval will keep the public from figuring it out a while longer. For, despite the obvious volatility in world capital markets, the Queen has given Alan Greenspan credit for stabilizing it all. Go figure. I'm so confuzed.

I think Alan should change his name to Arthur. It sounds better.

Sir Arthur Greenspan. I too would like to thank him for the stability he's brought to the world's economic system. As the Queen of England knighted him, last Thursday, it would have probably been appropriate to hear her say, 'well done Alan, you've accomplished peacefully what we failed to forcefully 226 years ago.' Controversial?

It might sound so, but I doubt it would be entirely inaccurate to contend the visions of America's founding fathers, for limited government, have been all but lost. More arguable perhaps would be the statement that it's an entirely new America today. One where limited government has been replaced with limited economic freedom, and one that is only notionally connected with its original Constitution. It would have to be a good arguer to prove otherwise though, and the best I think they would be able to do is to argue that our freedom hasn't actually been limited. It's still a democracy after all.

Of course it is, unless you're a producer. The concept of economic freedom applies to the system of production, not the consumer. Consumer sovereignty is a different, but associated matter. It's what producers depend on to determine what to produce. If the consumer didn't have sovereignty the state would necessarily have to plan production. If by democracy people mean the state has the free choice of whether to interfere with the private system of production or not... well.

Economic freedom is limited under a planned system because the state (whether it's leaders are democratically elected or not) decides what to produce, rather than the private owners of property and capital. A democratic election would be reduced to a choice of the candidate with the best economic "plan."

Of course the 'consumer' in such a system is free to cast a vote in the marketplace with whatever wealth he or she may possess, and among the various (necessarily) limited choices, but the votes would not really count, because to the planners of the system of production, it doesn't matter what the consumer actually wants. It only matters what the politicians deem correct (or want) to produce. In most planned economies, the concentration of power is thus necessarily in fewer hands. The more centrally planned they are, the more this is true. It's the ugly truth all socialists will work hard to hide from the public.

Unlike the political system, and despite the similarities on the surface, a free market economy is founded on the system of private property, anarchistic production, and of the consumer's sovereignty in the actual market place in determining production. Although it's true that the consumer's market choices are akin to votes, they cannot be equal, and only mean anything at all to the extent producers respond to them.

It may indeed be arguable whether the free market system of production has been displaced, or subjugated, as the increasing clamor for government intervention has us believing, but it is inarguable that we've become dependent on it (government help).

Why for instance do so many analysts, journalists, and corporate executives today clamor for their "government" to do more about the weak economy, as if the government could actually do anything? I know our views seem outmoded. I don't know what to say for being so young and believing in such outmoded things, as these. The government, after all, continues to receive credit for what it has done for the economy. It has replaced the market in this role (else the knighthood would have gone to an entrepreneur?). The economy around us is supported by policy, rather than real stuff. It's true, we keep saying so. Many disbelieve us, yet the next day they ask their government to do something about the economy.

Thus, the question today is whether we're producing what the market wants or what the government wants. In case you weren't aware, the Federal Reserve's mandate, which expired in 1999, was full employment.

Thanking a civil servant for the accomplishments that capitalism is supposed to achieve is perverse, and really only proves that we are right about the state of the market system. It proves that it wasn't capitalism that achieved full employment in the nineties, it was government.

Cutting tax rates is terrific. It means smaller government. But when people at the same time say, "the Fed should've done more to sustain the boom," then essentially they're making those tax cuts unsustainable. It's hardly outmoded to observe the irony in the fact that the Fed is widely perceived as a symbol of capitalism because it issues what people largely (and maybe wrongly but that's besides the point) perceive as money. If this is what people do in fact believe today - and why else would the protestors of capitalism be following the World Bank and IMF around the globe - then our thinking will not stay outmoded for long. For, the breadth of that kind of ignorance surely must be unsustainable.

Personally, I think the Fed's "risks are weighted towards economic weakness" speak is destined to compete with Bush Sr.'s "read my lips, no more taxes" speech for the western political world's most palpable lies. The Greenspan Fed is utterly responsible for the market volatility today. Markets are not inherently unstable. They are made so by the special interest groups that citizens empower, owing to the misguided dual belief that markets are unstable, and that the government can do something to stabilize them.

My favorite quote below illustrates the principle we consider to be at the root of the entire economic and constitutional problem today, or more accurately, the principle that has proved impossible to uphold.

Those who give up liberty for the sake of security deserve neither liberty nor security - Benjamin Franklin

This is as true of the birth of the Federal Reserve (thought of as a lender of last resort) as it may be of Bush's Homeland Security plan, and it is even truer when one considers the empirical evidence supporting the claim that government is no longer limited in the land of the free. An old vampire myth has it that a vampire can only come into your home if you invite him. It's uncanny how our fantasies relate to real circumstances.

Governments can't help the economy, they can't help the individual, their resources are not unlimited, they can't protect you from the animosity of foreigners whose ire they raise without your consent. They certainly are not the individual's friends and if the individual ever had an enemy that justified protection it would be the government.

They cost money, start wars, and engage in the process of wealth reduction, whether wittingly or not.

I wonder what Benjamin Franklin would think about his picture on a Federal Reserve note? It seems to me like the kind of mocking of America's roots reminiscent of the current aristocracy. I bet he's turning over in his grave at the thought. For, these notes are the epitomy of a false sense of security. And Greenspan's knighthood is the epitomy of the world's contemporary economic ignorance. No shame belongs to the Queen. The shame belongs to the ignorance of America's new order for betraying the principles of limited government that made America the symbol of freedom and individualism.

Just Say No!
The country is engulfed by a despotic government at a time when the winds of totalitarian sentiment are on the rise. If the individual won't make a stand now (just say no to more government help), the most dire social consequences will necessarily follow America's economic demise.

Sincerely,
Edmond J. Bugos
GoldenBar.com

Edmond J. Bugos is the founder and editor of the Goldenbar Report - calling markets accurately since 2000.

The GoldenBar Report is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

Copyright © 2000-2008 Edmond J. Bugos

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