The night they raided Minsky

Australian economist Steve Keen summarises Hyman Minsky's Financial Instability Hypothesis, which is that you get bubble after bubble, each time increasing the debt, until the process simply cannot continue and all will be catastrophically revealed.

So he's another forecasting and fearing systemic collapse - like Marc Faber and Max Keiser recently - and now Karl Denninger.

As the Dow heads for 10,000, the FTSE soars above 5,000 but gold seems now to be consistently drifting beyond the $1,000 breakwater, I feel of the bankers, traders and politicians, as Talleyrand said of the Bourbons, that "They have learned nothing and forgotten nothing."

Straws in the wind, the flight of birds

Yesterday, I read the entrails and thought the market was due to tank. Today, the FTSE drops 102 points, the Dow 290. Tomorrow - "¿Quien sabe?"

Protecting against inflation

Before we start, please read my disclaimer above!

How do we protect our little wealth against inflation? The gold bugs still enthuse, and it's true that if you'd sold the Dow and bought gold at the start of 2000, and bought back into the Dow now, you'd have multiplied your investment by 5:

But looking at the historical relationship between the Dow and gold, it seems the Dow is already below par.

When Nixon closed the "gold window" (15 August 1971), gold ceased to be a currency backing and became just another thing you could choose to invest in, so let's compare these assets from a little before that turning-point, onwards:

The gold-priced Dow is now well below average. So what are we to make of (I think) Marc Faber's recently-expressed view that an ounce of gold will buy the Dow?

That depends on whether you read this as a statement about gold, or about the Dow. I looked at the Dow in inflation (CPI) terms a while back (December 2008):

If we are in a downwave, then the Dow's bottom is still a lot lower than where it stands now. Extrapolation is always risky, but my curve indicates maybe 4,000 points as its destination. Having said that, the highs of the years 2000 and 2007 are so much higher than might have been extrapolated, that maybe the low will be correspondingly lower. A real pessimist might argue that, adjusted for inflation, the Dow might test 1,000 or 2,000 points sometime in the next few years.

Back to gold-pricing: it's also notable that the Dow is currently still worth some 8 ounces of gold, but in previous lows (Feb. 1933, March 1980) fell below 2 ounces:

So should we still pile into gold, as a hedge against the further collapse of the Dow?

I think not. Firstly, the Dow may well have a rally, since it's fallen so sharply in such a short time. And secondly, this is missing the point, which is that we are looking to protect wealth against inflation, not against the Dow.

So another question is, how does gold hold its value during periods of price inflation? A period some readers may have lived through, is that after the oil price hike of October 1973. Here is what happened in the 5 years from 1974 to 1978:

True, the Dow merely held its value over that time (though it also made some sharp gains and losses) - but gold disappointed. I think this may be because, when prices are roaring up, people start looking for a yield, which of course the inert metal cannot provide.

But let's wind the clock back just a little - let's go back to that closing of the gold window again, and see what happened between August 1971 and the end of 1978:

The massive rise in the price of gold anticipated the inflation of post-1974, and those who got in at the right moment were very well protected. It's also interesting to see what happened to the Dow in the '71 - '74 period - a fall, from which the Dow did not recover (in inflation terms).

Before we start blaming the "G-dd-mn A-rabs" for inflation, let's remember the inadequately-reported fact that monetary inflation was roaring for several years beforehand. The OPEC price rise was a reaction intended to protect the Saudis' (and others') main asset - and you'd have done the same. Yes, it happened suddenly, but like an earthquake, it merely released long-pent-up stresses. Instead, let's blame a goverment that failed to control its finances generally, and spent far too much on war - a retro theme back in vogue today, it seems.

Looking at it from an investor's point of view, once the preceding monetary trend was identifiable, going overweight in gold in the early 70s would have been a sensible precaution.

So I suggest that gold's value as an inflation hedge is for those who anticipate well in advance. And this may be the lesson to draw in relation to the present time:


The inflation protection has already been built-in, for those who bought gold at the right time. The rest of us should note that gold is now above the long-term post-1971 trend:

There may indeed be a spike, as in 1980 - but that's for speculators. For the average person, who wants a "fire-and-forget" longer-term investment, I can't say gold looks like a bargain now.

Nor would I be that keen to get into the stockmarket, unless you're a day-trader. Some may make a killing in the present turbulence, but many will get killed. I'm still looking for that Dow-4,000 moment, and as I explained above, even then it's possible I may lose 50% - 75% in the short-to-medium term.

What else?

Houses? Still too pricey, in relation to average income. Yes, some houses are now selling - it's a thriving auction business at the moment, I understand. But again, housing is above trend.

Bonds? No, indeed. Municipal bonds in the US are offering high yields, for a very good reason; and even national bonds are a worry. The debt has not been squeezed out of the system, since our cowardly politicians have absorbed it into the public finances instead.

Here in the UK, we have National Savings & Investments Index-Linked Savings Certificates (3- and 5-year terms). Between them, a couple could get £60,000 into that haven, and not many of us have that much. I'm not sure about the rules and limits for US equivalent (TIPS), but the general argument applies. Yes, there is the question of how the government will choose to define inflation, but I don't suppose the definition will get too Mickey-Mouse.

Besides, doubtless you'll keep some cash for emergencies (including sudden bank closures), and for bargains (e.g. looking for distressed sales).

And if you've got lots more cash than the rest of us, congratulations, since the rich will get substantially richer. There's no being wealthy like being wealthy in a poor country, or one that's getting poorer. Watch that Gini Index rise.

What goes up

Dow over 8k, FTSE over 4k...

I dont know where Im going
But, I sure know where Ive been
Hanging on the promises
In songs of yesterday
An Ive made up my mind,
I aint wasting no more time
But, here I go again
Here I go again

(Whitesnake)

Maybe the national brokers are right. I don't think so.

Is now a good time to invest?

I've just been asked by a client whether he should switch from cash to equities. Here's my view, and it may explain why I haven't earned much from investments over the last few years:

It is not possible to predict the market with any accuracy, but I think I have done well in foretelling the current state of affairs as early as the late 1990s. The market has dropped to half its 1999 peak (again, as it did in 2003), but that is not to say we are now at the bottom. Some (and I am moderately persuaded to this view) think that there may be a "bear market rally" soon-ish - maybe a rise that recovers perhaps 50% of the losses so far - but it is perfectly possible that the underlying trend is still downwards, so there may then be a horrid lurch towards - what? Maybe, ultimately, 4,000 on the Dow and 2,000 on the FTSE.

We are in the middle of an exciting ride and I fear that entering the market at this stage may still be for the adventurous and nimble. Yes, had one invested in mid-2003 and got out, say, late 2007, it would have turned a nice profit; but much depends on the entry and exit points. So as ever, attitude to risk and corresponding watchfulness are key factors.

There is also the question of what asset class to choose. I think domestic and commercial property are still overvalued, relative to income; because of fears regarding other assets, and also because of central bank investment ("quantitative easing" etc) government bonds are very highly priced, which is why the yields are so low (and if interest rates rise, bond values could then drop sharply); equities are depressed, but as dividends decline in very testing economic conditions, they may ultimately be depressed still further. Commodities (e.g. gold, silver, oil) are the subject of some speculation, but owing to shortage of borrowed money to invest with, not quite so much institutional speculation as formerly; even so, gold (for instance) is a bit above its long-term inflation-adjusted average, as far as I can tell - though if inflation takes off, the price could indeed escalate.

And then there is the question of currencies. The pound has lost heavily against the dollar; but some say the dollar may catch us up again. The Euro may also not stay as strong as it is now - several countries within the Eurozone are suffering economic problems and are hampered by the common currency; I have even read speculation that the Euro system may fall apart within a decade, or some states may secede from it.

In short, I still urge caution, and if you do decide to get in, be prepared to move quickly if the market should turn. Meantime, there are relatively safe options such as National Savings Certificates, including the index-linked ones that will at least keep the value of your savings roughly in line with RPI...

Dow 6,000 this year, FTSE 3,000 - Nadeem Walayat

Sez he, here. I'm still guessing Dow (inflation-adjusted) 4,000 sometime in the next few years, and it seems Jim Kunstler agrees ("I myself called for Dow 4000 two years ago") In which case, maybe FTSE 2,000 at some point, too.

Elliot, Kondratieff, or normal service resumed?

On 26th June I looked at the progress of the FTSE since around 1984 and thought that the next low would be no worse than c. 4,500. Here's what actually happened:



The lows were certainly lower, and we have only recently learned just how close we came to a banking collapse. The question now is, are we where we "should" be - following a trend set by the last 25 years - or are there longer cycles due to make hay of the pattern of the last quarter-century? Elliot wavers and Kondratieff followers say yes.

My guess is that, after the steep stockmarket falls and the horrid crisis apparently averted, there will be a bounce in the next 1-2 years, then a decline in real (inflation-adjusted) terms for maybe another 5 years after that. Your guess?

By the way, I'd also be interested to know your views on why the bankers and brokers have been allowed to Get Away With It. To me, it seems like a big fat moral hazard and unless there is some real squealy punishment for all this bad behaviour, I'd advise any bright, conscienceless youngster to become a banker.

Currently, my preferred fantasy solution is to bust all the overextended banks, leave the shareholders with zilch, sack the senior bank managers and ban them from being company directors for at least 5 years, halve all mortgages, and give the book of business to more prudent operators including well-run building societies. In my view, this was never ever going to happen, because the FSA, the BoE and the government are also implicated. So, not so much "too big to fail", but too well-connected to fail.

But there's a price to pay, anyway: it's now clearly Us and Them. Perhaps, since they are immeasurably more powerful, we should give up trying to rectify the world and merely ape their cynicism and corruption. Moralists will demur; and so this is truly an age when we can say, "Affairs are now soul size".

Relativism

It's hard to measure what's going on, because currencies have turned out to be rulers made out of very stretchy elastic - especially for us Brits, recently.

In this article, Kurt Kasun reproduces a chart from Marc Faber's latest newsletter, showing an estimated drop of c. 50% on the world's stockmarkets - a loss of some $30 trillion.

So I've looked at the Dow and the FTSE, as priced in Euros, since the Euro appears to be more stable than either the dollar or the pound sterling (until we discover the supermassive black hole at the centre of the European financial galaxy, no doubt).

Yet another letter to the Spectator

Sir:

Your leader (“Riders On The Storm”, 1 November) suggests that current investor sentiment is “excessively negative”. That depends upon one’s historical perspective, in both directions.

A reversion to the mean (over the last generation) for UK house prices would be some 3.5 times household income, which on 2007 figures would imply average valuations around £120,000. Turning to shares, the progress of the Dow over the past 80 years (adjusted for consumer prices) indicates that a return to 6,000 points should be unsurprising, and a low of 4,000 not impossible.

But in addition to the business cycle and recurrent bubbles, there are deep linear changes at work. While maintaining the Western consumer in his fantasy of idle wealth, the East has been building up its human and physical industrial resources. We are focussing on the present recession, but not what the world will look like afterwards. When Asia has sufficiently developed its domestic demand, it will lose its enthusiasm for US Treasury debt, and the credit markets will tear at our economies with higher interest rates. Already, the search is well under way for an alternative to the US dollar as a world trading currency; and foreign investors, sovereign wealth funds and oil-rich governments are building up holdings in our bellwether businesses (e.g. Barclays Bank), thus converting imbalance into equity and exporting our future dividends.

Besides, the Dow and FTSE companies derive an increasing proportion of their income from abroad, so stock indices no longer reflect national prosperity. Real wages have stalled, and seem set to decline against a background of rising inflation and global competition; this, plus an interest rate correction, might strengthen the downward trend for house prices.

In short, successive governments have failed to repair our economic structure, and bear market rallies notwithstanding, I think we must eventually recalibrate our measures of normality.

Are we headed for the Red Pond?

Recycled from my post of April 1st, 2008.

Guessing the low points

I looked at trends in the Dow earlier this year and guessed that the Dow's low might be 7,000. Now, Mish reports that Nouriel Roubini is saying the same.

The FTSE is currently hovering around 4,000, which is lower than the line I drew in June. But then, the line passed through, not under, the lowest negative spike in 2003. I seem to recall Wolfie predicting 4,000 in one of his comments here recently; well done, old chap.

Still air in the balloon

The FTSE ended 2007 at 6,456.90. Back in August, I constructed a rough RPI-related graph from 1984 onwards, and to get back to the equivalent of 1984 in real terms, the index would have to drop to around 3,000: at the end of that year the FTSE closed at 1,181.10. We forget how far we've come.

FTSE prediction: poll results

Thanks to all those who took part in the poll for the forecast value of the FTSE by the end of December. The median line is on 4,500.

This is what I guessed in June and repeated on Monday. Below that at the moment, but I'm still hoping that it'll settle back to the simplified trend I suggested. I prefer to be a sun bear, not a grizzly.

Are we there yet, Dad?

FTSE and Dow predictions revisited

The FTSE is standing (if that's the right word) at 4,732 (13:50 BST, 08:50 ET). It seems to be edging towards the region I guessed at on 26 June this year. It had closed the day before at 5,666.10 and I said this:

I suggested on Wednesday that the market may already have lost much of its bubble, considered in real terms, and here below is my simple attempt at chartism.

What I've done is to draw two purple lines, one connecting the lows in the mid-80s/early 90s, and the other the highs in the same period. I've chosen that time-frame because it's before the silliness of the late 90s, and it does also include a period when the UK economy was in the doldrums.

Using these parameters, the late 90s and early 00s were well above trend, whereas last year's highs only just peeped above the upper line and the current value is hovering a little above the centre of the hi-lo wedge.

The implications are that the next low, if it comes soon, shouldn't be worse than around 4,500, and by 2010 (when I'm guessing the tide will turn) the bracket would be in the 4,700 - 7,000 bracket, with a midpoint of c. 5,850.

Taking the market at close yesterday and extrapolating to that 5,850 midpoint, would imply a future return (ignoring dividends) over the next 16 months, of c. 2.5% p.a. - not nearly as good as cash, especially in an ISA. On the same assumptions, to achieve an ex-dividend return of 6% p.a. would require entry into the market at c. 5,400.

On this tentative line of reasoning, we should be looking for a re-entry opportunity somewhere in the 4,500 - 5,400 level, say 5,000. Shall we wait for the next shoe to drop?

How bearish are you? Too much so? See the poll in the sidebar.

By the way, I did a similar exercise for the Dow the next day and it suggested to me that the range should be 7,000 - 10,000.

UPDATE

I'm in good company:

Mr Lenhoff [chief strategist at Brewin Dolphin] predicted that the FTSE 100 could settle between 4,500 and 4,600: "In this bearish phase the market has given up more than 50pc of the bull market gain, we are back where we were in early 2004. One of the key retraceable levels is thought to be two-thirds of a bull-market gain, which would be between 4,500 and 4,600. The market looks like it wants to give up the gain."

Your prediction?

Experts and interested amateurs: please give us your best guess at the value by end 2008 - see sidebar.

Boing!

Dow and FTSE back up again. Thought so. But unlike 1987, I don't think this will be over by Christmas. Bear market rally, don'tcha know?

Super post by Denninger today, too. He points out, among other things, that the Dow started falling yesterday when everyone (himself included) expected the Bill to pass. And as he says, Bernanke upped the money in the system by vast amounts anyway, and it still hasn't fixed the problem. Just how much petrol do you need to throw onto a fire to put it out?

Banks: justice will not be done

Financial website ThisIsMoney speculates that the FTSE could drop another 20%. I couldn't resist commenting there:

20% down would be about right. The banks have blown up a balloon for the past 5 years and then popped it - it's what they do. They cannot be punished severely enough, nor can the regulators who shrank reserve requirements. If the FTSE hits 4,000 I will finally be able to invest again.

This temple-cleaning call is also pretty much the view of Karl Denninger, but he's doing more emphatic bold, capitals and underlining - unconsciously betraying that he knows, deep down, that "it ain't gonna happen, Cap'n."

Sell in May and go away

The truth of the adage is borne out yet again. Perhaps we're approaching fair value at last?

23 years of FTSE growth, RPI-adjusted