Thursday, October 23, 2008

Thoughts on near term action in equities

Many people have been telling me "we've hit bottom."  My usual reply is "well, were getting there but were not there yet...."  Rallies will continue to be sold, they are just short term rallies against the dominant bear trend.  The rest of October will continue to be down for equities, generally speaking, but there is a high probability that we get an election rally that could last into December as the so-called January effect takes hold for a month or so....

Then the reality will set in that Obama is not much different from the other politicians and the Obama rally will fail.  Even if the Dow rallies back to 10,000 it would not hurt the dominant downtrend one bit, it would just provide a new entry point for the next leg down.  In percentage terms this bear market is already up there with the best of them, but in terms of the length of time, it could easily run another 6 months to a year.  Like I said, it all depends on how much damage the next administration does - Bush will be tough to beat in that department as he and his neo-conservative pals have done a huge amount of long term damage to the country - government spending, wars, loss of liberties, etc.

Whether or not an Obama administration could help the financial markets remains to be seen. All he would really have to do is scale back the wars, limit the size of government, stop the bailouts and let the malinvestments work themselves out of the economy and we would probably be out of trouble and back to a bull market by mid 2010.

But I am not optimistic, he is basically a socialist (and not much different from McCain). There is an opportunity but in typical bureaucratic fashion they will squander it.  Government will continue to increase in size, become a bigger parasite on the private sector and continue to screw up the economy, and given that the democrats will likely control congress as well, they will have ample opportunity to increase government interventionism (of course the republicans would do the same!).

Currently,  we are suffering the negative effects of government regulation, government sponsored entities, and the Federal Reserves monopoly on interest rate setting.  Contrary to what the mainstream press is saying, Laizzez-Faire capitalism did not create this mess, a lack of it did, this mess was caused because we do not have free markets that can properly judge risk.

Bailouts waste money and prevent malinvestments from being worked out of the system.  The governments actions are putting us at risk of a Japanese style decade long recession.  At the moment there is no inflation as credit destruction is greater than credit creation, but that will only last so long as the Central Banks of the world are creating money out of thin air at an alarming rate and desperately trying to reinflate the global economy.  The likely longer term scenario then becomes an inflationary one.

To a degree, this could be mitigated by a strong dollar, and that is why politicians are hoping the current rally in the dollar will continue.  Having the world's "reserve currency" allows you to get away with a lot of things that you normally would not be able to., and as I previously wrote, the EURO will eventually completely collapse, as it is a horribly flawed currency, and that will help the USD rally.  Over the long run, currency markets are a simply a game of which country is relatively the least miserable.

So, in sum, this bear market in equities has been quite severe in percentage terms, but temporally speaking it has not been severe relative to past bear markets.  The economy continues to weaken and the government continues to make matters worse with more intervention.  There is likely a bear market rally right around the corner say beginning after the election and lasting into January that could take the indexes up as high as 15-20% but that would not hurt the dominant downtrend.  Beyone the next rally (after January) the dominant trend will likely take us lower over the next 6 to 12 months to new lows on the major equity indexes. -John Bardacino

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