But the thing to realize is that Europe will do everything they can to avoid default of anyone else. It could happen I suppose, but eventually, there will in fact be a bottom when everyone is so fearful. Now the unfortunate side effect of preventing default is the other side of the equation which is hyper inflation. A lot of people that are hyperinflationists and think that gold is going up, think so because they think the dollar will see a demise. That may be true, however, as the reserve currency that simply will not happen with everything denominated in dollars and banks having to hold dollars and exchange in dollars as it’s just how the banking system works thanks to the Bretton Woods agreement that essentially was indirectly defaulted upon by the US as they closed the gold window temporarily which turned into permanently. However, there will probably at some point be a realignment of currency and perhaps the reserve currency will no longer be the US, but there will be some kind of solution. When the dollar is no longer the reserve currency, that is when things get a little bit ugly for the US and stocks and gold will really go a lot higher. However, it will be a bit tough at that point to forecast since if you say what it is valued in dollars, if dollars are no longer used, and no longer have any value, stocks are worth infinite dollars. However, if you take what they were at before readjusted to the new currency, you could still come up with some estimate that could be equivalent. I believe there will ultimately be a top sometime in this timeframe, there will be radical political candidates and perhaps a 3rd or even 4th party but with the world dealing with the default or potential default (okay “realignment”), there will be serious fears of something more major occurring. My forecast is that the ultimate bottom will likely be in 2012, that Greece may default as early as November, or else sometime likely early 2012, and that the next 5 years of that there will remain significant volatility but the market will be set for a great run to somewhere between dow 20,000 and dow 50,000 around 2012. That is when the top likely will be. The timing can be more easily identified thanks to what I’ve learned from Martin Armstrong’s papers he has published along with other cyclical studies.
Stock prices are a function of
1)What people are willing to pay as a percentage of their disposable income, collectively
2)the amount of money in total that they have, collectively.
Now that’s the most basic pricing. How much people are willing to pay typically are associated with
1)how much money is in the money supply and what percentage people are willing to use on the stock market.
2)How high the earnings are collectively and how high they are forecast to be in the future.
It’s pretty simple. This is why you can identify trends in the stock market. There are trends in the liquidity cycle, these trends lead to more cash when it is in an expansionary or inflationary phase, and less in a contraction or deflationary phase. This often results in both earnings multiple (PE) expansion as well as earnings growth in an expansionary phase, and earnings contraction as well as multiple contraction in a contraction or economic recession or deflationary phase.
However, just because it’s simple to understand, doesn’t make it easy to invest or recognize. There are lots of indicators you can use just watching the market price of the individual stock indices.
I believe that you also will want to understand how capital moves to different areas, it’s just not as simple as the overall cash available to invest, but WHERE the capital tends to concentrate.
What I expect to happen is that when Greece defaults, there will be fears of “which other country is next?” at some point which will possibly result in lower prices, however I believe a panic low is likely to come on an event that hits mainstream news and that everyone hears about such as a Greece default. But if there is concern of “what country is next” there will be a flight to safety and the dollar is still the reserve currency so it is the only place central banks can move tens of billions of dollars and still be able to exchange them with other banks, and it can be printed almost at will better than any other currency because the demand will be consumed by the banks and large institution as it currently is the only liquid safe haven at that level. Since oil futures and everything else around the world just about is priced in dollars, a movement towards dollars will bring down prices of just about everything else. This is why stocks could go lower, and it is also why money can be printed rapidly without concern of short term inflationary pressures. However, I think Europe will do everything they can to avoid a 2nd default. This is when THEY start printing money. Now a shift from euros to dollars isn’t as bearish as some people might think, because if the dollar is strong due to inflation of another country’s currency and no one is selling equities just other currencies, it in theory shouldn’t effect prices. There still could be some effect though because so many traders react based on the action of the dollar. In the same respect, even as the fed continues to buy up treasuries and push their yields down even lower, there are people that think you should buy stocks when yields are low long term. Similarly there are those that also think low yields is a sign of a panic. (this is the reason why the model tells them to buy) but since we haven’t gotten that panic low in stocks that we saw in 2008, while we still saw a panic low in bond yields that are equal to 2008, that there is a very bearish divergence. Neither is true because the run up in bonds is artificial, but it is causing some serious sharp price changes in the market. So there likely still will be a reaction to the strengthening in the dollar when europe starts inflating. Eventually though, there will be too many people in the dollar, and the euro will have to be replaced and the dollar may be changed or defaulted upon as well. The reserve currency cannot be the dollar, but regardless of whether it is the new “amero” or a gold standard dollar, or a world reserve currency, with the dollar losing it’s reserve currency status being a high liklihood after europe defaults, I have to say stocks are going to go to the moon when priced in dollars. Everyone that was responsible and saved money rather than get into debt, that avoided student lons and that did everything right will then find thattheir money can’t really buy much anymore, unless they hold stocks and gold/silver/goods. If there is a realignment of currency it’s not really clear what will happen, except that stocks will go higher when priced in dollars, but they no longer will be priced in dollars.
The thing to understand is that stocks going higher tends to feed upon itself. See I think sometime in 2012, there will become a point where fear is very high. There may even be concerns that “what if the US defaults. Especially if there is a 2nd default. Even though prices may go lower in fears of “which country is next, that has to end up as a concern for even US bond holders, even if it takes the euro being eliminated in order for capital to concentrate so heavily into the dollar that there can no longer be a sustained flow of capital into the dollar and instead it must go out of the dollar and into stocks. The worst will really be behind us at some point and capital will flow into stocks. When capital flows into stocks, they tend to be able to use that capital. When companies use capital they create a multiplier effect due to the way the banking systems around the world are set up. It’s like this, if I have $1,000 and want to borrow, I can probably get $10,000. Now when I use that $10,000 even though I will eventually owe more than currently exists (say $20,000 in 30 years), for the system to work, there must continue to be inflation. Meanwhile, that $10,000 doesn’t just vanish when I buy something, it goes to the seller, who then likely puts it in a bank, and now the bank has $10,000 and can lend out $100,000. Actually, in reality, the reserve requirements are so low it can lend out a lot more than that. This effect is what creates a lot of growth and a lot of earnings expansion because the amount of money in the system can inflate so quickly, and especially does when people really think things are great and are confident enough to pour money into stocks, investments, and so on.
So you can imagine how when capital flows from bonds into stocks things can get bullish in a hurry. And perhaps even more quickly when they flow out of stocks and banks don’t have enough reserve requirements and everyone moves to bonds and businesses end up short on capital and everyone hoards money and without transaction the system freezes up and those in debt suddenly can’t pay and now the banks lose their income and can’t lend and everything contracts very sharply and is prone to crashes.
Now to project an exact level of the stock market it is a matter of knowing what overall amount of money will be in the stock market, which is a function of how much cash will be in print (or digital) and what percentage of it will be in stocks, which usually require a projected “earnings” and a projected P/E. You can use John Bogle’s formula which is based on using the last 30 years of earnings growth and the PE, or you can ue shiller’s model which use a 10 year trailing PE, and you can take 1 divided by the P/E to get the E/P or earnings price yield, what percentage of earnings is made up of stock. The PE would give you the number of years until your company you invest in double’s their money if they continue at that rate, 1 divided by PE or the EP gives you the percentage return if your earnings of the company you buy is reflected in the price over time. There are many methods to use.
One is to just consider a lot of things and factor them in. For example:
Right now there is more money in the treasury market in the world than the bond market. As of 2010 the global bond market was 96 trillion. There was about 36 trillion in stocks in the start of October 2008 Unfortunately the timeframe is a bit off but we can just say there was about 36+96 or 132 trillion dollars in the sum of both markets. Now we will say that by 2016 that could be inverted because of the massive fears of default and the large movement out of bonds and into equities. But lets say it is a 50/50 split, what that means is that if there exists the same amount of money in the system, 66/36 or about 80% higher than current levels without any inflation of the money supply is possible. That would bring stocks to 1.8 times what they were in October 2008. We will use the SPY which was about at 115 times 1.8 is 207. There could be deflationary pressures, but likely those will be over with and stocks will be higher due to inflationary pressures, this results in more money which typically happens along with multiple expansion and earnings expansion in a expansionary phase of the economy.
So the total sum of the bond plus the stock market (we will ignore derivative markets even though there is a lot of wealth here, and a lot of cash in currency and commodities markets as well for now) was about 132. Now how much money supply grows over time? http://www.shadowstats.com/ in expansionary times it can be as high as say 16%, or conservatively around 6-7%. I am going to just use the 7% number. I am going to say there was virtually no growth in 2011 (as well as 2008-2010 which is somewhat close to true, and just multiply 1.07 by the 132 trillion and then 1.07 for each year to determine how much is in the we’ll say “investment” money supply 5 years from now assuming money doesn’t flow out of derrivatives and into stocks or out of gold and currencies and others and into bonds/stocks. The number is 185. 1 now divide that by two you get about 92.57 each market. Divide that by the 36 trillion to get the increase multiplier from the 115 price level and you get 2.57 times more than 115 or SPY 295.7. So this is your forecast. In 2016 stocks will hit somewhere around SPY 300 or S&P 3000. In other words, if this forecast is right, you could be seeing an average of about 20% per year gains from these levels. Of course, more work needs to be done to verify that this is reasonable, and look at other potential projections and historical correlations such as forecasting based upon earnings and earnings growth and so on. I think it’s entirely possible that both 2012 and 2016 are the bottoms because one is nominal terms, the other is in value terms. Say the dollar loses it’s reserve currency status in 2012, stocks in nominal terms bottom, but trade much higher, even though in terms of percentage of the world’s wealth allocated towards stocks or priced in yen or priced in some other currency or perhaps gold, stocks could actually continue to go lower into 2016. but this is an example of how you might attempt it.
What I think will happen is a very big run up after all the carnage plays itself out. I don’t know if we test or break the 2008 lows before then, it’s really hard to say. What I can say is there are serious downward trends and it certainly is possible. But ultimately when things turn around, there already is so much money in cash and bonds on the sidelines it is ridiculous. if and when that money ends up back into the system, you are going to see stocks shoot up to unbelievable heights due to fears of defaults elsewhere and the need to own USD, gold will remain an excellent investment as well. I think the action is somewhat comparable to the late 70s. Buffett made some big “all in” bets in 1974 just like he did in 2008. Gold and stocks had similar action, there were similar fears, there was a very unpopular war then and now, and there is a growing movement of protesters then and now. There was a lot of sideways price action a decade before and pretty large price swings from bottoms to peaks then and now, prior to the sideways action there was a bull market then and now, and There also was a major realignment of currency as I suspect will happen again soon. There were definately major policy moves related to the economy then and now. in the 70s you had the ERISA act which required investors to invest if they wanted pension, as opposed to previously when the companies would pay pension, now the government requires plans to basically be investment and this forces everyday people into the investment class to compete with the big dogs. This time around however, in 2000 there was a change to the IRA, that was a way for the government to boost the cash they got NOW, as opposed to it going in as pretaxible income and being taxed later, This was one of the major changed Clinton made to temporarily manipulate the numbers (along with major changes in how unemployment and other key data such as CPI is determined [shadowstats.com]) to get his “surplus” even though it really was only masking the problem and creating a false sense of confidence that lead to a bubble that we have still not surpasssed. Dow/gold still has not gotten to 2000 levels, and in nominal terms the nasdaq was higher in 2000. But after subsidizing farming, and the temporary boosts in the economy due to the wars and high oil prices, Bush in the end of his 2nd term and 0bama in the start of his first responded by making major policy changes. One was that the government would socialize or nationalize a lot of industries such as healthcare, banking and auto (at the time) they can now buy stock in banks forcing the tax payer to share in the gains or losses, they no longer but formerly took GM private before it was reissued, and there is 0bamacare as well. In a sense the taxpayer money as well as the foreign bondholders are paying for ‘investments’ now the same way employers ere made to become “investors”. Over time the US became #1 or #2 in the world in taxes corporately depending on when you look, unlike prior to 1940s when less than 5% of the population paid any taxes in the US contrary to the rest of the world. The companies pay taxes along with the individuals to make up for the lack of income going to the government due to the pretaxible income benefits of the 401ks pension plans, the companies keep wages lower not only because of high taxes but the threat that exists of potentially higher taxes, sometimes that threat is greater when taxes are low if uncertainty is also high and the government is more desperate for money in the future. but that was then, now the tax payer pays for bailouts, sometimes for the corporate bond holders, sometimes the government buys the common (non-voting) shares of stock, but this is the type of similar movement of capital into business that has begun. This is an environment that seems like it favors bondholders because the social movements are towards government increases, the government increases funding, the fear is great, bondholders are flooding into the dollar and into more bonds, and people are fleeing stocks. However, keep in mind everything eventually changes, and the socialistic government managed economy in Europe and all the government managed movements in the US such as the bank bailouts, the government managed healthcare, the government managed economic changes, etc will not be able to b kept on forever, and a lot of those movements will filter more money into the economy eventually. Meanwhile all of the people fleeing to safety will eventually fear that the government’s path of spending is unsustainable, and it is then when they will move into equities, which will go much higher. Growth is likely around the corner, but it is always darkest just before dawn.
Lets put it this way. Globally we are inflating, so the money supply growth is perhaps not enough to consider the ultimate result. Globally money is going to concentrate in the US as US treasury bonds remain the only flight to safety. In the US, the government will have to spend quite a bit to inflate away their debts on the treasury bonds. This inflation will pump even more money into the US economy ultimately and probably means inflation will be much stronger than 7%. So yes, although I think things will get a lot worse to reach the panic low and flush everyone into US bonds at the same time, I think 5 years from now, things will be MUCH better at least in nominal terms of stock prices, for the time being. I fear after that there will be the type of mania top that you see and excess leverage until leverage is scaled back and people buy asssets on leverage that after a decline become worth less than they owe. This of course leads to a collapse, but we will cross that bridge when it comes to it.
For now mutual fund cash levels are still on a long term historical basis too low, Europe still has problems, and our allocation models say to be farily cautious here. This is why it makes sense to have an allocation made up of stocks/gold and BONDs/cash in deflation cash and guarenteed cash promises become worth a lot more. In inflationary times stocks and gold become worth a lot more. Even if you have an idea on direction, you should be prepared to capitalize off of a move either way, and then you can switch your allocation models more aggressively into stocks at lower prices, or more aggressively into bonds at higher yields and higher stock prices. Either direction you have an opportunity to gain and mitigate the risk in the other side of the trade. Even with treasury yields this low, I still believe it makes sense to be in them in a position size greater than 50% for the time being. Now you could adjust this based on your timeframe. A 5 year investment in stocks are wonderful if you plan to buy a basket of stocks and forget and revisit once a year or 5 years from now even. If you revisit on a monthly time frame though, Europe is still around and their economy is still standing, and the potential exists for some very large capital inflows into US treasury bonds if things really start to go bad, especially with mutual funds being vulnerable with their low cash positions.
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