Thoughts on P3 and the secular bear

Hi guys.

Sorry for being so quiet on the blog lately. I’ve been busy trying to take my mining site out of beta among other things, and not following the day-to-day action much.

In response to comments about Elliott Wave and EWI, I actually don’t read EWI anymore except for Prechter’s monthly essays. I don’t see that the short-term stuff offers much of an edge over just following basic technical and sentiment indicators. Trying to force the market into fitting a specific pattern has just not been a good way to go, but the intermediate-term technical indicators have been doing quite well.

For instance, put:call, vix and weakening RSI have nailed the tops in November, January and March-April. The last was just screaming SELL as loud as the market ever does, and we got the follow through we deserved.

Short-term oversold conditions in late May and July were marked by the VIX and weakening selling as indicated by RSI. ¬†Constantly anticipating a hard 1930-style P3 is just a bad way to play. Of course you don’t want to be caught long without protection at any point in this environment, credit crunch and depression that it is, but there is a tremendous degree of speculative enthusiasm and stubborn optimism among traders that is making this a long slog down.

Of course I think this is a secular bear market that won’t end until there is real value restored in stocks and real estate, which means solid after-tax yields high enough to compensate scared investors for the risk of further capital losses. But there is no reason why we have to get there in 3-4 years — this could go more like ’66-’82 in the US or post-’89 in Japan.

That said, we have not had full-on recognition of the extent of the economic problems within the financial community, with most analysts and economists clinging to the hope of Keynesianism. Trading horizons are so short-term among the big players that these considerations hardly matter. The technicals are all that drive the machines and guys like Paul Jones, Cohen, etc.

This is a deflation though, no doubt at all. Credit is contracting hard, and prices of everything not directly traded as futures or set by the government are falling. This includes private sector wages, groceries, capital goods, etc. In this environment we do not have the same set-up as for the rolling sideways market of ’66-’82¬†(only in nominal terms was that a sideways market – in real terms it was a 75% loss). The ’30s and Japan are still the corollaries to watch.

Also remember that the public sector has gotten itself into huge trouble, which is just starting to take effect with austerity measures in Europe and pending bankruptcies in US municipalities. US states are also broke and will have to finally deal with their union problems. Shrinking government worker salaries, if not payrolls, will put further pressure on demand for goods and leave banks with more bad loans. None of this is inflationary. Remember, in the ’70s private debt was low and growing, and companies were increasing their revenues and profits so that by ’82 Dow 1000 was a bargain. Now we’re in a generational de-leveraging, frugality-restoring mode, Kondratieff winter for lack of a better term.

The last couple of years should give deflationists confidence that we’re able to correctly assess the situation. Where is that dollar crash? What about $200 oil? What, in 2010 China still owns trillions in treasuries? Bernanke has tripled the US base money supply but a dozen eggs is still $1.50 and the long bond yields 4%? Obama spent how much, and unemployment is 17% ?

We make it way too hard on ourselves trying to get every squiggle right. Stocks and real estate are expensive and cash is still the way to go. Gold is still increasing in purchasing power. This is not bizarro world, it’s so far just a very big dead cat bounce after a 60% crash. US stocks are about where they were 12 months ago, and other markets are much lower, so clearly momentum is broken and bears should be confident so long as they’re not over-levered.

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PS- In response to Roger, upon first glance VXX looks like a fine vehicle for trading volatility. It seems to have tracked the VIX without much error since launch. Of course VIX futures and long-term OTM puts are also fine for going long vol.