So far, the stock market in 2007
has been tumultuously mundane. The economy has been
dancing on the fulcrum of time both in danger of
overheating and lapsing into recession. Home sales
and auto sales have been dissolving while second
quarter GDP was 'revised' higher to 3.8%.
Third quarter GDP was clocked at 3.9%. Now, we know
in the 'new era' of economic engineering, our
annual GDP has to be 3.5%. That's not too hot and
not too cold. Besides, Japan has laid claim to 3.3%
GDP and Germany 3.7% GDP. Everyone is not too
hot and not too cold and yet we all have different
rates of growth. Of course if we all claimed 3.5%,
even the stupid people (like members of our Congress)
would begin suspecting that it is all a ruse.
Let's do some math. 3.5 times 4 (quarters) equals
14. So, you can add up the GDP numbers that the
Commerce Department feeds us and you can now guess
what they will tell us about fourth quarter GDP. Yep,
it looks like it will come in at a hot 5.7%. Did I
say "hot"? Yeah, that's a bit too much.
What should we do? Yeah, that's right. We had to
subdue the third quarter to give the Fed more ammo to
lower interest rates. Now that they have, we can
'revise' third quarter higher so we don't
have to report such a 'hot' fourth quarter
number. I don't think the Commerce Department
wants a GDP number north of 5% so my guess is they
will 'revise' third quarter up to something
like 4.6%. That way, they can put fourth quarter at
5% or maybe even a smidgen less to pretend like
things are almost perfect but another rate cut
wouldn't hurt. What? Do you think any of the
government data is real? (Since I originally began
writing this piece, the Commerce Department did
indeed 'revise' third quarter GDP higher to
4.9%. So I was off by .3%. At least now, forth
quarter GDP will only have to be 4.7%.)
Oh please! Come on. Welcome to
the 'New Era'. I've been calling this the
'new era' now for several years. It is in my
book that I wrote now two years ago.
Barron's finally has started to call this
the 'new era'. Speakers are now calling this
the 'new era'. How dumb was I? I should have
patented the term! What is it? The 'new era'
is the modern period that we have entered in which
all economic data is engineered and massaged for the
benefit of the Dow Jones Industrial Average. Reality
is not in the equation. We are now servants to the
Dow. We must keep the stock market up and moving
higher. Why? Because if we don't, people might
come to realize that our modern day economy is
expanded on vapor. Our so-called wealth effect is an
illusion. Let's take an honest approach for a few
moments so we can get our strategies ready to take
advantage of what this 'new era' may have in
store.
Economic nirvana has been
achieved according to all government data and yet
August was witness to the greatest Federal Reserve
bailout/cash infusion in economic history. Heck,
given the mendacity of the times, I might as well
call this a 'mid-year' report given that the
year is now almost over with. This has led me to
issue a stock market DUI - Dow Under the
Influence.
When investing money, our
recognition of the real market influence is of
paramount importance. What drives the stock market?
What is the stock market listening to? Of late, the
real influence is the Federal Reserve. Yes, I know
they say they don't really pay the stock market
any attention. They say they don't base interest
rate decisions on the stock market performance. Of
course, they also claim that they aren't in the
business of blowing bubbles or 'pricking'
bubbles but we now know that to be a bit
disingenuous. So why should we now pay more attention
to the Fed than anything else?
Going back to the late
1990's, then Fed Chairman Greenspan spoke
specifically about 'pricking' asset bubbles.
We all remember the 'irrational exuberance'
speech in late 1996 that was followed by three great
years of stock market investing. As the market
ascended, Greenspan sought to dampen the
'exuberance' for making money by raising
interest rates. He did so until we were all
strangling on our exuberance. By May of 2000, he
concluded his assault by raising the Fed Funds rate
fifty basis points. By then, the markets had already
rolled over (unbeknownst to the man who could somehow
tell when we were 'irrationally exuberant' in
the first place). The greatest bear market since the
Great Depression ensued led by a Nasdaq plunge of 80%
from the March highs. The economy fell into a
recession and it was obvious to even members of the
Fed that the economy was now driven by the stock
market and not the other way around. It was also
obvious even to Greenspan that he needed the stock
market that he had tried so hard to kill. Eventually
realizing the error of his ways, the forever astute
one began to lower the Fed Funds target rate to 1%
(in part fueled by the terrorist attacks of 9/11).
Hhmmm, free money fresh off the printing press
printed without regard to monetary valuation would
surely drive the stock market higher. Indeed it did!
It also had another effect.
The nearly free money taught the
Fed a lesson. If you are a lender and money has
almost zero cost, you in turn have almost no risk in
lending that money out. Therefore, lending standards
were obsolete and unnecessary. You could lend to
anyone capable of fogging up a mirror in any amount
and risk of capital was miniscule. Cheap interest
rates spurred on the great real estate bubble of the
past several years. Suddenly, everyone it seems
bought a new house. Suddenly, people that
couldn't spell 'real estate' were buying
and 'flipping' real estate. The Fed had
succeeded in blowing their second bubble in less than
a decade. Fast forward to the present (late 2007) and
that second bubble is in the process of bursting.
That brings us back to the stock
market. The Fed knows the stock market controls the
economy. Now, if there was some way to control the
stock market the Fed would be in business. If only
there was some way...
Well, they are the leader of the
Plunge Protection Team. Oh, I'm sorry. I meant
the President's Working Group on Financial
Markets. What if whenever the economy needed a
defibrillator paddle shock, the Fed could just throw
money out of C130s? Don't forget, current Fed
Chairman Bernanke has suggested in the past that we
use helicopters. But now the real estate bubble is
bursting. And it's a whopper! Nah, helicopters
are too small. We need C130s! So now the question
becomes, how do you get all the money into the stock
market?
Certainly, they could simply buy
stocks. If they went this route, I think they would
use the index call options to overwhelm the put
holders. This way, there is no real ownership, you
could drive all stocks at the same time, and the
options could expire at the end of their terms. And,
if you own the printing press, you have no risk
either way. Your only goal is to drive the market
higher. Another tactic is to print gobs of money and
throw it into the international economy via C130s,
trucks, tanks, and humvees while at the same time,
employing hundreds of thousands of people to help
spread the cash. But where would we find this
scenario where it wasn't so obvious what we were
doing? Well, there is Iraq! Finally, the Fed could simply
make more money available to banks at ultra-low
interest rates. Ah, the old 'injection'
trick. Indeed, August was the 'injection'
month as the Fed joined with Feds of the world and
injected hundreds of billions of dollars into the
banking system. Now remember, by using the lending
power of nine, a few hundred billion turns into over
a trillion. That's nearly 10% of our annual GDP.
And they did this all in one week! As I write, the
Fed continues to inject billions. So I have to ask,
'Are we really this weak?' Is the economy in
some kind of desperate condition?
So what do I mean by the market
being 'tumultuously mundane'? August was an
interesting month. July saw the Dow fall 1.4% and the
Nasdaq fall 2.1%. Housing was evaporating faster than
Britney Spears' career. Lenders were faced with
an avalanche of defaults, foreclosures, and
inventory. The major indices were suddenly weak and
in fact, the Russell 2000 went negative for the year.
Is that allowed? In an era where the Fed runs
everything, can a major index be allowed to lose
money? Da-da-da Da, Da-daaaaaaa! Here comes the Fed.
Here comes the Fed! They went to work immediately as
the calendar rotated to August. Below is a
five-minute intraday chart of the Dow from August 1,
2007. The Dow continued to fade all day and showed
signs that it would surely fall below the coveted
13,000 level. Suddenly, from out of nowhere, at
precisely 3:25 pm, someone with a big printing press
started buying. Boom! The Dow gained 200 points in
thirty minutes! Take a look at Figure 1.
Figure 1
Chart courtesy of www.bigcharts.com
We were then inundated with
the 'happy news' in the following weeks.
Housing was at a bottom. Mortgage applications had
picked up. American workers were more productive
than ever and making more money. There was no
inflation. Second quarter GDP was revised up to 4%.
Things were going better in
Iraq. Even France had started to like us again!
Boy, could it get any better? Well, with complete
nirvana at hand, the Fed had to step into the fray
on August 8, 9, and 10. Coincidently, trading
volume on the NYSE spiked to over 3 billion shares
per day for each of those days just like it had on
August 1. That was considerably higher than normal.
On August 13, the Fed announced that they had put
the defibrillator away and did not inject any
money. By August 16, the Dow was again in full
retreat falling to 12,520 by midday. This looked
like the 'big one'. Suddenly, a quick
hour-long 200 point rally burst forth. It
immediately lost steam and fell until 3:10 pm.
Bernanke was seen dashing over to the NYSE..., uh, I
mean the CBOE, with defibrillators in
hand. The owner of the giant printing press
couldn't wait any longer. Boom! We got a 240
point 45-minute rally at the end of the day. Take a
look at Figure 2 and see if you see a similarity
between August 16 and August 1 (Figure1)? It's
almost as if someone now controls the Dow! This was
apparently the nadir. This is the Fed's
'line in the sand', if you will. On the 17
th, the Fed lowered the Discount Rate
fifty basis points to 5.75. The next day, their
friend, Bank of America stepped forth to borrow a
half billion at this Discount Window and promptly
put it (and another 1 and ½ billion) into
Countrywide Credit in return for 'special'
preferred stock yielding 7.25%. Of course, the Fed
denied any deal making but they also deny any
involvement in the stock market. What mendacity! I
think the charts tell a different story.
Figure 2
Chart courtesy of www.StockCharts.com
As for the 'tumultuous
mundane' nature of the market in August,
consider that August had 23 trading days. Of
those, the Dow only had seven days in which the
close was either up or down less than a half a
percent from the previous day's close. To
amplify this turbulence, the Dow had 12 days in
which it closed up or down more than 1% from the
previous close. That, is tremendous turbulence.
The markets tried to digest the reality of our
economy and therefore, attempted several severe
sell offs. The Fed would have none of this as
they intervened with their monetary printing
press and created the 'mundaneness' that
in the end, led to the Dow finishing up for the
month. Ta-Daaaa!!! How about that? It is amazing
what a little manipulation can do!
What evidence do I have?
Maybe I'm just crazy. Maybe investors have
suddenly become very smart in that they can
recognize real buying opportunities. Yeah, right!
In fact, investors' behavior is and has
always been a contra-indicator. Let me put into
evidence 'Exhibit A'. On September 4,
2007, the Options Industry Council announced that
total options trading volume was up 83% over
year-ago levels for the month of August. The all-time
record volume set in August was higher than the
previous record volume set in July. Seven of the
top ten all-time volume days occurred in August with of
course, August 16 setting the single day volume
record. Coupled with the previously mentioned
volume spikes for the major indices, the market
behavior looks a little fishy. Think about it. If
you owned a monetary printing press and your sole
job was to keep the Dow Jones Industrial Average
moving higher, how could you best accomplish this
goal? I'm just speculating here but I would
run off voluminous sheets of freshly printed doe,
send them to an omnibus trading account, buy call
options with reckless abandon, and wait for the
reaction. Oh, I'd probably signal my big
banking and brokerage buddies as to my handiwork
so they could get on the train too. The beauty of
the plan is the ownership of the printing press.
If my only goal was to manipulate the market
higher, I could buy my options, let them expire
un-exercised, and I haven't lost a dime! I
have fiat money! And remember, my only goal was
to make the market go up. Of course, again, I
could be crazy!
Now the question is, can we
anticipate Federal Reserve interference,
manipulation, injection, intervention - whatever
you want to call it - and therefore seek to
profit from their actions? Take a look at the
next chart so we can now discuss what is known as
the 'put-call ratio'. Puts, are of
course, the right to sell a stock at a
predetermined price. When the markets look weak,
traders move more money to the put side for
obvious reasons. Figure 3 is a two-year chart
showing the Dow with the Put-Call ratio on top.
Clearly, when the Dow dips, the Put-Call ratio
moves higher in favor of puts. Clearly, when the
ratio moves above 1.2 or so, the Dow rallies. Are
traders just stupid? Or, is it possible that
someone, or some body, intervenes in the natural
order of the stock market?
Figure 3
Chart courtesy of StockCharts.com
Figure 4 is a five-year
weekly shot of the same chart so you can see in
more detail where Dow rallies come from.
Let's see if we can predict what is about
to happen.
>
Figure 4
Chart courtesy of StockCharts.com
The chart on Figure 4
shows the Dow down about 1000 points from its
high in early July. The credit bubble is
bursting, housing is falling, corporate
earnings are weakening, and recession talk is
coming from the lips of the market
cheerleaders on television. What do we do?
Well, check out our Put-Call ratio at the top
of the chart. Yep, we are over 1.2 so it is
time to buy. Check out Figure 5 and you can
see that we were saved again as a rally
ensued right on queue.
Figure 5
Chart courtesy of StockCharts.com
So where do market
rallies come from in the new era? Better
earnings? Ha! Low P/E ratios? No way! Good
fundamentals? Please, don't make me
laugh. You could argue that extreme
put-call ratios indicate over-sold
conditions that set up the rally. You could
argue a lot of things. You could also argue
that someone with a big monetary printing
press wants to control the stock market by
punishing sellers. You could argue that
that same someone can overwhelm the put
owners with call buys and if the calls
expire worthless, there is no money lost
since it came from a fiat printing press.
Look at Figure 4 very closely. There are a
million indicators you can look at but in
today's 'new era' stock market,
there is clearly one indicator that you
need to refer to as often as possible. In
no way did I invent this nor did I
originate this idea. Hey, I'm not Al
Gore! Whether or not you believe the
Federal Reserve now controls the stock
market or not, you have to admit this is
pretty interesting stuff. Investors have to
anticipate. If you know Santa visits on
Christmas night, you put in your wish list
well ahead of time, right? The same holds
true of the stock market. The Federal
Reserve has one goal and one goal only.
They strive to keep the Dow Jones
Industrial Average moving ever higher.
Period. All the rest of their act is a
façade. It is a show. So, now when the
Dow sags and the puts get heavy, we can
look to the North Pole for a visitor to
bring us a stock market present.
Okay, so now the
Federal Reserve has completely abandoned
their mantra of being a central bank to the
commercial banks of our country. They were
originally commissioned to strive for
orderly financial markets, low
unemployment, and consistent growth. They
fixed the last two by simply working with
the government data sorcerers to just
pretend that growth was good and
unemployment was low. Data is easy. You
just write down a number and read it to an
ignorant public. But something profoundly
changed in the Greenspan era. The stock
market used to reflect the strength of the
economy. Now, the economy reflects the
strength in the stock market. And in the
stock market, the Dow is everything. So,
the Fed focuses on the Dow. What does the
Dow need to move higher? Money. More money.
So they print more money. Printing money
has an interesting domino effect. Let's
see how this works.
Simply printing money
devalues assets. Please notice that
'price' and 'value' are two
entirely different things. In this sense,
printing more money is inflationary as it
tends to push prices of goods higher. But,
higher prices lower values. The Fed
doesn't want you focused on value.
Here's why. In 1971 we were on the gold
standard and gold was $35 per ounce. If you
had 35 dollar bills, you could exchange it
for an ounce of gold. If you wanted to buy
a house priced at $100,000 dollars in 1971,
it would have cost you 2,857 ounces of gold
($100,000 divided by 35). If you sold that
same house today, it would be worth 142
ounces of gold (As of this writing, gold
was moving above $700 per ounce). In other
words, if our house were valued in ounces
of gold, our original investment of 2,857
ounces has shrunk to 142 ounces. The value
of our house, relative to ounces of gold,
has declined precipitously. What happened?
Well, the price didn't fall but the
value sure did. Now, to carry on the
illusion of wealth, we have to apply
inflation to the equation. If gold went
from $35 per ounce to $700 per ounce, that
is a factor of 20. Gold is up 2000% so to
keep up, we have to apply the same math to
our house and now that $100,000 house is
worth $2,000,000! The price, that is. As
the original investor, we spent 2857 ounces
of gold to buy the house. That is our value
benchmark. Now, to sell the house and break
even, we have to get $2,000,000 dollars for
the house or our original 2857 ounces of
gold. Now, did the house appreciate in
value or price? Did gold appreciate in
value or price? The answer is that the
house did not appreciate in value because
it still fetches the same amount of gold
that it did when we first bought it. It
only rose in price. Gold, however, did
appreciate in value because it is twenty
times more expensive in dollar terms. The
linking commodity is the US dollar. If we
apply 1971 gold prices to our house that
has shrunk to 142 ounces of gold, the price
is only $4,970!
Another way to look at
the effects of money, inflation, and gold,
is to look at the Dow over time. In 1971,
the Dow closed the year at 890. If you took
your gold selling at $35 per ounce and
bought the Dow, you would have needed 25
ounces. In late 2007, you decide to sell
your holding in the Dow in exchange for
gold. At $700 per ounce, you are rewarded
by receiving 20 ounces of gold. That's
right. By holding the Dow for 26 years, you
have now lost 5 ounces of gold! But the Dow
is over 14,000 (early October, 2007)!
Don't you feel richer? Yeah, that is
just part of the illusion of wealth.
Listen to our
language. We say 'the price of gold is
up/down'. We say the 'value of the
dollar is up/down'. Why is this
important? Well, it is the difference
between 'reality' and
'illusion'. Therefore, consider the
following:
'Barry's Supposition' (BS)
Prices of assets move in
opposite direction of values of currency.
The value of assets move in
the same direction as currency value.
So, the current Fed is
creating US Federal Reserve Notes (we used
to call them 'Dollar Bills' when
they were really worth something) at a
double digit percentage increase clip. Of
course, the currency is dropping in value.
And now you know that the assets that we
own (or think we own) are also dropping in
value. In other words, we are losing our
gold. If our stocks are up and so too is
our gold, we have to ask a question. Which
went up in price and which went up in
value? Price is a reflection of monetary
inflation and value is a reflection of
monetary supply. Price and value are very
different. Poor people pay attention to
price. Rich people pay attention to value.
Real wealth is generated through value.
Simply inflating prices does not produce
wealth. It does, however, perpetuate the
illusion of wealth.
How do we really know
what is going on in terms of price and
value? As investors, how do we really take
advantage of the relationship? Well, think
of a see-saw. Money is on one end and an
asset is on the other end. We all know that
increasing the supply of money lowers its
relative value. As the value of money
falls, the price of the asset rises. For
instance, a chief worry that the media
likes to harp on at the moment is the price
of oil. When will high oil prices derail
the economy? Who cares about the economy?
This is the new era. All we care about is
the Dow. Look at figure 6. This is a chart
of a commodities index (with oil), the Dow,
and the US dollar. The red and black line
is the commodities index, the black line is
the Dow, and the green line is the dollar.
As you can clearly see, beginning in the
magical year of 2003 when the Fed
completely took over, the Dow has been
moving higher with commodities. Oil and the
Dow can both go higher at the same time! The
dollar, has of course, been disintegrating.
It would therefore appear that the Dow can
move higher and higher with oil and other
commodities. Going back to our see-saw
analogy, as the dollar looses value,
commodities gain in price. And now, so too
does the Dow. So, we can now make the
argument that the Dow is not moving higher
in value. It is moving higher in price as
inflation simply pushes the price of
everything higher. Inflation is cruel and
tricky.
The key is what do we
do with this information? How do we use it
to our advantage? For one thing, we can now
ignore the media. They will continue to
parrot the past and give us data that no
longer matters. For instance, the Energy
Department puts out the oil inventories
every Wednesday. I call them the L.I.E.
(Latest Inventory of Energy). The report
will always say whatever they want it to
say in order to manipulate the price of
crude. Besides, it doesn't matter
anymore because oil and other commodities
are driven in price by the dollar. The
truth and reality is that demand for all of
the above is increasing. Perversely, even
demand for the dollar increases because oil
is traded all over the world in dollars and
if you want to buy oil, you have to have
dollars. The higher oil goes in price, the
more dollars you have to have.
Figure 6
Chart courtesy of StockCharts.com
So where do you put
your money? Oh please, don't pester
me with economic data. It doesn't
have anything to do with stock markets in
the new era. The stock markets are a
function of money. Period. Do you want
returns or not? Then I have one word for
you - 'Zimbabwe'. Yes, I know.
The unemployment rate in Zimbabwe is 80%. A sheet of
toilet paper costs $417 zdollars.
That's right, I said 'sheet'
and not 'roll'. A sack of
potatoes costs $500,000 zdollars today
and maybe $700,000 next week due to an
inflation rate in the thousands. Child
birth costs $7 million and funerals cost
$6 million. The military is asking for a
1,000 % pay increase. The government
needed to repay a $221 million dollar
loan to the IMF so they printed up $21
Trillion Zimbabwe dollars to buy the
US dollars to do so. A $500 dollar bill
is the smallest denomination they have.
GDP has shrunk for seven straight years.
I think you would agree with me that the
economy of Zimbabwe is in utter
shambles. The people are destitute. What
caused this calamity? The government
printed currency to pay for everything
and at the same time, outlawed inflation.
Yes, by mid-2007, the government
instituted laws prohibiting price
increases punishable by six months in
jail. They have no health care. No one
wants to put money in the bank or save
anything because prices are rising so
fast. What's that? Did I get off
track and start describing the
US? No,...,
well,..., there are some parallels
for sure with what our current Fed
Chairman is doing. But no, my point is
this. The economy of Zimbabwe is absolutely
disintegrating. But you know what freshly
printed money does to a stock market?
Well, take a peek at the following chart
(Figure 7). It is the Zimbabwe Industrial
Index. After what I have just described,
you may find this chart a bit
unbelievable. Believable or not, this
Zimbabwe index is one of the
best performing indexes you will find for
early 2007.
Figure 7
Chart courtesy of John Paul
Koning from
www.mises.org/story/2532#
So what can we conclude from Zimbabwe? One, printing
money excessively will push stock
markets higher. Two, money absent true
economic alternatives will compound
number one. Three, stock markets and
underlying economics are often
uncorrelated. Four, in the new era,
anything is possible. Five, the current
Federal Reserve is using Zimbabwe as a model of
currency/stock market manipulation.
Six, as long as the stock market is
going up, we don't care about
anything else. Seven, the safest place
in the world is right behind the man
that operates the monetary printing
press. Eight - did you know that
English is the official language on
Zimbabwe? How about that!
We don't even have to translate the
words 'printing press' to
understand how the Zimbabwe markets move higher.
What do we do
now?
It is clear and
obvious that the Federal Reserve has
taken over our stock market. They are
obsessed with the ascent of the Dow. In
the month of November, members of the
Fed took turns confessing their
allegiance to the advancement of the
Dow. Nothing else matters. Not
inflation, not the future, not the
dollar, nothing! The Fed will
cut rates and 'infuse' money.
Economic data will be
'tailored' to the Fed action.
If they have to, I believe they will
send each of us a little miniature
monetary printing press to take the
place of our ATM cards. When we go
shopping, we can just clip our printing
press to our belts and press the
buttons corresponding to the bills of
our choice. Of course, the keypad will
have to be pictures only because in the
Fed's eyes, we are all idiots
because we can't see what is going
on. Well, not all of us. And now after
reading this article, you too know what
is happening. If for nothing else, we
need some accurate historical recording
of the truth. So here it is.
As investors, we
have to eat when the meal is cooked. We
can't concern ourselves with how it
was slaughtered. We may be in a period
of rampaging inflation spurred on by
Federal Reserve power printers. That
inflation pushes prices of everything
we use higher and it also pushes the
price of stocks higher. So be it. If
the Fed wants the Dow to push past
20,000, it will. One thing is for sure.
The Fed does not want the Dow to fall
back to 10,000 or lower. Let me end
this with a passage from my newsletter,
Barry's Bulls, Volume
230:
'When my Son
was younger, we used to play the board
game, Monopoly. On one occasion, he had
encountered the bad luck of running out
of money. He opined that we should get
slips of paper and write dollar
denominations on them and divide them
up so each of us would have even more
money so we could keep playing. I
explained to him that that would
devalue all the money and the game
would therefore become pointless. The
whole idea of the game was to embrace
the challenge of monetary prudence. If
we were to create some infinite pile of
paper that we assigned numbers that
represented money, there would no
longer be a loser. There would no
longer be risk associated with real
estate purchases. You land on property
- you buy the property. Ah, from the
mind of a six-year old comes the policy
of our Federal Reserve!'
The moral to the
story is this. We can't become a
Don Quixote and fight imaginary giants
that are in reality windmills. We have
to focus on reality. And, the reality
is that we see windmills in front of
us. The only question is whether forces
of nature are turning the blades or is
it a big giant with a case of gas? I
sense an odor of mendacity!
