My most recent newsletter has caused a flood of emails on a host of different issues. The most obvious controversial topics were my suggestion that deflation is still a serious prospect for the U.S., my suggestion that the Dow Jones Industrials might someday soon begin with the number 4 and finally the prospect that the Federal Reserve may be responsible for the massive rally in the U.S. stock market.
I recieved the below email a couple of days ago and the person who wrote me managed to weave all three issues into their concise note:
I’m a financial planner in (State name removed). I really enjoy your blogs, although I feel my mind always wanting to “not want to believe it” which fits right into the prevailing mood of the marketplace as you describe it. I’m not a trained economist, but I shudder to think of what would happen to the equity markets if a Glenn Beck got wind that the Fed was artificially inflating the stock market with its printed up monopoly money. There is already a huge distrust and uncertainty among everyday Americans. If there was a “run” on Wall Street similar to the “run” on banks during the Great Depression, I can’t imagine the fallout. I’m presuming that is the premise of your Dow four-handle, but for us simpletons out here in the sticks it might be good to have you expand on how you think that could play out. Just out of curiosity, have you heard from anyone in the political sphere since posting the blog? Also, I’m curious about why the 10-yr. treasury was one of your possible recommendations; won’t that get killed in a higher-rate, inflationary environment. My feeble understanding is that we are going to be like a group of people locked in a room where one person has a candy bar and the other nine have $1 each, and then the Fed is going to drop in several $100 bills and the things that have any intrinsic value are going to appreciate. Ok, lousy example, but the idea is that the money supply / velocity of money will pick up in the next decade- to me it’s the only feasible possibility with the American mindset (both politicians and beneficiaries) will go along with. Your feedback is greatly appreciated.
Let me me give some concise and perhaps inelegant explanations for my feelings that inflation is not as big a worry to me as it seems to be for everyone else and why I think the Dow is going to the 4,000’s.
First, the Dow prediction is not at all scientific. I have argued for many years now that we have been traveling down an extremely familiar road to me since I have watched the Japanese for the previous 20 years and I know how this story ends.
Here are some facts for you to quickly consider:
–The Nikkei 225 Index reached 38,957 on December 29, 1989
–The Nikkei 225 Index reached 7,603 on April 28, 2003
–The was a total of an 80.5% decline from top to bottom and it took 4 years to acheive.
–As of this morning, the Nikkei stands at 10,092, which is 74% below its peak over 20 years ago.
Now make this application to the U.S. markets:
–The Dow Jones Industrials peaked on October 11, 2007 at 14,279.
–80.5% of 14,279 is 11,494 points.
–If the U.S. were to suffer the identical drop as Japan (which is statistically improbable) the Dow would stand at 2,785.
–If the timing of this drop was identical to Japan’s (41 months), this drop in the Dow would occur by March of 2011.
Now of course I am not predicting the Dow is going below 3,000 in the next 13 months, but I am simply making the case that Americans should stop the arrogance that causes them to dismiss the possibility it COULD happen. Japan is not some Banana Republic/Third World country, but is still the 2nd largest industrial economy in the world…and it happened to them. With all that we have endured during the past two years are we really so foolish to think it couldn’t happen to us too? Gosh, I hope not.
So my “prediction” of a Dow Jones in the 4,000’s is actually giving myself a lot of room for error actually.
The prediction of possible deflation is also tied to the correlation to Japan. For the past 20 years Japan has been issuing MASSIVE amounts of government debt and their short term interest rates near zero. And do you know what happened?
Severe deflation. Deflation that has even been accelerating in recent quarters.
I’ll finish by pointing out something all of you should already know.
Whenever EVERYONE is in agreement that something is absolutely going to happen (I think you’ll notice an almost universal consensus among investors and economists about inevitable inflation) than you can almost be guaranteed that it’s never going to happen.
“Life is what happens when you’re busy making plans.” – John Lennon