Ghost of Bubbles Past: Let's Play a Game

All things one has forgotten, scream for help in dreams.
Elias Canetti, Die Provinz der Menschen

Mr. Wall Street Says: Don't worry, the Fed's got your back!

Let's play a game.

This is the alternative to a 'crash' which is a two year grinding bear market. The classic example is 1973-74 but since we did not have good numerical data we decided to use the bear market most recent, 2000-2002, that everyone seems to overlook. The SP took a top to trough haircut of 47%!

Bear Market: And So It Begins....

Plus ça change, plus c'est la même chose.

After sorting out the limits and characteristics of their capital and cash flows, for any trader, any investor, the first and fundamental question should be: am I operating in a bull or a bear market, or one of indeterminate trend, a sideways drift?

For those who do it, the reason for this is obvious. Even a daytrader will notice the change in the complexion of the tape during a bull or bear market in a given stock, index, currency or commodity. Or should we say, any trader who remains in the game for any length of time.

The highest percentage way to make money is to be long in a sustained bull market, and to hold your positions, with minimal changes, adjusting only at periods of obvious relative strength and weakness. Thus do bull markets make geniuses of us all, and therein lies their greatest danger to the self.

In a bear market, short positions tend to 'work' for longer durations than usual, but the rallies are sharp and ferocious, and can wreak havoc on both your account and sympathetic nervous system. In a bull market, short positions work only during the corrections, which are short and sharp, with prolonged perids of generally upward drift. Short side trading is almost never easy, even during bear markets, when nothing really is easy. And when trying to buck the tiger's odds of playing options or the futures, life becomes a triple black diamond adrenaline ride. You might be surprised at how many traders get hooked on the rush of the occasional big profit in brief periods, from styles that are indeed harsh mistresses, both giving and taking small fortunes. We are no different, having done it, all.

So, are we in a bull or bear market, and has anything really changed? The fundamental question, and perhaps the one we so often forget to ask?

The Bonfire of the Vanities

When we speak of new highs and new lows in prices, or the value of most things in commerce, remember that we are speaking in terms of something else. In the case what we discuss here, it generally is the US dollar. And its not your grandfather's dollar, but one which is fully fiat, from the Latin, "let it be done, or it shall be because we say so." Perhaps its nature is better understood when used in the hopefully familiar phrase, fiat lucere, "let there be light."

"Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency. . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose." J. Maynard Keynes, Economic Consequences of the Peace, pg. 235

Given fiat money, they shall be as gods perhaps. Except in this case fiat is a vanity, and provides not light by which to see clearly, but rather clouds and distort the true value of things for those who would use it so.

"...wealth gotten by vanity shall be diminished, but wealth gathered by labor shall increase." Prov 13:11-12.

Keep these charts in your mind going forward, because we may see some unexpected twists and turns as we move into this endgame, which of course is nothing really new, at all.

"The real menace of our Republic is the invisible government which like a giant octopus sprawls its slimy legs over our cities, states and nation. At the head is a small group of banking houses... This little coterie...run our government for their own selfish ends. It operates under cover of a self-created screen...seizes...our executive officers...legislative bodies...schools...courts...newspapers and every agency created for the public protection.” John Francis Hylan, NYC Mayor, 1922

The January Stock Market Indicator

"As January goes, so goes the year."

The January Barometer basically says that as goes the S&P 500 in January, so goes the market for the year. “A down January means a down year” would seem to be the obvious reading for 2008. Credit Yale Hirsch, editor of the Stock Trader’s Almanac, for devising the January Barometer in 1972. According to the Hirsch research, January’s trend matches the trend for the year about nine times out of 10. If you toss out a few close calls, when the market was up or down less than 5 percent for the year, the January Barometer still works three out of four times, the Stock Trader’s Almanac reports. Since 1950, the S&P 500 has posted a gain for the year 91% of the time that the index experienced a positive January. For those "cautious" investors who desire an even larger sampling, since 1926, that percentage [a positive January foreshadowing a positive full year] falls to 80%, although that’s still a pretty telling predictor of future market activity.

Strictly market lore like other purely coincident indicators, like winning football teams, magazine covers, and women's hemlines? Not so, according to peer-reviewed statistical research.

"...We systematically examine the predictive power of January returns over the period 1940–2003 and find that January returns have predictive power for market returns over the next 11 months of the year. The effect persists after controlling for macroeconomic/business cycle variables that have been shown to predict stock returns, the Presidential Cycle in returns, and investor sentiment, and it persists among both large and small capitalization stocks and among both value and growth stocks. In addition, we find that January has predictive power for two of the three premiums in the Fama–French [1993. Journal of Financial Economics 33, 3–50] three-factor model of asset pricing."

The Other January Effect, Journal of Financial Economics, Volume 82, Issue 2, November 2006, Pages 315-341