The US Bear Market as Seen from the Shoulders of Giants

US stocks are in a bear market which started from the last highs in October 2007.

The 'correction' became a bear market when the declines originally surpassed twenty percent in March. It does not matter that a few of the broader markets did not confirm. Once two of the major markets crossed that was it.

Since then we have had a corrective bounce which retraced approximately half the decline, and then turned sharply lower once again. Notice how all the index moves are starting to become more 'synchronized' although the broader markets are still lagging.

It would be classic bear market action to see this leg decline down to the thirty percent level, with perhaps a little bounce back up.

The US is also in an economic recession, despite the games being played by the Bureau of Labor Statistics with the GDP and inflation numbers. All the classic signs and co-indicators are there. Slapping paint on a falling building does not make it stronger or keep it from collapse.

The financial sector is in disarray. The investment banks have turned into predators in the speculative markets, and are engaging in little productive activity or efficient capital allocation. What we are seeing is the final transfers of wealth from the many to the few as the Republicans exit the Beltway.

We are also seeing a 'changing of the guard' from the leadership of the Cold War generation to Aquarian Agers and Generation X. A shift in attitude will be noticeable especially as the last of the Depression - World War generation fade away. They bore heavy burdens, they accomplished many great things, and had many flaws as a result of their harsh environment, but they also are of the past, and their time is done, and new challenges lay ahead. The US presidential election could not be more representative of this change.

It will not be easy, as for example the change of this type that occurred with the demise of the Victorian era and ushering in of the twentieth century.

As such this is more than a bear market, but one of those generational cyclic changes that are quite painful and sometimes violent, but which often lead to a more sustainable equilibrium.

Certainly there will be new schools of economic thought to supplant those which have gone before, but all of which are echos of the past.

Who was it that said we look and move forward 'standing on the shoulders of giants?' Isaac Newton in the 17th century comes to mind, but before that Bernarnd of Chartres in the 12th century, and before that the Greeks in the myth of the blind giant Orion carrying Cedalion. So it is that we have a debt of gratitude and preservation to the past, but a obligation of achievement and advancement to the future.

More Warnings from Europe: Fortis Bank Forecasts a US Financial Market Meltdown

We won't disagree with the forecast, although timing may be another matter, and we do have our 'talking their book' filters in place.

As background, Fortis has been making some moves to raise 8 billion euros in capital, and the stock was sold sharply in a share offering last week, out of fears of shareholders dilution and further troubles at the bank.

Interestingly enough, Fortis is part of the tripartite acquisition of ABN Amro, along with Banco Santander and the Royal Bank of Scotland, the largest bank takeover in history. The US retail operations were separately taken by Citigroup. ABN Amro was one of the largest banks in Europe and had operations in about 63 countries around the world.

RBS issued a similar dire prediction of the US financial crisis around 17 June. We just thought it was striking that both banks issued such forecasts about this time. Barclays issued a similar forecast last week. Something ugly in those balance sheets?

Warnings from Europe ahead of a US crash which is ignored by the American media and dismissed by the financerati have an historic resonance, as in the case of the stock market crash of 1929.

We think there is a strong probability of a dead cat bounce that may turn into a multi-day short squeeze relief rally within the next two weeks, barring fresh disclosures and confessions from the corporate crowd.

There are a number of pros expecting the same thing, as they did on Friday past. So you can see we are cautious, and back into our short term 'advantageous' trading posture. The narrower index charts show the breakdowns are in progress, and we may be over the edge, but the broader market indices are inconclusive. This may actually be quite bearish since the bulk of the market shows little fear yet and the VIX is at moderate levels for this bear market leg.

Oil is an interesting market. Is it a bubble driving by 'speculation' or a flight to safety haven for those disaffected by the US dollar, and without further desire for the euro? Is oil a sustainable world 'currency?' Perhaps its industrial demand is a two-edged sword in this discussion.

One thing we like about gold and silver is that they keep only one set of books, and nothing is off balance sheet, although the same might not be said of the Central banks that often muddy their markets.

Fortis Story roughly translated into English

American 'Meltdown' Reason for Capital Raising - Fortis
28th of June, 9:10
De Financiële Telegraaf

Fortis Bank predicts US Financial market meltdown within weeks...

BRUSSELS/AMSTERDAM - Fortis expects a complete collapse of the US financial markets within a few weeks. That explains, according to Fortis, the series of actions by the bank of last Thursday to raise €8 billion. "We have been saved just in time. The situation in the US is much worse than we had thought", says Fortis chairman Maurice Lippens. Fortis expects bankruptcies amongst 6000 American banks which have a small coverage currently. But also with Citigroup, General Motors, a complete meltdown in the US is beginning."

Amerikaanse ’meltdown’ reden geldinjectie Fortis - De Financiele Telegraaf


Fortis expects no more capital raising
Sat Jun 28, 2008 9:59am BST

BRUSSELS, June 28 (Reuters) - Measures taken by Fortis to shore up its finances should be sufficient, the Dutch-Belgian bank's supervisory board chairman told Belgian financial daily L'Echo on Saturday.

Chairman Maurice Lippens, asked if there was a chance that further capital-raising measures will be announced, replied: "Normally, it's sufficient. Of course, if this is a return to 1929, then we are in a different ball game."

Fortis raised 1.5 billion euros ($2.36 billion) from a heavily discounted share issue this week, part of a package of measures to shore up its finances by more than 8 billion euros.

Lippens said Fortis has been the victim of speculators and wondered how much money certain -- unnamed -- hedge funds made.

"Besides, Thursday's step was completely successful," Lippens said.

He also backed Fortis Chief Executive Jean-Paul Votron.

"You don't kill the captain in a storm," Lippens said.

The drop in Fortis' share price -- down more than 40 percent so far this year -- has not made the company a takeover target as other banks also have their problems, he added...

Barclays Warns of an Oncoming Financial Storm

It was the Royal Bank of Scotland that issued a similar warning on 17 June RBS Warns Its Customers of a Financial Storm.

Barclays warns of a financial storm as Federal Reserve's credibility crumbles
12:01am BST 28/06/2008
UK Telegraph

US central bank accused of unleashing an inflation shock that will rock financial markets, reports Ambrose Evans-Pritchard

Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall "below zero".

"We're in a nasty environment," said Tim Bond, the bank's chief equity strategist. "There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth." (Hmmm. Let's see, what is renowned through the ages as a safe store of wealth in troubled times especially of inflation? Celery futures? Google? - Jesse)

Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. (The bond vigilantes are all retired to keeping bees in Sussex. These must be imports. - Jesse)

"This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility," said Mr Bond.

Strategists at Barclays accuse Ben Bernanke of a policy blunder

The grim verdict on Ben Bernanke's Fed was underscored by the markets yesterday as the dollar fell against the euro following the bank's dovish policy statement on Wednesday.

Traders said the Fed seemed to be rowing back from rate rises. The effect was to propel oil to $138 a barrel, confirming its role as a sort of "anti-dollar" and as a market reproach to Washington's easy-money policies.

The Fed's stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2pc to 5pc over the last year.

Mr Bond said the emerging world is now on the cusp of a serious crisis. "Inflation is out of control in Asia. Vietnam has already blown up. The policy response is to shoot the messenger, like the developed central banks in the late 1960s and 1970s," he said. (If China were wise they might move to place their currency in a foundation of gold and silver to anchor it in this storm. - Jesse)

"They will have to slam on the brakes. There is going to be a deep global recession over the next three years as policy-makers try to get inflation back in the box." (Where did we hear a specific and strong stagflation forecast for this time period? Oh yes, in our predecessor blog last year. - Jesse)

Barclays Capital recommends outright "short" positions on Asian bonds, warning that yields could jump 200 to 300 basis points. The currencies of trade-deficit states like India should be sold. The US yield curve is likely to "steepen" with a vengeance, causing a bloodbath for bond holders.

David Woo, the bank's currency chief, said the Fed's policy of benign neglect towards the dollar had been stymied by oil, which is now eating deep into the country's standard of living. "The world has changed all of a sudden. The market is going to push the Fed into a tightening stance," he said.

The bank said the full damage from the global banking crisis would take another year to unfold.

Rob McAdie, Barclays' credit strategist, said: "The core issues have not been addressed. We're still in a very large deleveraging cycle and we're seeing losses continue to mount. We think smaller banks will struggle to raise capital. We're very bearish - in the long-term - on high-yield debt. The default rate will reach 8pc to 9pc next year."

He said investors had taken their eye off the slow-motion disaster engulfing the US bond insurers or "monolines". Together these firms guarantee $170bn of structured credit and $1,000bn of US municipal bonds.

The two leaders - MBIA and Ambac - have already been downgraded as the rating agencies belatedly turn stringent. The risk is further downgrades could set off a fresh wave of bank troubles. "The creditworthiness of many US financial institutions will decline in coming months," he said.

The bank warned that engineering and auto firms we're likely to face a crunch as steel and oil costs surge. "Their business models will have to be substantially altered if they are going to survive," said Mr McAdie.

A small chorus of City bankers dissent from the view that inflation is the chief danger in the US and other rich OECD countries. The teams at Société Générale, Dresdner Kleinwort, and Banque AIG all warn that deflation may loom as housing markets crumble under record levels of household debt. (Interesting that the French are preoccupied with deflation. - Jesse)

Bernard Connolly, global startegist at Banque AIG, said inflation targeting by central banks had become a "totemism that threatens to crush the world economy".

He said it would be madness to throw millions out of work by deflating part of the economy to offset a rise in imported fuel and food prices. Real wages are being squeezed by oil, come what may. It may be healthier for society to let it happen gently.

Charts in the Babson Style for Market Close 27 June 2008