What lies ahead for equities, real estate and gold?
Question -- How might gold act in a bear market?
Answer -- Do you note how erratic gold is acting now? Surging volatility -- down 20 dollars, up 14 dollars, down 14 dollars. . . This is indecision, confusion, clashing opinions. One scenario -- the economy starts to tank in a bear market, gold first gets hit. The Bernanke Fed freaks out in the face of potential deflation as home prices sink. The Fed drops short rates a full point and opens the money spigots wide. The dollar plunges, and gold then starts to climb.
I've written repeatedly about the Fed's fear of even a hint of deflation. The Greenspan Fed made a long and exhaustive study of the long Japanese deflation and bear market. Moreover, Fed chairman Bernanke is an expert on the Great Depression and the Fed's mistake in allowing and even abetting deflation. Take my word for it, the Bernanke fed will use any means at their disposal to fight a recession and deflation. I have no doubt that the Fed would institute and accept hyper-inflation rather than deal with deflation.
Question -- Russell, are you saying that the Bernanke Fed would create hyper-inflation if a deflationary recession set in?
Answer -- That's exactly what I'm saying. In fact, I believe the Fed would institute a number of "unconventional" techniques if they had to -- in an effort to turn any hints of deflation around.
Question -- If the Fed opened the flood gates and drove interest rates down again, wouldn't this impact on the dollar?
Answer -- Absolutely.
Question -- With it all, I hear that Bernanke wants to prove that he can be tough on inflation, and that he will raise rates another quarter at the end of March.
Answer -- Yes, that is definitely the talk. In fact, the money market has already factored in another rate boost. But many analysts don't believe Bernanke will take a chance or raising Fed Funds to 4.75%. The next Fed meeting at the end of the March will be fascinating.
Question -- Russell, what other comments do you want to make regarding the picture ahead? A lot may depend on what happens to real estate over the next six weeks.
Answer -- One thing that bothers me and it's something that I haven't talked about is this -- the great bull market that began in 1980 topped out in January 2000. Following the top-out, we experienced the initial bear leg which took the Dow down to a low in October 2002. But at that low stocks never declined to "great value" levels; in fact they never even got close. At the October 2002 lows, the yield on the S&P was a minuscule 1.79%. No bear market in history ever ended with the S&P yielding 2% or less. The 1.79% yield of the S&P was more characteristic of a top rather than a bottom!
Following the 2002 low, we had the recovery which was inspired by Fed Funds as low as one percent and a huge infusion of liquidity. But now six years have gone by, a mountain of debt as been built up in the US economy, and yet the Dow has never been able to reach its 2000 bull market high of 11722.98. To my mind, that's ominous.
Then more recently we've seen the Transportation Average rise to new record highs unconfirmed by the Dow. That's a Dow Theory warning phenomenon that nobody has paid attention to. I may be the only living person who still follows the tenets of the Dow Theory, but I maintain that the recent non-confirmation by the Dow was a classic warning that "something is seriously wrong."
As I interpret it, the primary bear market has been "held back" for six years due to manipulation by the Fed. When the primary trend is artificially held back, the bottled-up bearish forces become like a compressed spring. Ultimately the bear force will express themselves. They will be released with great force. This concept bothers me, it bothers me a lot. And I am fearful regarding how it will impact on the economy.