WL October 19, 2009

October 19, 2009 Volume 32: No.
18
SMOKE AND MIRRORS EVERYWHERE

Abraham Lincoln once said:
You cannot help the poor by destroying the rich.

You cannot strengthen the weak by weakening the strong.
You cannot bring about prosperity by discouraging thrift.
You cannot lift the wage earner up by pulling the wage payer down.
You cannot further the brotherhood of man by inciting class hatred.
You cannot build character and courage by taking away men's initiative and independence.
You cannot help men permanently by doing for them, what they could and should do for themselves.
(courtesy of www.traderview.com)
Read the Abraham Lincoln quotes again: how many members of Congress today would agree with
those? How many have ever read even one speech of Lincoln, or the U.S. Constitution?
THE STOCK MARKET
SMOKE, MIRRORS, AND LOTS OF HOPE
The stock market rally since March 6 is widely proclaimed to be the best of several decades, some say
since the Great Depression. Let's see what it has done.
There were two phases: March 6 to June 11, and the rally from the correction bottom on July 13 to now,
with the DJI hitting 10,000.
Bert Dohmen’s Wellington Letter, P.O. Box 49-2433, Los Angeles, CA 90049
Phone: (310) 476-6933 Fax (310) 440-2919 Website: www.dohmencapital.com E-mail: client@dohmencapital.com
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Wellington Letter TM
The S&P 500 Index rose 43.5% in phase 1. In phase 2 it gained another 15.8% from the June 12 peak.
The NASDAQ COMPOSITE gained 48.5% in phase 1, and the same 15.8% as the S&P in phase 2 from
the June 11 peak.
Obviously, the first phase was much more powerful. We participated in that nicely right from the
bottom. However, the second phase didn't meet our requirements for a positive risk/reward ratio. When
the risk is too high vs. potential reward, we would rather not take the risk.
Our view is that the second phase was and is a highly promoted affair without broad participation.
Our colleague Rob Arnott of Research Affiliates calculated the performance difference between the
small cap stocks and the big caps, using components of the Russell 1000. For the five months starting in
April, stock selling below $5 gained an impressive 116.9%. Yet stocks selling at over $50 gained a
much smaller 22%. Yes, the "cat and dog" stocks soared the most.
In the financial media, you always hear the phrase that so many companies are reporting earnings "better
than expectations or estimates." But you seldom hear how much down they were from the earnings a
year ago. That is very deceptive.
The "estimated earnings" come from Wall Street. It behooves them to keep them low so that companies
can easily beat them. That's what stimulates buying enthusiasm. It's a charade. So, let's see what the real
earnings comparisons were. Second quarter earnings for the S&P 500 stocks were down a hefty 27%
over the year ago numbers. For the third quarter, they are expected to show declines of 25%. And
that's with all the easy cost cutting. What will the companies do next year, when they really have
to cut into the muscles to get some cost reductions?
On a valuation basis, this is now a very expensive stock market. Valuations are at levels as high as or
higher than what's normally seen at bull market tops. Another mini-bubble has been created by the
Fed. They think that piling trillions of debt on top of the trillions existing in 2007 will resolve the
crisis. That can only happen in fairy tales.
Statistics show that corporate "insiders", i.e., the top executives, are very busy selling the stocks in their
own firms. The ratio is now at a very high 18:1 sell to buy, the highest ration since the 2007 bull
market top. Obviously, they don't think today's stock prices represent values.
Sentiment has been and is still very bullish. That is a contrarian indicator and shows that too many are
on the bullish side of the fence. The sentiment amongst S&P futures traders is still over 90%, which
equates to important bull market tops. The difference between bulls and bears amongst investment
advisory services is at a high last seen at the 2007 bull market top (from Investorsintelligence.com).
The public, however, hasn't been buying stocks in large quantities. Normally that would be a bullish
signal. In fact, they are still liquidating equity mutual funds in large amounts. The average investor is
strapped for cash. Americans find that selling stocks is the only source of ready cash they have left. The
public lost 50% or more of their lifetime savings in the 2008 bear market. They have nothing left to
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gamble with. That's why Las Vegas is dead. The average person is having trouble paying the monthly
bills.
There are so many distortions in the markets today that traditional technical indicators are no longer as
reliable as in the past. Trading volume in the markets used to be a most reliable indicator. But today,
about 50-70% of daily trading volume is from the "high frequency" trading computers. Imagine! If
it weren't for these, the stock market might have to shorten hours for lack of interest. But trading volume
in the dollar term is at a record high. What's going on? Here is a great chart from our colleague, Alan
Neuman's Crosscurrents (www.cross-currents.net):
It shows that although the total worth of listed stocks is now lower than in 1998, the dollar value of
trading is about 3 times greater. That's the "high frequency" trading operations. They are in a trade
only for minutes or a few hours. That's keeping the exchanges alive. They need that business.
Additionally, big volume has come from just four stocks: Fannie Mae, Freddie Mac, AIG, and
Citigroup. On some days, these four stocks accounted for 40% of total volume. The first two firms are
considered to be totally worthless by some analysts. To us that confirm that this rally has nothing to do
with "investing," but more with computerized speculation.
A FLURRY OF OFFERINGS: Have you noticed the number of IPO's and secondary offerings? The
private equity firms are taking a bunch of their company’s public. These are firms they acquired during
the boom, loaded them up with debt to pay themselves multi-billion dollar fees, and now they are
scrambling to shed the over-indebted carcasses.
Other firms are going public as well. They can't get credit, so they sell stock. Is all this bullish or
bearish? The media tells you its bullish. It shows that the markets are functioning again. That's true.
However, we notice that many of this IPO's aren't working: the stocks quickly drop below the offering
price within a few days. That means that the syndicate offering the stock couldn't or wouldn't support it.
They didn't want to risk their own money.
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Therefore, to us it looks more like an effort to exchange paper (stock) for good cash, much like was seen
at the top in 2007. Remember, that was one of our important "canaries in the mine" in 2007, when a
major P-E firm hastily went public, grabbing around $4.5 billion of the public's money. The stock
imploded thereafter. Our reaction to IPO's that fail is, when Wall Street is eager to sell you something,
pretend you're in a used car lot: be suspicious!
So, if technicals are distorted, and the fundamentals are irrelevant in the markets, what can a
trader or investor rely on? The speculators can do well to "go with the flow." That's a high risk
proposition. The more prudent investor should go with his own analysis, ignoring all the stuff in
the media. He will look at the facts, not the promotions in the media. Listen to the CEO's, who are
much more cautious at this time.
The CEO of Norfolk Southern was on CNBC. He was telling why business was down substantially from
last year. One factor was reduced shipments of coal, as electrical consumption is way down and the
utility firms have excessive stockpiles of coal. Electric power consumption is one of the best indicators
for the economy.
Yet the stocks of coal mining firms have rising sharply this year. Even if it's because of China demand,
the coal has to be transported to the ports. Could it be that the coal stocks are overvalued? In China, the
government has just issued an order to slow steel production because of excessive stock piles. Beware!
For us, there are many "canaries in the mine," just as we wrote about in 2007. And we know how correct
that was.
QUESTION from a subscriber: Do you still consider this a "bear market rally" and not a cyclical bull
market that could last 2-4 years? What would you need to see to change your sentiment?
Answer: Definitions are very important. A "cyclical bull market" can last up to 4 years. It can occur in
the confines of a larger "secular" bear market. We believe this is a secular bear market, but the rally is a
larger "bear market rally" which some will call a cyclical bull market. If we had a different leadership in
Washington, knowledgeable about economic history, there would be a chance to produce a long-term
period of improvement in the economy. Under the current policies, we don't think that is possible.
THE CRISIS STATE: Our colleague John Mauldin had a very interesting article recently on "the
fingers of instability" and the "crisis state." It also quoted economist Hyman Minsky who proposed the
theory that "stability creates instability." The longer the period of stability, the greater the instability that
follows. This is a topic we have discussed in the past, before the crisis started in 2007.
Fortune magazine had an "anniversary" issue on the alleged start of the financial crisis in 2008. Yet the
crisis started in 2007, when we identified it in these pages, and when I started writing my book,
PRELUDE TO MELTDOWN. Fortune quoted Treasury Secretary Geithner that most people think the
crisis started in September 2008, "but it really began at the end of July 2007." He is correct.
John described an experiment in which the researchers add kernels of sand to a pile of sand. The pile
grows and grows. Measurements can determine more and more fingers of instability occurring in the
pile until finally, one kernel is added, and the pile collapses.
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The "fingers of instability" in the global markets started growing rapidly from 2005 until 2007. Then the
"crisis state" was reached and the mountain of debt started collapsing. Is it possible that such "fingers of
instability" are once again growing silently?
We identified the stock market top in July 2007 to the exact day. The markets tumbled into August.
However, then there was another rally going into October. We wrote in these pages that the last rally
was manipulated. We showed that the majority of stocks were being sold in big numbers, while the large
cap stocks that control the major indices were being promoted upward to disguise that selling. While
some subscribers were just itching to plunge into the market and questioned our sanity during the rally,
the October 2007 top preceded the worst financial crisis in history. In the WELLINGTON LETTER of
October 17, 2007, we said it was a top. And it was.
The point here is that just because a rally continues while the dark clouds are forming, doesn't
mean the rally is genuine. Eventually, the fingers of instability reach the crisis state, and
everything comes tumbling down.
The S&P 500 Index is now selling at 26 times operating earnings. That's more expensive than at the bull
market top in 2007. Are things really better than at the five-year bull market top in 2007? What about
the trillions of dollars of bad assets still on the books of financial institutions around the world? Most
analysts agree that the market is over valued. Yet they have to participate because the market is going
up. They hope to be the first ones out of the exit when the plug is pulled. Do you think you can do that?
Although we participated nicely in the first part of this rally from the March bottom, we became
cautious in the summer and therefore have missed part of the rally since that time, depending on which
of our services you receive. However, experience shows that unless you have a crystal ball that works,
the way to successful investing over the long term is to pull back or go to the sidelines when the
risk/reward ratio is unfavorable. That doesn't keep the market from climbing; it does prevent you from
being invested in a massacre later on.
Do you remember the 1987 crash? We got warning signals in early September. We had an investment
management subsidiary at the time. We raised cash positions in the portfolios to about 77%, (23%
invested). We got complaints over the next six weeks from some clients for being too cautious. I
remember two of these people using extreme profanity to one of my people. Then came the mid-October
crash. Clients were very happy. Several days after the crash, we bought back some of the investments
we had sold earlier at half the price. Then we got angry phone calls for getting back in. They screamed,
"don't you know that the collapse of the financial system is ahead."
The fact is that no one "knows" what the market will do. We just go by the "weight of the evidence."
Sometimes the evidence is not all-encompassing. If you are totally convinced that we are missing an
important move, then jump in and take responsibility. Nothing keeps you from doing that.
Our first target for the S&P 500 is the 1100-1120 area. We are just about there. If it can get through that,
then we have to look at the 1180-1200 area. When so many traders and money managers are in the
market only because it's going up, they will also be very quick to sell when the uptrend breaks. That
means the downside move could be sharp, not giving slow investors a chance to get out.
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You may have seen our views on national TV. Well, sometimes things get lost in translation. For the
record: I am not looking for "Armageddon." The world's central banks are in control now. They can and
will do anything to prevent another crisis. They do that with freshly created money. And that's what is
driving the market. On any correction, the March lows will probably not be broken at this time. That can
occur in late 2010 or 2011.
We continue to repeat that the current rally has nothing to do with fundamentals. It has
everything to do with hope, expectations, and liquidity which are not going into economic activity.
The current Fed policy is ZIRP. That means Zero Interest Rate Policy. That's the driving factor,
especially for the financial stocks.
We know that the Washington power clique will do everything it can think of to prevent the recession
from worsening again, and to win the 2010 elections. Losing would mean that their 40-year battle for a
socialistic remake of the U.S.A. will have failed. If they win, start packing.
They only problem: they have to depend on the usual apathy of the American public. That may not be a
good bet this time. Americans have been awakened. They care less about political parties: they just want
the government out of their lives. It's all about FREEDOM now. Will Americans be able to get their
country back? That's the most important question in 200 years.
Let's look at the facts:
1. The valuation of the major indices are now more extreme than at the bull market top in 2007.
2. It takes jobs to make the economy grow. The consumer is 70% of the economy. If he only has welfare
money, how can he produce a vibrant economy?
3. Tax policies out of Washington promise to increase taxes by unprecedented amounts over the next
several years. The budget deficit will grow by $10 trillion over the next 10 years, an amount impossible
to finance by borrowing from every government in the world. The world has never seen this.
4. A nationalized health care system will be a monster. The deficits thus created will bring the dollar to
ruin.
5. The "energy tax," or "carbon tax," now renamed the MARKEY-WAXMAN BILL, is another
program that will impose trillions of dollars of taxes on every American, stifling growth. In other
countries, for every one job created by "clean energy" about eight jobs have been lost in other industries.
6. Unionism is back. It's a fact, that unionized firms underperform significantly the non-union firms.
Unions usually keep new workers out. Therefore, that's another impediment to job growth. A recovery
has everything to do with JOBS, JOBS, JOBS. And you won't see these being created.
7. Policies out of Washington are causing foreign investment money to leave the U.S. That's causing a
dollar decline, which is what Washington actually wants. Eventually, our creditors abroad will lend to us
no more.
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8. Stimulus programs, as designed in Washington, have done nothing to stimulate. If you would remove
all these programs, the financial system would come to a standstill again.
9. Credit, credit, credit. Yes, credit growth is needed for any recovery, yet all the credit numbers still
show a huge credit contraction. Instead of lending, banks are happy to speculate in bonds, with the ultra-
cheap money from the government. They borrow at 0.25% and invest it in Treasuries at 3.5%. No risk,
no loan applications. The profits of banks will grow even as the economy crumbles. However, no credit
growth, no economic growth.
WALL STREET TALK: The two guys who ran the Bear Stearns hedge funds, which in 2007 were the
proverbial "canaries in the mine" for us in regard to the coming implosion of the financial sector, said to
clients in April 2007 that redemptions "are in only a couple million." Actually, at the time they had
redemptions of around $50 million. If I remember correctly, they had leverage of over 6 to 1. That
means that for every dollar of redemption, they would have to liquidate at least $6 of assets.
One of them had said in an internal memo "we should close the funds down." At the same time, they
were telling clients "we are comfortable where we are." The two have been arrested and are charged
with fraud.
One of these two managers reportedly (www.dealmaker.com) had amassed a collection "of three
Ferraris, and real estate and assets that include a $12 million property in Southampton, New York, a
$3.5 million home in New Jersey, a $3.25 million home in Vermont, and two Florida properties worth
$7.1 million and $1.25 million." One could ask, "Where are the customers' mansions and Ferraris?
THE CHARTIST'S VIEW
The S&P 500 INDEX

(weekly) is the same chart
we showed last time, with
the still unfulfilled upside
target of 1100-1120.
Actually, the target range
was entered today
(Monday). This is the 50%
retracement of the entire
bear market. Such 50%
retracements are normal in
a bear market, and can
even extend to a 61.8%
retracement.
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The DJ TRANSPORTS (monthly) is a very long term chart. It shows that the 50% retracement has been
exceeded. That sets up the 61.8% area as the next target. That also coincides with big chart resistance.
It's close.
The DJ TRANSPORTS (monthly)
The NASDAQ
COMPOSITE
(weekly) has
reached our
first target
given last
time. This is
chart
resistance
from the crash
of last year. It
could still go
to the 61.8%
retracement
level, in the
2250 area,
which is not
far away.
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The DJ US TECHNOLOGY INDEX (weekly) is now at resistance. It could still go slightly higher, to
the 590 area. Then it will face extremely strong resistance.
The DJ US TECHNOLOGY INDEX (weekly)
The DJ US
REAL
ESTATE
INDEX
(weekly) is
having an
anemic rally. It
hasn't even
rallied to the
first
retracement
level around
38.2%. This
represents the
REITs. It
suggests big
trouble for this
sector next
year.
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The US DOLLAR INDEX (daily)
The US DOLLAR
INDEX (daily) is a
basket of currencies
vs. the dollar. The
chart shows a
"declining wedge"
which is a
potentially positive
formation. Usually,
when the graph
reaches the apex of
the wedge, there is
a strong rally. It
seems to be there
now. That means
you have to be very
cautious in all
investments right
now.
The chart of GOLD (monthly) shows the bottom in 2001, and the big rally. A 400% rise is better than a
dividend. The
strong
correction in
2008 appears to
have been a
typical mid-
course
correction. That
suggests a long
term target in
the $2000 area.
Another way to
get an
approximate
upside target is
to look at a 10
fold gain,
which is what
major bull
markets in
sectors accomplish. Starting with $265 in 2001, that would give us a $2650 target.
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A shorter term technical measurement, valid for next year, would be the $1300-1350 area.
CONCLUSION:
The different markets appear to be ready for trend reversals. Whether gold will follow cannot be known.
We believe it will, at least initially. It would be the shakeout to test the resolve of the bulls.
GOLD: BREAKOUT, but be cautious now!
We turned bullish again on gold in September, after taking a break during the summer. In our September
14 issue, we discussed the bullish picture going into February next year at least, after which gold could
have a sharp correction. But the long term remains very bullish as well.
Those who argue against gold talk about gold not having a dividend. Well, when something rises 400%
over 10 years as gold has, you don't need the dividend. We have never accepted this argument.
Then they say that gold is an inflation hedge, and with today's dismal economic numbers, we don't need
to fear inflation. That's a better argument. It is our view that gold will not necessarily rise because of
rising inflation, but because of a lack of confidence in paper currencies around the world. Everyone is
well aware of the unrestrained money creation in the U.S. and Europe. These deficits cannot be financed
through borrowing or raising taxes. It must be through the printing press.
All currencies are declining in value, just at different rates. This means that diversification into gold is
only prudent and its global. Slow economic growth will not enable many of the industrialized nations to
grow out of their predicament. The interest on the debt alone will assure that the debt can never be
reduced.
Income tax receipts are plunging. In the U.S., corporate tax receipts by Washington are down 56%
from the prior year. Soaring expenditures, while tax receipts are plunging, is a prescription for disaster.
And that's why the prudent money of the world is diversifying into gold.
Additionally, we believe that gold will be a part of a basket of currencies which some major creditors of
the U.S. are discussing now. These creditors are the Middle Eastern central banks, Russia, and China.
There are huge, virtual short positions in gold because of the "gold leasing" programs. (Look it up on
www.google.com). These must be closed out as gold soars and the lessees of the gold cannot put up
more margin for those losing positions.
The near-term view: We see signs that all the markets may be getting ready for trend reversals. We
consider the trend of the dollar the leader. If the dollar turns up, the dollar rally could be sharp because
of the huge short positions. This will cause a sell-off in the commodity markets. The big question:
will gold follow? We believe it will, initially. But then it could stage a turn to the upside again.
A dollar rally will also be the trigger a stock market correction. Hedge funds don't want to give back the
profits of the last 6 months. Other money managers have similar incentives. Everyone has stayed in the
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market just because it was going up. And they all think they can be the first one to the exit. It could get
crowded.
Gold investors have to decide now whether they want to stay with their positions through a
correction in gold, or not. Selling is always the toughest decision. So much depends on a person's
psychological profile, and, of course, the financial situation. Less active investors don't mind. They
recognize that gold is probably the best investment for the next 5-10 years. It's your decision.
THE PLUNGING DOLLAR
The dollar had a big, volatile rally in 2008 while the financial crisis accelerated. That's contrary to what
the average analyst assumed. Why did it rally while the financial system was on the brink of a
meltdown? It was a flight to safety, primarily into U.S. Treasuries. Remember, the yield on short term T-
bills actually went below zero, which means that investors were willing to pay interest just to have the
safety of T-bills.
However, the dollar rally came to an end when the stock market started the current rally in early March.
The dollar started weakening and the decline has continued. Now there seems to be a global rush out of
the dollar. Stocks are still rallying because a weak dollar is bullish for U.S. firms doing business abroad.
It gives their products a price advantage. For now, Washington loves the weak dollar. However, our
large trading partners, especially those who have been financing the U.S. budget deficit, are meeting
quietly to discuss reducing their exposure to the dollar.
What can we make out of the pattern of the dollar, and its future? It seems logical that the dollars bought
last year during the financial crisis have already been sold. That was the first phase of the decline this
year. So why is the dollar still weak? Our view is that the reasons for a declining dollar have shifted
quietly. The confidence in a country's government, not interest rates, are the primary determinant
of the currency value of that country. That's why boosting interest rates, the normal governmental
reaction to supporting its currency, never work.
So, we must ask, how does the world consider the policies of the leadership of the U.S. at this time? Is
there reason for great confidence? After all, the leader has just received a Nobel Peace Prize and he is a
great talker, i.e., speaker. Or is there reason for the capital of the world to flow out of the U.S., fearing
ever higher taxes, ever more governmental control of the private sector, and ever more stifling
regulations? If the latter is the case, than there is no bottom to the dollar over the long term.
He is about to sign a treaty in Copenhagen which will make the U.S. subject to heavy fines and penalties
for polluting. The U.S. will pay billions to less developed countries as restitution. (Will China and
others' pay us anything/). The treaty will be heralded as a gigantic step to "save the world" from carbon.
"Global Warming" is a hoax, as more recent scientific studies have shown. The treaty will be the success
of a long term socialist agenda, from people now Czars in Washington, to "redistribute" the wealth of
the U.S. Read some of their writings from years ago (go to googlecom.) And who do you think will be
on the receiving end of all these billions? The people now flying around the world in their private jets,
warning about "climate change." It's amazing that so many people can fall for such pseudo science.
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Let's get back to the dollar. Who will want it if all these financial burdens in the U.S. can only be
serviced with freshly printed money? We know that Middle Eastern countries, Russia, and China have
been discussing a change away from the dollar. They are working on a basket of currencies, including
gold, to replace the dollar. That certainly would produce a sharp rise in the price of gold. Yet it takes a
long time to agree on such a new payment mechanism.
A rally in the dollar now will coincide with a downward correction in stock market. That could occur
soon. Improving economic statistics going into year end could be the background excuse. But we don't
see a meaningful, long-term rebound in the dollar.
Looking out over the next 5-10 years, here is why the US dollar is "toast." Just click on this link of the
"debt clock." http://www.usdebtclock.org/
THE ECONOMY
INFLATION IS BREWING
Our view still stands that inflation would be seen in all the things you need, and not in the things you
don't need. We are seeing that already. Just look at supermarket prices.
Will we eventually see an upside breakout in general inflation levels? For the past two years, we have
been in the minority, saying that inflation would not be a problem yet. That was the correct view.
Eventually that will change.
Prices rise for these reasons: 1. Excess liquidity, 2. Cost push, and 3. Depreciating currency.
It appears that the majority of analysts are concerned about #1. Yes, there is a lot of liquidity in the
banks, but it's not going anywhere. It is not used for lending and won't be for a long time. As we
mentioned, for a bank it's easier to borrow from the Fed at less than 1% and put it into Treasuries bonds
at 3.5%. No work, no credit risk, and no tedious loan documents to process. The broad money supply is
barely growing. Therefore, we don't think that the bailout liquidity will cause inflation for some time.
The "cost push" is a different story. All the tax increases being pushed through in Congress will raise the
cost of doing business. A study says that the most recent version of the health care plan will cause taxes
of people making between $100,000-200,000 to rise by 29%. That's huge. Anyone having a secure job
will ask for a commensurate increase in pay. And that increases the cost of doing business, which results
in higher costs to the consumer.
All the taxes that will be imposed on companies in the health sector will be passed on to the consumer in
the form of higher prices. Such "cost push" prices rises will be contagious. When other firms see these
prices rising, they will want to raise their prices. And that causes more and more industries to follow.
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Bert Dohmen’s
Obviously, when unemployment is double-digit and rising, people can't afford the higher prices.
Recessionary pressures will increase. That requires further bailouts and "stimuli" from the government.
Because the government doesn't have the money, they will have to create it out of thin air. And this is
what the nations who are buying our debt are worried about. That gets us to #3. The dollar will decline.
What's worse, Washington will encourage a cheaper dollar as it tends to produce more exports.
The typical governmental remedy to support a currency is to hike interest rates. That never works, but
they think it does. In government, the rule is: "If something doesn't work, do more of it."
Soon you get to the point that people around the world won't want dollars. We saw that in 1987. And
that's when a plunging dollar will create rapidly rising inflation in a recessionary environment because
of a worthless currency.
Gold will become king. Washington may try to prohibit gold ownership by U.S. citizens again, as was
done under Roosevelt. But this is not the 1930s anymore. The flight away from the dollar into gold will
be worldwide as all paper currencies become suspect.
High inflation causes high interest rates. And that will depress the economy even more. Under the
current leadership in Washington, there is just no way out. Tax cuts are an anathema to these people,
especially when the cuts are for people who actually pay taxes and create jobs.
BOTTOMLINE: We don't expect the inflation statistics to rise substantially over the next year.
However, inflation will be simmering below the surface. The dollar will be the key to the markets.
ECONOMIC RECOVERY OR AN INTERLUDE
The big announcement on October 12 came from the NABE (National Association of Business
Economists): "The Recession is Over."
On the surface, that sounds great. But then you think, what does it mean? Unemployment is expected to
rise above 10%, mortgage defaults are rising sharply and now spreading to high-priced homes, credit
card defaults are soaring and expected to go above 10%, commercial real estate loans are in big trouble
(about $750 billion). So, how do they define the "end of recession?"
Is it two consecutive quarters of positive GDP growth? Is the "growth" a comparison with year-ago
levels, or the last quarter? You see, you can have the so-called "end of recession" without any
meaningful effects for the average person. And don't forget, this proclamation came from a large group
of economists, the same people who were so optimistic in 2007, just before the financial and economic
crisis started accelerating.
My rule is "don't believe economists," even when it's the Fed Chairman. On January 10, 2008, when the
country was already in recession, the Fed Chairman said, “Thus, notwithstanding the effects of multi-
billion dollar write-downs on the earnings and share prices of some large institutions, the banking sys-
tem remains sound … The Federal Reserve is not currently forecasting a recession.”
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Bert Dohmen’s
Three months later, he testified before Congress. As we know now, this was four months after the
recession had started. He said: “Recession is possible, but recession is a technical term … I’m not
ready to say whether or not the US economy will face such a situation.”
Yes, and these are the people allegedly "steering the economy." Heaven help us.
Currently, the consensus view of economists, Wall Street analysts, and even Nobel Prize recipients in
economics is that the economy is recovering and that now is the time to go bargain hunting for the good
times ahead. The Economist writes: “After the storm: How to make the best of the recovery.”
Well, the world's most devastating financial crisis in a century or more isn't over in two years, especially
with the current disastrous policies coming out Washington. Even enlightened political leadership would
have its work cut out for them. But when the leadership wants to replace capitalism with socialism, there
will be a lot of broken eggs,
The default rate on Commercial Mortgage Backed Securities (CMBS) is skyrocketing. The Fed still has
hundreds of billions of dollars to buy up some of this paper in order to avert another crisis. As you can
see, the government is now the whole ball game. They are spending money created out of thin air. That
is not the way to resolve a problem produced by an imploding credit bubble. A better way it to let the
defaults occur and let the marketplace take care of the shakeout.
Unemployment now officially stands at 9.8%. The “Employment Report” today for September was
dismal. Officially, the payroll survey showed a decline in payrolls of 263,000. However, the household
survey shows 785,000 people losing jobs. You don't hear that in the financial media!
Because of an accounting gimmick, the unemployment rate rose only 0.1%. You see, the civilian labor
force shrunk by 571,000 in September, compared to an increase in the labor force of 73,000 in August.
If the labor force had held steady in September, the unemployment rate would have increased to
10.2%!
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Bert Dohmen’s
This chart (courtesy of www.chartoftheday.com) goes back to 1960. The straight line through the graph
is a regression line. Note that this is the greatest drop below the regression line in 50 years. In fact, non-
farm payrolls are now back to 2001 levels. Imagine, no gain in the number of people working in eight
years.
Rutgers University just did a study, using the normal job growth during recessions, and the current
jobless numbers. The conclusion is that it will take almost 8 years to get back to 5%
unemployment. And that is under the most optimistic assumptions.
Well, that coincides nicely with our view that, at minimum, the current period of economic stagnation
will last until 2017. That's a number we predicted in late 2007, using a 17-year downturn, which is
normal for a post-bubble "readjustment." We measure from the year 2000, which by many measures,
was the real top. The 2007 high in the stock market was not confirmed by economic indicators, and was
simply the result of an artificial credit bubble created by the Fed and Wall Street.
The New York Times, on September 27, 2009 published: “U.S. Job Seekers Exceed Openings by Record
Ratio — 6 Jobless for Each Spot. September Labor Department statistics revealed that “unemployment
among 16-24 year olds hit a record 52 percent." Wow!
Economist David Malpass said that "real, per capita GDP" has declined 25% since the year 2000.
That is an astonishing number. The word "real" means "after inflation." In other words, factoring out
inflation, we are all 25% poorer than nine years ago. This is another number that seems to confirm our
thesis that the actual secular top in the economy was in 2000.
The August trade deficit narrowed to $30.7 billion, which surprised economists. A big drop of crude oil
was one of the factors. Exports of capital goods fell to the lowest level in four years. In 2007 we forecast
that in this secular downturn, the trade deficit could even disappear.
There is a lot of enthusiasm around the idea that the housing market is bottoming. It could, but not under
the current programs. On October 8, the Treasury Secretary said that 500,000 mortgage modifications
have been made under the governments program. Well, that's about one month's worth of mortgage
defaults. Their goal had been 4 million. So, they are a little short. The fact is that the program is entirely
ill-conceived, too complicated, and counter-productive.
People who were defaulting the past two years were those who bought houses bigger than they could
afford. Their income didn't match the cash flow. But now the wave of defaults is from people who have
lost their jobs. You can "modify" these mortgages all you want, but if a person has no income, he
can't afford a mortgage.
The way to stabilize housing is to bring out the buyers who can afford the house, and are able to pay for
it. That's not the first time buyer. But the current regime is so worried that people with money can take
advantage of a governmental program, that they would rather let housing go down the drain then give
people with money a bargain.
Looking out over the next 10 years, we believe that the U.S. will join Europe in its chronic economic
malaise, where double-digit unemployment will be common. We have changed our view on the Asian
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Bert Dohmen’s
less-developed countries, and now believe that Asia and related regions will do very well because
entrepreneurship can still flourish there. China has huge foreign reserves which it deploys much better
than the western world to stimulate the economy. U.S. influence in Asia will vanish over the years, and
China will rule that part of the globe. Europe and the U.S. are committing economic Hara-kiri, with their
excessive taxations and regulations. The future lies in Asia.
AUSTRIAN ECONOMICS: This is the "free market" school of economics, unfortunately not usually
taught at our universities. The liberal institutions prefer Keynesianism, which preaches that the
government should control the economy. Dr. Murray Rothbard, a great scholar of Austrian economics,
wrote this about the writings of Ludwig von Mises years ago. Von Mises wrote about what government
should do when its prior policies cause a depression. The advice is so appropriate for the current times,
yet is totally opposite of what government is doing:
What does Mises say should be done, say by government, once the depression arrives? What is the
governmental role in the cure of depression? In the first place, government must cease inflating as soon
as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and
commence the inevitable recession or depression.
But the longer the government waits for this, the worse the necessary readjustments will have to be. The
sooner the depression-readjustment is gotten over with, the better. This means, also, that the government
must never try to prop up unsound business situations; it must never bail out or lend money to business
firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression
phase into a lingering and chronic disease.
The government must never try to prop up wage rates or prices of producers' goods; doing so will
prolong and delay indefinitely the completion of the depression-adjustment process; it will cause
indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The
government must not try to inflate again, in order to get out of the depression. For even if this
reinflation succeeds, it will only sow greater trouble later on.
The government must do nothing to encourage consumption, and it must not increase its own
expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting
the government budget will improve the ratio. What the economy needs is not more consumption
spending but more saving, in order to validate some of the excessive investments of the boom.
Thus, what the government should do, according to the Misesian analysis of the depression, is
absolutely nothing. It should, from the point of view of economic health and ending the depression as
quickly as possible, maintain a strict hands-off, "laissez-faire" policy. Anything it does will delay and
obstruct the adjustment process of the market; the less it does, the more rapidly will the market
adjustment process do its work, and sound economic recovery ensue.
The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep
absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own
budget."
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Bert Dohmen’s
The 1930s Depression was a result of government intervening in the free market with full coercion.
What could have been a sharp, but brief, two-year shock, became a 10-year depression. It resulted in a
World War, costing millions of lives. The government is once again making the same mistakes, because
they worship Roosevelt.
HOUSING: ANOTHER FAILED PROGRAM FROM WASHINGTON
Almost 53 percent of loans modified in the first quarter of 2008 went bad again within six months.
The administration's plan requires participating loan servicers to reduce monthly payments to no more
than 38 percent of the borrower's gross monthly income. The government would then chip in to bring
payments down further, to no more than 31 percent of the borrower's monthly income. In lowering the
payment, the servicer would first reduce the interest rate to as low as 2 percent. If that's not enough to hit
the 31 percent threshold, they would then extend the terms of the loan to up to 40 years. If that's still not
enough, the servicer would forebear loan principal at no interest. How many homeowners in trouble will
understand all this?
The plan does not, however, require servicers to reduce mortgage principal, which Richard Green, the
director of the Lusk Center for Real Estate at USC, considers a shortcoming. "For underwater loans, if
you don't write down the balance to be less than the value of the house, people still have an incentive to
default," Green says. "Writing down the principal first instead of last—which is what [the Obama
administration is] proposing—makes sense to me."
The first two years of the mortgage crisis came from people defaulting on subprime mortgages. That's
basically done now, with the majority of these mortgages in default. The current foreclosure wave
comes from people with regular mortgages who have lost their jobs. How does the government intend to
modify a mortgage for someone who has no income?
The Congressional oversight panel monitoring admits that the current program doesn't address this
situation. They wrote in a recent report: “The foreclosure crisis has moved beyond subprime mortgages
and into the prime mortgage market. It increasingly appears that [the program] is targeted at the housing
crisis as it existed six months ago, rather than as it exists right now."
As always, the government is fighting the last war. How do they intend to administer the health care
system, which is 17% of the economy?\
MORE PROTECTIONISM FROM WASHINGTON
First it was the tariffs on Chinese tire imports into the U.S. for types of tires which aren't even made in
the U.S. Now Washington is imposing duties on Chinese steel pipe imports. China is one of the bankers
for U.S. debt. Is it smart to poke a stick into your banker's eye? What is the real purpose of this? Why do
they want U.S. companies and consumers to pay more for products we import and consume? Where is
the logic?
18
Bert Dohmen’s
If China wanted to give away for free some of their excess inventories of copper, zinc, aluminum, etc.,
would Washington prohibit U.S. companies from accepting such gifts? If so, why should we refuse
bargains? Are the politicians really smarter than the rest of us lowly servants?
Greetings,
Bert Dohmen
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October 19, 2009 Volume 32: No.

SMOKE AND MIRRORS EVERYWHERE

You cannot help the poor by destroying the rich.

THE STOCK MARKET

SMOKE, MIRRORS, AND LOTS OF HOPE

Let's look at the facts:

THE CHARTIST'S VIEW

The S&P 500 INDEX

The DJ TRANSPORTS (monthly)

The DJ US TECHNOLOGY INDEX (weekly)

The US DOLLAR INDEX (daily)

GOLD: BREAKOUT, but be cautious now!

THE PLUNGING DOLLAR

ECONOMIC RECOVERY OR AN INTERLUDE

HOUSING: ANOTHER FAILED PROGRAM FROM WASHINGTON

MORE PROTECTIONISM FROM WASHINGTON

Client Services: Dohmen Research Inc. EDITOR: Bert Dohmen

THIS NEWSLETTER MAY NOT BE REPRODUCED EXCEPT BY PRIOR WRITTEN PERMISSION.

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