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Judging from recent market action - oil approaching $100, gold nearing its all time high of $850, and the dollar setting new all-time lows daily - things indeed appear to be getting more serious. I'll start with the Dow simply because it is the headline number, the one that everyone hears about. Even those who know little to nothing about the market in general are familiar with it from news summaries and headlines. But headlines don't tell the whole story:
With today's 360 point drop, the Dow has broken down through shelf and trendline support in the 13,450 area. The last time the Dow's trendline was threatened, the Fed came to the rescue by cutting interest rates. Those cuts put some temporary juice back into the Dow's uptrend, but had the opposite effect on the dollar, which is collapsing rapidly. The US Dollar index broke through its multi-decade shelf support of 80 and hasn't looked back. How low it will go - especially with talk of China diversifying out of dollars - is anyone's guess.
While the Dow may still be up 6% on the year, the unit that it is measured in is down 13% for the year. So much for those gains - they've evaporated into currency losses. At the same time, notice the Fed's rate cut hasn't helped the big banks, which form the backbone of the global financial system. The banking index is plumbing new depths:
Ever since 1987, the Fed has used the same play from the same playbook: When markets get into trouble, slash interest rates aggressively. The result - until now - has always been the same: Markets have risen in unison, giving the appearance that prosperity prevailed and that all was well. But again, appearances can be deceiving, as the following chart shows. Prosperity appeared to reign from 2000 - 2005, based on the growth of housing.
(Chart courtesy EWI Inc, More housing charts in the 10/2007 Elliott Wave Theorist, click here.) Remember when housing was a sure thing? Time Magazine does (June 5, 2005):
Those were the days, weren't they? Too bad they didn't last. Of course there were plenty of signs that it was an unsustainable bubble, as the Time article itself mentions before quickly adding, "But who wants to listen to buzz-kill talk?" Things Become More Serious When history is written on the waning days of the American Empire, it might very well say that the final decades witnessed a series of increasingly intense temporary booms, driven by steady increases in debt - consumer debt, corporate debt, and government debt. Eventually, the debts simply became unsustainable. The Federal Reserve's trusty old trick of lowering interest rates stopped working. Markets stopped responding. Everything went into reverse. What the Fed failed to grasp is that printed money eventually reverts to its intrinsic value of zero, and that there is a difference between a lack of liquidity and just plain old-fashioned insolvency. Look at the Banking Index chart again. More interest rate cuts and money printing won't help these banks, and they won't help the housing sector to recover. The Fed's credibility is all but lost. The endgame is upon us. Let me close this with the words of Galbraith, who captured something timeless. At the beginning of Chapter VII, he recounts a series of unfortunate events in the history of the NYSE - the crashes of 1873 and 1907, and the day a bomb exploded on Wall Street in 1920, killing thirty and injuring 100 more. He continues:
Re-reading this passage, I wonder if a similar fate awaits us as well? We've already been reassured that the worst is behind us, but many have the feeling that it is still yet to come. Galbraith's account of 1929 is something to keep in mind over the coming weeks and months as the temptation to "buy the dip" increases. For the last 20 years, investors have been conditioned to understand, to believe and simply to know from experience that market dips, especially when accompanied by Federal Reserve rate cuts are buying opportunities, always and without exception. But as those ubiquitous mutual fund disclaimers say, "past returns are no guarantee of future performance. . ." Maybe I should just stop there. After all, I think you get the picture. If you want more buzz kill talk, check out the latest Elliott Wave Theorist.
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