Redd Foxx’s “Big One?”

As I write this, the Dow has dropped about 700 points in barely over one full trading day.

Fed Chief Ben Bernanke spoke on Wednesday afternoon and markets did not like what they heard. Right before his announcement yesterday, the Dow was at 11,380. By noon the following day, it had fallen to 10,704.

Bernanke announced a continuation of loose monetary policy, something that markets have been applauding. Apparently, the markets were disappointed that he did not announce something more aggressive in terms of liquidity. See Zerohedge for coverage of this point.

Stock prices, in the opinion of many, were too high, held up only by infusions of liquidity provided by Central Banks. Even though Bernanke promised more, it appears it was not enough to meet market needs and expectations. The market, not unlike a junkie, requires increasingly larger doses to maintain its high. When there is no economic strength in an economy, markets should fall. They can levitate for a while on the drug of liquidity, but not forever.

Is this the big crash?

Predicting apocalypse is a fool’s game, for you can only be right once. Not very good odds for those in the prognostication game. It has not occurred yet. Even if you correctly predict Apocalypse, where is your advantage? Presumably the world ends, either figuratively or literally, without even the benefit of a few “I told you so’s.” Being right would enhance your reputation, but then reputations no longer matter.

With these caveats, let’s explore this situation. Is this the end? That sort of depends on your definition of “is” or what is meant by the “end.”  Phoenix Capital Research sounds like they believe we are near the end or some version of a financial/economic apocalypse:

The primary backstop [The Fed] for stocks and the financial system in general is gone. We’ve already wiped out one year’s worth of gains in a matter of weeks. And this is just the beginning. The markets are realizing that it’s Game. Set. Match for Central Bank intervention.

What’s coming will see stock market Crashes, sovereign defaults, bank holidays and bank runs, civil unrest, and more. This mess is going to make 2008 look like a picnic.

Others have been predicting a similar end. If the above outcomes are apocalypse, then apocalypse is probable. Indeed, as defined in the last sentence above, it seems virtually guaranteed.

The economic system is filled with so much distortion and imbalance that it no longer functions properly. Each attempt to “juice” the system only adds more noise and distortion. Ultimately the system will cease to be able to function and collapse. It will collapse of its own weight, probably led by the financial sector.

The only issue, it seems to me, is the timing of the debacle. This correction could be it, or it could drag on a bit further, say as much as five years.

The government and Federal Reserve are out of constructive fixes and money save that which can be created via the printing press. Arguably, nothing constructive in terms of government action has been forthcoming for decades. Small crises have been deferred, only at the cost of each subsequent problem being larger. The size of the problem now dwarfs the political class’s ability to solve it. Markets, not politicians, are now in charge.

Politicians will not become passive.  There will be additional efforts to avoid paying the piper, but they cannot solve or avoid the inevitable problem. These efforts, at best, will only lessen the current pain at a cost of greater suffering when the end finally arrives. Even this attempt to kick the can may be futile. We may have run out of road.

If my overview is correct, then there are some observations worth noting:

• The government will try to defer the event.
• There is no political solution possible.
• The event will likely be triggered by or accompanied by a worldwide collapse of financial markets.
• The trigger could come from Europe or the US or some other unforeseen event.

There are few ways to protect oneself against what is coming. No one escapes without being bloodied. Winners will be measured in terms of retention of purchasing power, not increased wealth.

Here are my thoughts. They are not recommendations for you or anyone else. You must do what you feel comfortable with and what fits your personal situation.

• I am wary of the stock market and have been for several years. There is little upside to be gained and potential downside of 75%. In true bear markets, P/E multiples of blue chip stocks contract to the 4 – 8 range. Companies will eventually sell for discounts to book value. Earnings will also contract because of the contraction coming in the economy. Use your imagination for what that could mean for non-blue chip companies or your portfolio.
• Commodities, in general, will contract with the economy, unless currencies collapse. Even if that happens, commodities will likely not keep pace with the deterioration in the purchasing power of the currency. The demand for most commodities is driven by industrial demand which will shrink as the economy collapses. Commodities may have a rebound when the Fed goes into full-printing mode. I expect that to happen as the last ditch effort of political scoundrels.
• Gold is different from industrial commodities. It has been and should continue outperforming other commodities during this period. The reason is that gold trades as a currency. As the dollar weakens, gold should do well. It may exceed the loss of purchasing power in the currency as it becomes a flight to safety. It may benefit from rumors (perhaps fact) that it will be part of a new currency arrangement. Silver is a “tweener.” Its price is determined by both industrial demand and as a substitute currency. It may provide some protection in its role as the latter.
• Physical commodities should be looked at as stores of value. That includes gold and silver. It is likely you will never utilize any of these commodities in a barter economy. If you believe that barter is where we are headed (and it seems likely), then stocking food, soap, wine, liquor, deodorant, toilet paper, ammo, etc. in excess of personal needs might be prudent. These are items that can be used to barter.
• Cash is trash, or it will be. It will lose value. However, in the last few days, cash was King. As people rush to exit all investments, all asset classes have declined. Cash has held its value while everything else (except the bubble in US treasuries) was losing. Cash balances should be increased in periods of uncertainty and market volatility. That is likely now and for the foreseeable future.
• Let this turmoil play out a bit before you make a judgment that this is or isn’t the ultimate crash. I suspect it isn’t, but that doesn’t mean you should be attempting to make money during this turmoil. Stand aside and watch. If things stabilize, then decide how much you want to recommit.
• Remember, even after things return to what appears to be normal, there is limited upside. We are in a massive move to the downside. The only question is over what time period?
• Know your math. A 50% up move followed by a 50% down move does not leave you even. You have lost 25% in such a scenario.
• Re-evaluate all fixed income contracts — pensions, social security, life insurance. If inflation becomes a problem, the income you receive in the future will purchase a lot less than you assumed. Even if inflation is not a problem, the guarantor of the income stream to commence X years in the future might not survive the recession/Depression.
• The country is getting poorer on both a relative and absolute basis. On a relative basis that will continue long into the future. Wage arbitrage around the world ensures that other countries gain relative to the US. On an absolute basis we will get poorer until our standard of living declines to what can be supported by our income.
• For a couple of decades we fooled ourselves by using debt to support a living style that our incomes could not support. That living style caused new businesses to form and old ones to contract. Now our incomes cannot support our debt levels.  Consumption will shrink while savings increases. Massive adjustments to this reality are in our future. Businesses now must downsize. Much capital has been squandered.
• Those who bought large homes with little down are especially hurting. Housing values have dropped below the mortgage value on the house. These folks are “underwater,” faced with the questionable ethical but proper economic decision of walking away from their homes. Debt defaults on mortgages and other debt are still to be felt.
• Those considering physical relocations should consider what is coming. People living further out and closer to the land are apt to be better off than those living in cities when things become truly terrible. Farms and farm communities provide access to food that grocery stores probably can’t in times of shortages and civil unrest.

The question is whether this current decline is what Redd Foxx referred to as “The Big One.” Is this the beginning of the end? Or are we merely in a deep adjustment that will be followed by a subsequent rally?

I suspect the latter, although do not intend to invest based on this possibility. The long-term trend is down. It is difficult to make money in a Japanese-type market. Recall Japan’s market at one point was close to 40,000. It is under 10,000 today. Over the last twenty plus years, there have been numerous 25 -30% rallies, yet each one has been followed by lower lows. That may be what we face. It may be the best scenario. That scenario is not for investors, nor is it for most traders.

If the Japan scenario doesn’t play out, it is straight-down from here.

Good luck and be careful! Once you understand reality, it is a lot easier to accept it.