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Falling off the tulip truckDavid Chuhran Inspiration often comes when you least expect it. While having a discussion with my wife the other day, I teased her about something (I don't even remember what it was) and she came back at me with, "What do you think, I just fell off the tulip truck?" I started to laugh, which of course made things worse, and I reminded her that it was a "turnip truck." Her retort was that she liked "tulips" much better than "turnips," so heretofore she proclaimed it would be known as the "tulip truck." I couldn't argue with that and decided to make a hasty retreat saving myself for another day. It wasn't until later that I realized the pure genius of her statement. How did she know? I was warned that once you start putting your opinions on paper you're open to criticism from every direction. That's okay, I can deal with that. To tell you the truth I was expecting a barrage from my last editorial, but it only came in the form of a challenge to my use of the term "bear market rally." After thinking about it a bit, the challenge was probably technically valid when you consider that we've surpassed one year with a gain exceeding 20%, but I know things are out of place especially when you consider that there hasn't been a correction in the broader markets since March. Imbalances and distortions have manifested themselves in the stock markets as our political and economic leadership have thwarted normal market retrenchment while digging a deeper trench. I've seen some wonderful historical comparisons of bubble charts with the most exceptional being the NASDAQ 2000 vs. DJIA 1929 by Adam Hamilton. After seeing that a while back I thought maybe there was some correlation of Dow vs. Dow that hasn't yet materialized, so I decided to make the comparison to see what I could find. In 1929 the markets were much narrower offering fewer investment options while at the same time attracting capital from a relatively small segment of the population. Today it's different; we have a much wider range of investment options and attract a significant portion of the population through 401k's and IRA's as well as capital from the World at large. There are some other stark contrasts. During the Tech Bubble the markets acted in distinctly different ways. The technology heavy NASDAQ was a riskier, more speculative market for the aggressive investor. It attracted greed capital in search of higher returns and therefore suffered the sharpest and most rapid decline. The broader S&P 500 offered a diverse cross section for those seeking a medium level of risk and did in fact suffer a middle-of-the-road decline. The blue chips of the Dow were the safe haven for the more conservative investor. The Dow is laden with quasi financial institutions like General Electric that are virtual single entity mutual funds producing a wide range of goods and services from refrigerators to aircraft engines and from toasters to airplane leases. Much of their profit is derived from the financial arena. It's this exposure that makes them vulnerable in the future to non-performing loans, bankruptcies, and credit tightening. If this happens it will most certainly cause a collapse in the interest rate spread pressuring their exposure in the derivatives contracts used to maximize their returns. While the NASDAQ more closely paralleled the Dow of '29 in both scope and time (2), I believe the Dow's post-top moves were muted as capital flowed away from risk in search of safe havens like General Electric. This dampened and delayed the effects that may still occur. Dow Jones Industrial Average (1900-1955)
As a quick review of the Crash of 1929 (numbers aren't exact) you can see that from 1900-1925 the Dow traded in a range below 50 and up to approximately 100. The Dow began a steady almost 300% rise to a top of 381.20 in late 1929 followed by a rapid 48% drop. Over the next several months the Dow gained 48% from the initial Crash low followed by a resumption of the downtrend ending in the low 40's. The total loss from top to bottom was 89%. Three important points to note are the fact that the Dow bottomed on its 30 year low, the recovery point when the Dow recrossed its 1929 high wasn't until sometime in 1954 (that's an investment lifetime for a buy and hold investor), and finally, the Fed did not actively intervene. Before we move forward a couple more things distinguish today's Dow. First, in 1971 we walked away from the Bretton Woods Accord of 1944 removing the Gold/Dollar peg allowing the World's currencies to float. Since this ultimate monetary discipline was discarded, the money supply has climbed by ~1000%. (3) This massive currency debasement, and the resulting inflation, has served to inflate the stock markets as well. In the late '70's, when Gold began to act again as an alternative medium of exchange and store of wealth it threatened to usurp the supremacy of the fiat money regimes. It was beaten back, ensuring the monetary power and control structure remained unchallenged and the Fed's implied right to inflate remained intact. Over the 32+ years since Bretton Woods was abandoned the largest expansion of any money supply in the history of the World came between 1995 and the present where our M3 doubled to ~$9 Trillion. This expansion, along with negative real interest rates, has served to thwart normal and healthy market forces while lengthening and extending the stock market's ascent. I think the Dow is the last bastion for defensive capital on the run and will therefore be the last to fall. It is the stock market's "impenetrable" Maginot Line. The exercise of putting this next chart together made my stomach sick and I almost abandoned this project. My goal was to take what actually happened in 1929 and show what the same aftermath would look like today. I didn't like the results. Dow Jones Industrial Average (1963-Present)
As you can see the Dow traded in a 400 point range between the early '60's and the early '80's. This was actually a tighter range by percentage than the Dow of the early 1900's. Soon after we stepped away from Bretton Woods we had to deal with an Oil Embargo and the aftermath of the Vietnam War. The severity of that decline was greater than the decline experienced between early 2000 and mid-2002. After Gold topped at $887.50 in 1980, and its suppression began in earnest forcing it into a 20+ year hibernation, we began an 1172% ascent that was only interrupted by the crash of '87. Notice how the mid '95 shift in monetary policy resulted in an upward pivot in the trend propelling the Dow up another 266% to its all time high. After the Dow topped at 11,722.90 it followed the other markets down, but not as far or as fast. I believe there was a flight to the Dow's "perceived" quality along with frozen "widows and orphans" that only know how to buy and hold. Also, more liquidity was flooded into the economy while interest rates were held artificially low punishing the savers and forcing them to expose themselves to greater risk in the stock market. (Where Did The Money Go?). This additional "reluctant" capital further delayed and distorted the Dow's retrenchment muting its response. The top, the drop, and the bounce look similar in many ways to 1929, but they're elongated in time and shallower in depth due to active intervention by the Fed. Regardless, a 39% bounce, with many technicals still looking perplexingly bullish, cannot be called a "bear market rally." So, I suggest a new term: "cyclical Fed bull within a secular bear." Now, when I drew the final drop to coincide with the Crash of 1929 my first response was, No way! An 89% drop from the high would take us into the sub 1300 range and to bottom at the 30 year low puts us at -95%. I'm not ready to predict that, but what I will predict is that the global currency markets will lose their patience and the market will fall. How far? Far enough for the market to cleanse itself of the imbalances and distortions created by an overreaching Fed. That cleansing will culminate in a fear driven capitulation just as all bubbles have dating back to one of the first in recorded history, Tulip Mania. Alan Greenspan's dream of an economy/market paralleling '29 has come true and he's living up to his promise, his grand experiment, to cure it with the unrestrained creation of fiat paper money backed only by a false promise to pay. This grand experiment stands in stark contrast to Alan Greenspan's paper titled Gold and Economic Freedom first published in The Objectivist in 1966 where he extols the virtues of the Gold standard .(7) The global marketplace is unimpressed answering his defection to the Keynesians with a steady drop in the dollar. That steady drop will turn into a plunge if the Fed digs the trench another $2 trillion or so deeper while attempting to prop up the money supply, the markets, and the economy. Keep your eye on the Dollar index, the long bond, and Gold as it moves toward remonetization. Their movements will signal that the global marketplace is sending us a vote of no confidence in the Dollar, our policies, and our ability to pay and will precede the beginning of the final market capitulation. So, you see my wife had it right and she didn't even know it. Even though we lived in Holland for nearly 4 years, she was certainly unaware of the Tulip Mania and subsequent collapse that happened there in the mid 1600s. We have fallen off that same "Tulip Truck" and we're about to get run over if we don't find a way to restore global confidence in our monetary system. That confidence and natural fiscal discipline can only be restored one way and that starts with some form of a Gold standard. David Chuhran |
