What Does The Return Of Dow 10,000 Really Mean?

No.: 
65

It pays to look at where we’ve been if we’re to understand where we’re going. The U.S. stock market bottomed in the first week of March 2009, beginning a vigorous bounce in the month’s second week. By late March a breeching of the midterm downtrend line suggested significant changes in store. Nevertheless, most members of the general public thought the March rally was nothing more than a dead cat bounce. Indeed, most market commentators expected the bounce to end no higher than technical resistance around Dow 8500.

One of the first widely read market commentators to break with the bear mantra was Marketwatch’s Paul Farrell. In a March 30 commentary, Farrell said the market had bottomed and a new bull was underway — a cyclical, temporary bull, not a secular, persistent bull. Not surprisingly, reader responses ran strongly against Farrell’s adjusted outlook, many accusing him of convoluted thinking.

Five days PRIOR to Farrell’s early call, a Marketwatch participant posted a detailed commentary in which he presciently suggested that market indices might well retrace 50% of their crisis period decline. (Posted to a March 26, 2009 Marketwatch report on hedge fund activity, “Institutional Investors Plow Back into Stocks.”) The post’s author, “Dr. Benevolence,” argued as follows:

“There is an increasing possibility — evident in various ways during the last couple weeks — that the Geithner plan may inflate U.S. equity values back into a range that would put the DJIA around 10,000 within 18 months, perhaps much sooner. (While 10,000 is not 14,000, it would constitute something close to a 50% retracement.) If this occurs, the move will be billed incorrectly as a new bull market — as though the problems that created the bear market of 2008-2009 were undergoing sufficient repairs.”

The doctor continued:

“When the U.S. can no longer fund the new leg of the debt-driven expansion there will be a market crisis of larger proportions than the one we've been through. When this Kodiak bear appears it will change the world for all time. Meanwhile, some people believe they can be investors rather than speculators in certain stocks at these prices — especially sound infrastructure stocks with solid dividend histories. Perhaps so.”

Was the recognition of an emerging cyclical bull sheer dumb luck? Or, were these two writers onto something? (Both men were employed in earlier times by Wall Street firms.) On April 6th and April 9th, the benevolent doctor (a political scientist) explained in detailed Marketwatch posts how George Soros’s theory of disequilibrias suggests that the manipulation of markets by hedge funds and investment banks can change the economics underlying the markets. This type of intervention can create a market recovery unanticipated by the standard lens of economic analysis. (The posts are archived in an easy search format at truthsavvy.com.)

Fast forward to today, October 15, 2009. David Callaway argues that real economic and social facts “tend to get lost in the numbers game on Wall Street.” He further proposes that the real economy is “much harder to manipulate into anything remotely positive, unlike the Dow’s apparent rally.” If Callaway is right about the prospect of manipulation, some hard questions should be asked.

For starters, why is it that such a big stock market rally has developed at the very time that mutual fund investors are significantly on the sidelines and positioned vulnerably in bonds? Why has the rally been so incredibly fast when the public is significantly on the outside and the trading desks of investment banks like Goldman Sachs are so heavily in? Is it any accident that Goldman Sachs gathers record profits while much of America suffers financially?

Is it any surprise that Wall Street had early access to the Fed’s strategies? Or, early whisper numbers on corporate financial trends? Or, preferential treatment in receiving bailout money? Is it any surprise that small businesses suffer while the S&P500 soars on hedge fund money? There are no surprises here: this is merely the ‘sanctified corruption’ that self-anointed fraternal patricians demonstrate in their efforts to rule national affairs.

What can be made of the third quarter results of JP Morgan Chase, Goldman Sachs, Morgan Stanley and their favored hedge funds? What is this but an incredible redistribution of wealth to victors anointed with the oils of moral hazard! How can these events not call to mind the 1940 Academy Award winning film, “The Grapes of Wrath”, where monied interests stomped decent folks like grapes in a winepress?

For quite some time Mark Hulbert (Marketwatch) has argued that the Wall Street game assumes the general public must lose (on a relative basis) so that the people of Wall Street can amplify their wins. This is contrarian theory. Decades of evidence attest it is right overall. Indeed, while the stock market may continue rising on momentum and disequalibria adjustment, the main theoretical argument for higher stock prices is that so many members of the public are sitting out this rally. Contrarian theory says the rally will die when the public comes running in — arriving late but just in time for pumped up securities to be dumped down upon them. How else is Wall Street to maximize its plunder?

Granted, many Americans have stayed invested all along. They live in HOPE, many putting new earnings to work to replace investment values recently depreciated. The rally for them is not new wealth but a partial return of paper losses, the Dow having breeched 10,000 some ten years ago. When the secular bear trend returns — as it surely will when this cyclical bull is spent in a retracement of something between 50-75% of the 2008-2009 decline — many “sit pat” investors will watch their recovery turn to ashes as the nation slides into an economic position more precarious than the one recently endured.

The mass public’s dilemma is illustrated in the gold price boom. As observed by Mark Hulbert, gold recently broke through its former highs because most gold timers decided to sit this one out, paper gold dynamics (ETFs) undermining their confidence in timing any leveraged speculative positions. Mark Hulbert asks rhetorically, “What’s it going to take, gold timers?” (Oct. 6, 2009, Marketwatch). In several articles he argues that gold prices will continue climbing until gold timers buy more gold to relieve the gut-wrenching experience of standing on the sidelines while their preferred investment soars (Sept. 3, 4, 25; Oct. 6). But the contrarian news is also this: Once the gold-timers establish large positions to make up for lost time, “the market” will magically know of their vulnerability and will sell off. Contrarian theory says these market-timers should not ride their losses too far because the downtrend is not likely to relent until they capitulate. By design, Wall Street induces proletarian market timers to buy high and sell low.

Isn’t it time to completely reform the corrupt Wall Street architecture? When will the public wise up to the siren song? Wall Street’s architecture is not an evolutionary accident but a cleverly designed system for siphoning off the wealth of nations for the disproportionate benefit of a few. America will never be morally and economically healthy until we get a more honorable form of capitalism. While currently proposed reforms are constructive in some regards, they will preserve Wall Street’s key advantages at a cost to the public good.

Externalities for industrial companies will be identified but Wall Street’s externalities will be largely ignored, including investment distortions generated by the carry trade’s speculative exploitation of low interest rates. Indeed, what is the current market rally if not the ability of large corporations to beat lowered expectations by dumping workers (i.e., as ‘externalities’) onto welfare roles! Perversely, Wall Street off-loads its recession onto the government, the market choosing to focus on Wall Street’s improving condition with little regard for the decay of government finances. As David Callaway wrote on March 26: “It’s hard to believe that this isn’t the bear rally to end all bear rallies, and that something even more frightening to the financial system still lies ahead.” Indeed, as one Bank of America analyst noted in March, the road to recovery is “now paved with sovereign risk,” a potential dollar disaster blocking monetary strategies that might mitigate the sovereignty risk.

There are too many variables to predict short and intermediate stock market trends from here. But one thing is very probable: Democratic plutocracy will triumph over America and much of the world within twenty years — maybe in half that time. Fortunately, the new system will not likely hold together, giving the United States a good chance of being reborn to a better future after its fiery trial and a partial depopulation of the world. In the meantime, it may be prudent for many “buy and hold” investors to liquidate up to one-third of their long-term stock portfolios here at Dow 10,000, using the proceeds to pay down mortgage debt, enhance liquidity, and prepare for mobility if needed. This is not capitulating at the bottom. This is prudently managing risk in the upper one-third of whatever this cyclical bull ends up accomplishing.

A 50% retracement for stock indices was a good probability once the Fed’s intention to flood Wall Street with money was clearly evident. Now, the loose money environment creates a coin flip chance or less for this retracement to stretch toward 75% (around Dow 11,700 if one uses DJIA 13,500 in December 2007 as the market “norm” before the big sell-off). While a 75% retracement would take stock indices to the level of consolidation preceding the October 2008 plunge, such a retracement would increase the likelihood of a very difficult to contain sell-off when inflation appears and interest rates rise. Those who want to get their money out of the Wall Street system before rules constrain capital egress should not wait too long.