Dear Friends, As expected, the Dow is taking a beating this morning at 8420.92, which may have proven helpful to gold, at 319.80.
Gary North has asked that his newsletter be forwarded. It came to me that way. I'm doing likewise. What he says is pertinent to this discussion. Regards, Jim http://cambist.net/ Subject: July 10, 2002: The Yellow Light Finally Flashed On Date: Thu, 11 Jul 2002 11:40:00 -0500 From: Gary North <[EMAIL PROTECTED]> Reply-To: [EMAIL PROTECTED] To: Anders Mikkelsen <[EMAIL PROTECTED]> [You have a FORWARD button on your e-mail program. I am asking you to use it today. Use it more than once. You have friends and relatives whose financial future are now visibly at risk. Maybe today they will listen. You have read this newsletter, month after month, perhaps since March 24, 2000, the day that I sounded my warning on the stock market. I had sounded it in February for subscribers to my printed newsletter, REMNANT REVIEW. I told them why I thought the NASDAQ was a disaster waiting to happen. On March 6, I warned them again. The NASDAQ peaked on March 10, about the day they received REMNANT REVIEW in the mail. By March 24, the collapse of the NASDAQ was 13 days old. There was still plenty of time to get out the NASDAQ. Today, of course, it's far too late. The NASDAQ is down by 70% or more. It will not come back to where it was on March 10, 2000, in this decade. As for the Dow and the S&P 500, there is still time to get out. That's why I am asking you to forward this report to anyone whose future you really care about. Yes, even if you have forwarded bad news before. Even if they called you a worry wart. Send this issue. They deserve another warning.] Gary North's REALITY CHECK Issue 157 July 11, 2002 JULY 10, 2002: THE YELLOW LIGHT FINALLY FLASHED ON Yesterday morning, I did what I rarely do. I sat in front of my computer screen, watching the Big Charts website, staring at the charts of the Dow Jones Industrial Average and the NASDAQ, watching a train wreck unfold. I don't usually watch the charts, moment by moment. I have known where this stock market was headed since early 2000. I have not changed my mind. So, why bother to watch it, moment by moment, this late in the investment game? It was because I had just finished reading R. E. McMaster's July 2 issue of THE REAPER. I have been reading THE REAPER from its inception in 1978. It is a commodity newsletter, but McMaster comments on many things, including stocks. I pay attention to what he says about the markets. I had just read this: The June 26 turning point low so far only led to a minor bounce by stocks. The risk is a downside acceleration. . . . ongoing consolidations should be seen as bearish, and a weak close by the September S&P below 950, and September DJIA below 9000, are extremely bearish. McMaster was speaking of the futures market, which is normally higher than the spot (cash) market. I was watching the spot market -- the moment-by-moment market. The DJIA was barely above 9100; the S&P 500 was barely above 950. Would they hold? I watched as the DJIA began its descent below 9100. It had opened above 9100, but had dipped below, had recovered bruefly, and was now again below 9100. I watched in fascination as it began its descent toward 9000. It was not a panic sell-off, but it was slow and steady: down. Then I checked the S&P 500. It, too, was falling. It was below 950. Big Charts is a great site. You can retrieve almost any chart you can imagine. http://www.bigcharts.com At 11:14 a.m., I sent McMaster a brief e-mail: "Dow below 9000. S&P below 950. If the plunge team stays out, tomorrow could be bad." The Dow lost 282 points, closing at 8813. The S&P closed at 920. PLUNGE PROTECTION: AN OFFER WE NOW CAN REFUSE The plunge protection team is an investment group inside the Federal Reserve System. It uses the FED's newly created money to manipulate the stock market, always to the up side, by buying stock market futures, because the PPT gets "more bang for the buck" than by paying cash. The PPT usually intervenes about 2 p.m., or so some of us think. There was no intervention yesterday, it seems. The PPT didn't fight the tape. This mysterious investment group keeps its collective mouth shut. It's "don't ask, don't tell." Nobody on CNBC interviews anyone from this elite group of market manipulators. Such things are not supposed to go on. But Congress and the President turn a blind eye, because nobody in office wants to face the voters during a stock market crash. For a brief introduction to this shadowy organization, read the September 16, 2001 issue of THE GUARDIAN, a British newspaper. This was written just before the U.S. stock markets re-opened after September 11. Here is an excerpt: The Fed, supported by the banks, will buy equities from mutual funds and other institutional sellers if there is evidence of panic selling in the wake of last week's carnage. The authorities are determined to avert a worldwide slump in share prices like the crashes of 1987 or 1929. Investment banks and their broking [brokerage] subsidiaries are to block short-selling by speculators and hedge funds by making it hard for them to obtain prices on favourable terms. 'Everyone is eager to avoid "contagion", where prices fall rapidly as investors react lemming-like to a falling index,' said one banker. . . . The 'plunge protection team' was established by a special executive order issued by former President Ronald Reagan in 1989. It is known to include senior bankers at leading Wall Street institutions such as Merrill Lynch and Goldman Sachs. It has acted before, in the early Nineties and during the 1998 LTCM hedge fund crisis. http://www.observer.co.uk/business/story/0,6903,552535,00.html There is a major risk with the PPT's strategy of using the financial futures market to reverse a downward move in the stock market. If the move downward is the result of widespread selling, which it surely is today, then this intervention threatens to cost the FED billions of dollars when it comes time to close out the long position (a promise to buy at a set price) by selling short (promising to sell at a set price) in order to offset the long position. The PPT's strategy works when its intervention reverses sellers' sentiment, and the broad market recovers. Later, the PPT can close its position by selling short into an upward market. But if the market continues down, then the PPT will find itself on the wrong side of the contract. It will be in a highly leveraged position, promising to buy stocks at a high price, when the market is falling. The PPT will get phone calls from the commodity exchange calling for more margin money. If it closes out its long position by selling short, this will create even more panic. "Insiders sell short!" The PPT is the ultimate insider. Here is the threat facing the PPT today: its intervention will be recognized for what it is, which is a temporary intervention to reverse investor sentiment in the short run, preventing a full-scale sell-off. Large investors know all about the PPT. If investor sentiment really has changed, and pessimism has spread to the small investor, large investors will not be fooled into believing that the stock market is going to turn up just because the PPT buys stock market futures. The PPT may try it again. Their money isn't personally on the line. But be aware how limited this manipulation is. When any broad market move goes against a central bank, the bank gets hurt badly if it tries to fight the market. We see this from time to time in downward moves of a national currency, when a central bank intervenes by selling billions of its foreign exchange reserves to prop it up. As George Soros once said of the Bank of England's threat to intervene to reverse a shorting of the British pound by him and other speculators who were convinced that the pound was overvalued, "What will they do in the second half hour?" Soros made billions on that play. I'm not talking today about speculators in the financial futures market. I'm talking about the general public. All it takes to break this market for years to come is for the average guy to call his pension fund and say, "No more stocks. From now on, buy bonds." This is what foreign investors are now doing. They are ceasing to buy American stocks. Panic has not arrived. That is months away -- maybe a year away. But a yellow light switched on yesterday. The day of the blow-dry 30-somethings on TV who seek to calm investors by soothing, optimistic words is coming to an end. They are now sounding frantic. And why not? They should be frantic. Their jobs are tied to their shows' Nielson ratings, and these Nielson ratings are tied to the hopes of investors who think they can get even with this bear market by selling one stock and buying another. This mentality is green-light investing. The yellow-light investment mentality thinks, "I will stop buying stocks." Red light says, "I must sell all of my stocks." We aren't there yet. But we will be. This means there is still time to get out. But those millions of investors who have ignored the tell-tale signs for two years, and have brushed off warnings, have already paid a heavy price for their blind optimism. If they continue to stay in a green-light mentality, trading one stock fund for another, they will pay an even heavier price. BEAR MARKETS ARE NOT SHORT-TERM PHENOMENA For months, legal insider trading has been 80% bearish. Corporate insiders have been selling four shares for every share they have bought. They know that this market is a loser. They are cashing in by cashing out. McMaster says that this is the highest sales/buy ratio in 16 years. The little people have been long in this market, McMaster reports. By contrast, the net short positions of large speculators is the highest it has been in seven years. Speculator/trader sentiment has been over 80% bearish for the past two weeks. The 16 days of straight bearishness is the highest in 15 years of data. ... If stocks cannot rally now, they (we) are in big trouble. That's why I was in front of my computer screen yesterday, watching the Big Chart site. I think the word has at long last gotten out to the small investor: the man who has a small pension fund portfolio and a lot of hope. I think yesterday's action has demonstrated to millions of investors that this market is not what the TV bulls say it is, and have said it is since 2000. There is too much market volatility. Volatility scares small investors. Up 300, down 300: this is not comforting. It reveals that too many contrary factors are placing their financial hopes at risk. They want steady upward growth. Instead, they have gotten downward moves for over two years, despite the calming words of the experts and the TV interviewers. The big upward moves have not been sustained. It is volatility day by day, but downward drift, month after month. At some point, people say to themselves, "These blown- dry blow-hards don't know road apples from apple butter. I am not going to listen to them any more." It took Japanese investors a decade to figure this out. They retained faith in the "New Japanese Economy" hype. It will not take American investors that long -- not when the captains of Industry are being sent to jail. Not when Arthur Andersen is dead and gone. This time, it's different. This time, the bankruptcies are enormous, and they don't stop. It's not some speculative hedge fund full of millionaires, like LTCM. This time, it's Enron, WorldCom, and Qwest. (Any company spelled Qwest was a loser from day one. It was spelled the way that Elmer Fudd talks. Now it turns out to have been run by Elmer Fudd.) The supermarket magazine rack investment news industry now faces a major problem: loss of hope. When investors lose hope, they sell stocks, invest in T-bills, and stop reading about the stock market. They don't want to be reminded about how much money they have lost by listening to these salaried journalism school graduates in their thirties, whose personal money isn't on the line, the way Warren Buffett's is -- non-investors who gave them no warning. Worse; these journalists interviewed thousands of commission-absorbing brokers, who told the readers to "stick with it for the long haul," to buy and hold and then buy more, to buy on the down ticks. Their readers are now covered with "down ticks" that are sucking the blood out of them. Readers will read the magazines and watch the down ticks for no longer than they think there is reasonable hope that they can "get even" with this bear market. But, when they at last realize that it isn't getting better, that they will lose even more money if they stay in this train wreck of a stock market, then we will have reached the bottom. They will turn off CNBC and watch "I Love Lucy" re-runs. Meanwhile, Congress is doing its famous Ricky Ricardo routine: "Kenneth, you've got a lot of explainin' to do!" The bottom will stay a bottom for a long time. As McMaster writes: The average length of a bear market is 14 years. The shortest cyclical bear market is eight years. Investors have forgotten this historical fact over the last two decades. They don't recognize a bear market for the terror it is, for the devastation to men's plans that it can cause. This stock market has barely begun to fall. The average guy is still hopeful. Or was. I think the mood shifted yesterday. Small investors are now beginning to recognize that this stock market isn't going to turn around soon. The frantic interviewers who keep asking the pundits, "Are we getting close to the bottom?" are getting this answer: "I hope so." That answer is not the call to action that drives people to call their stock brokers to buy. At best, it keeps them in the market as holders. When millions of stock investors give up as holders and call their brokers to sell -- as I hope you did two years ago -- that will be the panic phase of this market, which will keep this bubble-burned generation out of stocks, and will make the next Warren Buffett the next Warren Buffett. THERE IS USUALLY A TRIGGER EVENT We have not yet seen a trigger event. These financial events convey a sense of finality to the investors, rather like a gun shot in a herd of cattle that has sniffed the odor of wolves. Be out of the herd's way when the shot is fired. Yesterday, Stephen Roach of Morgan Stanley wrote about this phenomenon. I think his warning is worth repeating. Previously, I warned of the mounting perils of systemic risk in the US economy (see my 8 July dispatch, "The Drumbeat of Systemic Risk"). History tells us that systemic risk almost invariably comes to a head in the form of a major financial accident -- an unexpected event that triggers a broad constriction in the availability of credit. What are the odds of such an event occurring in the not-so-distant future? What kind of event does Roach have in mind? It could be anything, he says. Each era has had its own poster child of systemic risk -- the micro accident that wreaks widespread havoc on the macro landscape. The speculative excesses that give rise to these accidents are as old as markets themselves. . . . While each financial accident is different, they also have much in common. Former Fed Chairman Paul Volcker puts the blame on what he calls "the human genomes of greed, fear, and hubris." It's hard to believe that one of the biggest bubbles of them all was lacking in that genetic material. He is convinced, as I am, that the most obvious candidate is the debt market. Debt/credit is what got us into this mess. The unwinding of the debt monster is going to take us out this mess -- painfully. The US financial system was hardly out of the loop in fueling the upside of the bubble. By providing the risk capital for another "ironclad" virtuous circle -- the so-called recession-proof New Economy -- America's financiers took risks reminiscent of past periods of speculative excess. Again, the lessons of history are painfully clear on this point -- the excesses of debt are a breeding ground for financial accidents and the systemic risks they uncover. Record ratios of debt to GDP that persist to this day -- for businesses and consumers alike --- drive that point home. As we continue to peel away the layers of the onion in this post-bubble era, I can't help but fear that a major financial institution will end up suffering from a classic bout of excess exposure to one of these nonfinancial corporate accidents. He thinks that the FED will open the money spigot even more. So do I. This would mean monetary inflation even worse than today, and it is in double digits today. The FED giveth, and the FED then giveth even more. This is why we are in the mess today, and why the NASDAQ bubble arrived in the first place. By failing to pop the equity asset bubble when it first warned of such a possibility back in late 1996, I believe that the Fed set the stage for the systemic risks that are now at hand. All that is missing from this script is the catalytic spark of another financial accident. Systemic risk has an uncanny knack of being painfully obvious in hindsight. Given the extent of the excesses that built up during the late 1990s, I would be very surprised if the endgame of this post-bubble downturn weren't punctuated by a serious financial accident. Don't get me wrong -- I am not attempting to predict the future on the basis of a mindless extrapolation of the past. But in this instance -- the era of the post-bubble shakeout -- I believe we ignore the lessons of history at great peril. The same human genome that Volcker refers to is also steeped in denial -- that such accidents can't happen again, especially to us. History argues strongly to the contrary. This time -- of all times -- is not different. http://www.morganstanley.com/GEFdata/digests/20020710-wed.html#anchor0 MY PARTING WORDS: DEJA VU ALL OVER AGAIN In the March 24, 2000 issue of this newsletter, I concluded my report with the following words. I stand by what I wrote then. Greenspan is trying to engineer a soft landing by raising rates a quarter point at a time. The stock market shrugs off these moves as meaningless. But Greenspan has made it clear that he intends to call a halt to what he regards as a malinvested stock market. He is doing his best to avoid a financial panic. The trouble is, the FED's actions seem marginal. Investors are ignoring these rate hikes. If [Ludwig von] Mises and [Benjamin] Anderson were correct, there will not be a soft landing. When pricked, bubbles do not deflate slowly. All those people who are rushing into stocks at the end of the longest economic boom in U.S. history will not be able to sell at the top and move into money-market funds. Someone has said that the second most pleasurable experience is being out of a market that is falling. It more than offsets the uncomfortable feeling of being out of a rising market. I am begging you today, July 11, 2002: if you have not yet sold, sell. Stay out of this stock market unless you have good reason to believe that a particular stock can buck the downward trend. (Some of these special situations are discussed in the paper-based newsletters published by Agora, Bill Bonner's publishing form.) If you have not contacted your pension fund and switched out of stocks into bonds (50%) and a money market (50%) -- that is, if you aren't 100% out of the stock market (metals and resource stocks excepted, which pension funds don't buy) -- then you have bad news ahead for your retirement. Some of you have listened to me, Bill Bonner, and Eric Fry. We have been warning you, month after month. Maybe you have already done this. If so, you have not gone through this meatgrinder. But most people procrastinate. They think that things will get better. Things are not going to bet better until this stock market bottoms, and it is nowhere near the bottom. Get out of stock funds, now. For over two years, we have told to get out. We'll tell you when it's time to get back in. Don't listen to anyone -- I mean ANYONE -- who tells you that this is the bottom, unless he also told you, close to the top, two and a half years ago, to get out of stocks, NASDAQ first. If he didn't get you out in time, or at all, then you have no good reason to believe that he knows what he is talking about now. Note to any recipient of a forwarded e-mail: If you don't already subscribe to this twice- weekly report, and also to the Bonner/Fry report (DAILY RECKONING) that comes on days that mine doesn't, sign up now. It's free. Don't wait until a friend forwards you another copy. You must protect your financial future. 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