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Phase 2

By Paul Lamont

May 31, 2009



The recent stock market rise is lulling investors back to sleep.


Ulysses and the Sirens. Herbert James Draper. WikiCommons.


Meanwhile S&P500 earnings have collapsed 90% which has caused the commonly used P/E ratio to rise to astronomical levels.  As we have shown, the inflation-adjusted DJIA is by no means near a historic low. Additionally, a consensus of economists are expecting a recovery soon. In 7 Reasons To Sell published back in January of 2007, we described our use for Wall Street economists and strategists;


“In addition, all 14 ‘Strategists’ at the largest Wall Street Firms are calling for a higher market in 2007. The last time this bullish consensus occurred was at the start of 2001. The DJIA subsequently fell ~40% over the next 2 years.”


The DJIA did rise for most of 2007. But here we are two years later again with the DJIA down roughly 40%! By the time we reach the real bottom, most investors will have given up hope of recovery and most economists will have given up on their own forecasting abilities.


Revaluation Blues

As we stated in October 2007; “Without loans and leverage the market is expecting bankers to price assets at cash value. It is as if you woke up one morning and paper cash was the only medium of exchange.  No credit cards, loans or mortgages. How much is that house really worth?” Dan Fasulo’s description on May 20th of the commercial real estate market is eerily similar: 


"Just imagine in a residential market, if there weren't 80 percent loans available for everyone…If everyone had to buy their houses in cash, the values of houses would plummet everywhere. That's happening on a massive scale on the commercial side."


Peak Characteristics

Prices usually move two steps forward, one step back. And so far the stock market has only made a half step back. The S&P 500 has recovered only 27% of its 908 point decline that it suffered from October 2007 to March 2009. In the near term, we suspect it could go higher. We need to refuel with confidence before the drive lower. When confidence eventually does brim, we expect politicians to declare the crisis over just as Hoover mistakenly did in April 1930. Some Wall Street strategists already have. We would also not be surprised if some of our own clients give up on the bearish outlook. It will be hard to stay the course (even tougher than 2007) as the next peak arrives. The pull of the optimistic herd may be too much.


“The greater part of our daily actions are the result of hidden motives which escape our observation….When studying the fundamental characteristics of a crowd we stated that it is guided almost exclusively by unconscious motives. Its acts are far more under the influence of the spinal cord than of the brain. In this respect a crowd is closely akin to primitive beings.” – Gustave Le Bon, A Study of the Popular Mind, 1895.


Bailouts Usher In Next Crisis

History (and our recent Report titled “The Invisible Hourglass”) suggests how this financial episode will end. The bailout borrowings are ushering in the next wave of the crisis. Just like the bankers who could not see their own downfall, it is the politicians and their Keynesian advisors that are now pushing us over the second cliff. As expected, the Treasury bond yield has risen sharply from 2.53% to over 4.5% in 5 months. The Fed is confused. According to Russell Napier (author of Anatomy of the Bear), yields over 6% could cause the next leg down. He expects this within the next two years. We disagree, there’s no definite trigger point. As we mentioned in The Haughty Bond, yields rose as investors dumped Bonds (well, everything) for cash. Stocks and bonds were sold simultaneously. Regardless, the yield is on track to reach 6% by this fall. According to Weiss Research’s recent white paper on banking bailouts: 


“In the 1930s, interest rates moved down, up, and then down again, in three distinct phases: In Phase 1, all interest rates declined due to deflation. In Phase 2, however, despite sharp GDP declines, interest rates surged unexpectedly: The 3-month Treasury-bill rate jumped six fold - from about a half percent to 3 percent; the yields on 20-Year Treasury bonds surged beyond their pre-crash peak; and the average yield on low-grade corporate bonds exploded higher to 11 percent. At this juncture, like today, the federal government came under increasingly intense pressure from creditors to reduce its federal deficit; limit its efforts to save failing banks; and, shift to a more disciplined, austere, tough-love approach. Finally, in Phase 3, interest rates fell and mostly remained low for the balance of the decade.”


Source: Weiss Research Inc.


Instead of borrowing money to prop up Wall Street Firms, the U.S. Treasury should save its ammo. More important events could come along that would require government action.




As we wait for creditors to force the issue, Treasury bond yields continue to fly.




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***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.


Copyright ©2009 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at advrequest@ltadvisors.net, or call (256) 850-4161.