In the Long Run...

More than a great line from an Eagles song, today's title expresses my desire to step back from the daily myopia and see where we are in the grand scheme. So I offer this chart:


This is a yearly chart of the Dow Jones Industrial Average since the turn of the century. That was the turn from the 19th to the 20th century (1900, in other words). This was created by drawing a trendline between the 1929 and 1999 highs (2000 would also work well, I believe). Then a parallel line was added using the 1933 opening level as the starting point. Some of the interesting characteristics of this chart are first, that even though the data points preceding the 1929 peak were not taken into consideration when drawing the upper trendline, the data points of the earliest years in the 20th century are quite neatly contained by this line. Second, momentum peaks precede actual price peaks by a full decade! Talk about an early sell signal! Note momentum peaks in 1955, 1989 and 1997 being followed by price peaks in 1966, 2000 and 2007. Third, in hindsight, we should not be surprised by the violent drop witnessed last year after the failed breakout in 2007 above the previous peak in 2000. Third, notice that the 34 year moving average has contained most selloffs (the 1930's being the key exception). Anyone who bought at or near this average during the last 75 years and held on has likely made tremendous profits. Fourth, the major exception to this observation (the early 1930's provided a fantastic buying opportunity of multi-generational proportions anywhere during the year of 1932 and through most of 1933! In other words, there was an 18-month period when buyers who were not shaken out during this time (this is no mean feat, by the way) would have experienced massive profits for their lifetimes even if they had purchased at the highs of the year for 1932 and experienced an immediate 50% drawdown!

"That is all well and good!", you say, "But what does this tell us about the future?" OK, first of all, 15,000 is likely a pretty substantial area of resistance for the foreseeable future. "But that is 50% higher than where we are today!". Yes, but the flip side of that equation is that 3,000 is the low end of the range of possible expectations. So does a potential 50-100% gain justify risking a 60+% loss? I would argue that it doesn't. "But how likely is it that we will go that low?" I will address that point a little later. But first, I want to point out the current year's action has the initial makings of a reversal. Of course, the year is nowhere near over, so this can change, possibly drastically. But 2009 has seen the DJIA hold support at its 34 year moving average, roughly a generational support line. And this rally has also brought the Dow back above its 2002-2003 lows, if only by 5% or so. The next few months will be critical for the next few years potential for the market. If the Dow cannot hold above its 2002-3 lows, then a visit of the lower end of this channel becomes a high probability. At least, the likelihood that the 8,000 level (give or take a few hundred points) will become a significant area of resistance unlikely to be breached in the next few years. If the market can hold its recent gains for the next few months, then a return to the upper range of the channel around 15,000 over the next few years will be quite possible. But notice that when the market reached the upper end of the channel in 1929, it was 25 years before that level was exceeded. This would imply that 15,000 may not be seen much before 2025.

Now, what about the likelihood of a return to the bottom of the channel? If we compare today's environment to that of the other where the Dow touched the bottom this channel are they different or fundamentally similar? In the early 30's, we had excess capacity leading to declining pricing with a large debt burden producing significantly abnormal levels of defaults. This seems to parallel our current state of the housing market perfectly, as well as many other areas of economic and financial activity, such as consumer credit and government debt. So while there may always be a small chance of seeing stock prices touch the lower end of this channel, the next few years will see a much greater likelihood of low stock valuations.

Finally, this chart should indicate that a drop of the Dow to 3,000 in the next 5-10 years is entirely in the normal range of expected outcomes for our economy and financial system. At such a point, the risk/reward would be so heavily favorable with 15,000 + points of upside with only hundreds of points of downside risk, that anything less than a fully invested position would be short-sighted. So while many prognosticators may forecast extremely dire consequences should we see stocks trade at this level, most likely Dow 3,000 would not indicate systemic collapse. Sustained levels below that would indeed indicate that a 110 year advance has been broken and that the "system" itself is vulnerable. Let's hope that we do not witness such a fall, but be aware and cognizant of the fact that more than one year below this key level is a likely indicator that the worst has come to pass.

Negative Charts

Is IBM looking a little toppy? We will know soon enough...


Yet, it looks like it is in a strong uptrend longer term....


RIMM seems to be heading for a trip down South.



While 10 year Treasury yields are leading the way lower.

Deflation anyone?

Is the Tow Truck Running Out of Gas?

Todd Harrison of Minyanville has been talking about the Feds "buying the cancer and selling the car crash". Instead of mixing metaphors, I am going to take a shot at it using the automobile. And for my road trip, we need to start 75 years ago on an economic side since washed away by history.

When FDR (who I believe did almost nothing else correctly) closed the banks and devalued the US Dollar against gold at the beginning of his first term, he did not fix the flaws in our financial system, but he did rebalance it sufficiently that once the right conditions were in place, the economy returned to growth at a healthy pace. The relaxation of onerous regulations (enacted by the same FDR) combined with the annihilation of our economic competitors during WWII and the release of pent-up demand after the war, propelled the US economy down the road of prosperity for the next two decades. But when the performance of the American economic vehicle started to get a little sluggish in the 60's, an economic tow truck (with the name Easy Fed Policy painted on the side) gave the Mustang that was the economy a little push to get it going again. For the next decade, the tow truck was kept busy continually giving the Mustang a little bump to keep it going until the late 70's when it had gotten lost and ventured off the economic highway and was cruising down a back country road in excess of 100 miles per hour. Somehow a new tow truck driver named Paul Volcker strapped himself into the tow truck and managed to pass the out of control Mustang and get in front of it and apply the brakes to force the rampaging beast to slow down. This was no light tap on the pedal either! By the time the decade of the 80's was in full swing, he had both feet stomping on the brakes as hard as he possibly could. Within a few short years, the once mighty stead found it way back onto the highway and started making progress at a healthy, yet controlled speed. Of course, all those years of cheap gas had taken their toll and the muscle car was now a little bloated, but still powerful and attractive enough to turn a head or two as it passed by. The road was pretty smooth, with an occasional sharp turn, but most of the hills were gentle and rolling. One of the sharpest turns was the stock market crash of 1987, which most people could not help but compare to similar events almost 60 years earlier. But a brand new tow truck driver had recently taken over and he gave the aging beast a solid push as it came out of that turn and was at risk of stalling and it breezed on down the hill that immediately followed. That grade didn't last too long as the next hill was a little steeper than the gas guzzler was accustomed to handling and it wasn't able to make it over the crest without another serious nudge from the bookish tow truck driver named Alan Greenspan. But after a very brief flirtation with stalling near the crest, the next downhill stretch of road appeared and it was off to the races for the by now seriously bloated Detroit machine. There was a small Mexican detour and a little fishtailing in Greenwich, CT, but by the turn of the century the once mighty Ford was cruising along at an astonishing fast clip for such an aging hulk. Especially when most of its Asian competitors were being pulled out of the ditch after wiping out! What came next was truly amazing as good old Alan really stepped on the gas and gave the old Mustang (which by now was not recognizable and resembled a UPS cargo van with fading paint) a good, hard shove forward. And he kept on pushing hard for a couple of years until the graceful pony turned big box on wheels appeared to fly along at speeds as great as any that had been seen in the last few decades. Yet, as often happens at the bottom of every descent, another hill appeared and this was going to turn out to be a doozy. At first, it appeared to be another gentle climb and Alan felt confident enough to hand tow truck's keys over to a nice, well-educated man named Ben. Why he would want to drive a tow truck was anybody's guess, but for some reason he had become obsessed with that big crash that occurred during the 30's and he was going to make sure that it didn't happen again! And the first few years up the hill were fairly easy and Ben said "Don't worry, just around the next turn, it will level out." Oh, how wrong he was! Because after coming out of the next turn, not only did the road not flatten out, but hill was a mountain the size of the Sierras! Not only was the Mustang (now the size of a Mack truck but even uglier) losing momentum, it was actually starting to slip backwards and at a pretty good clip! Ben had two choices, let the monster roll back as far as necessary to find an off-ramp to a more level road or press on ahead with all his might. Of course, he chose the latter, because that is what his predecessor Alan and his studies of the 1930's crash had taught him! And that is where we find ourselves today. Ben was worried that he was going to lose his job, but the tow truck company owner decided to keep him on (probably because he couldn't find anybody stupid enough to take the lousy job, but ostensibly to make sure the job is finished right!) Now Ben and his Boss Barack and all the other drivers back at the shop are saying "Don't worry, it will level out again after this bend in the road." Where have I heard that before? But what if they are wrong? If the road starts sloping down again, we might have a runaway Mack truck on our hands again, like happened in the 70's, but if the road continues to climb or heaven forbid, gets steeper, is there enough gas in the tow truck to push it over the next crest? Ben says that it is no problem, but I have my doubts. Meanwhile, I wonder what he feels like with the sign saying "Gasoline, 50 miles ahead."