The Next Bear Market

by Addison Wiggin & Ian Mathias

  • Investors beware: Stocks flashing bear market signals

  • Chris Mayer highlights an unlikely buyer of American equities

  • One asset class hits record highs… why our traders are betting against it today 

  • Plus, a reader offers his one and only blame for the global recession


  With its 3% tumble yesterday, the S&P 500 reached an “inflection point” for U.S. stocks.

Since its inception, if the S&P 500 falls 15% or more from its top, 80% of the time it keeps dropping until it passes into bear territory (-20%). The S&P reached a new low for the year… and is now down 14.4% from its top. One more bad day and we’re likely in for another rough stretch.

  Another ominous indicator for U.S. stocks comes by way of Dow Theory historian and newsletter legend Richard Russell:

"If this isn't the mother of all head-and-shoulder top formations, I've never seen one,” Russell told MarketWatch. “If this formation falls apart, I expect the break to signal the start of a brutal decline in stocks… If the formation breaks down, I think all previous plans, scenarios and strategies will hit a stone wall.

“Wall Street and public sentiment will turn black bearish. Consumers will head for the storm cellars, and once in, they'll shut the door above them and lock it."

A breakdown of this chart would be a few days of new lows for the Dow, about 60 points down from where it ended yesterday. The S&P chart looks very similar… except it’s already making new lows.

  We updated our own forecast for Futures magazine this week. If we enter another bear market for stocks — the end of the great “sucker’s rally” — we expect this bear market to last longer and cut deeper than the sharp declines we saw in the fall of 2008.

  Not that this bear won’t be addled by strange occurrences. Since the “flash crash” on May 6, there have been several other bizarre “errors” on major U.S. stock exchanges. It’s a short list… but what’s going on here?:

June 16: Shares of the Washington Post Co. zip up nearly 100% in seconds.

June 28: Boeing crashes 44%, rebounds instantly

June 29: Citigroup falls 12% instantly, on one trade.

There are supposed to be new “circuit breakers” installed on major exchanges to keep this from happening. One kicked in yesterday and paused that Citigroup trade, which was eventually called back and canceled.

Citi fell 5% anyway, and now goes for about the price of a large cup of coffee.

It’s getting dicey, isn’t it? With the Dow and S&P teetering on technical precipices, traders wouldn’t stop to ask questions if either exchange were to drop sharply.

  Of course, this new bear trend will one day yield a buying opportunity in U.S. stocks. The easy question is: When?

But a more interesting one: For whom?

“The U.S. market also seems to be picking up new fans — Chinese investors,” Chris Mayer reports, citing a Wall Street Journal article that declared: "Securities filings show that Chinese funds that cater to individual investors have been allocating a larger share of their investments to the U.S. market in recent months."

“It's not a lot of money yet,” Chris adds, “Chinese investors have only $700 million in U.S .markets — but it could be huge down the road. The Chinese have $64 billion they can invest abroad. More and more, they are looking to invest in the U.S. As Wu Da, a portfolio manager at Changsheng Fund Management, put it: ‘We are now bullish on the U.S. market, because we expect the U.S. economy to have a healthier recovery’ than other developed countries.

“There is irony in this. Here we are looking at the China growth story and thinking how attractive that is, yet more and more Chinese are looking at the U.S. Maybe the grass is always greener…”

  Here’s another unsustainable trend for today:

In a 2008 redux, the market has deemed it more “rational” to lend the U.S. government your cash for two years than it would be to lend the same money to a bank for six months. Yields on the 2-year note are now lower than the rates banks lend to each other (Libor) for a six-month period… just a breath above the 3-month rate, in fact. As we mentioned yesterday, there are a whole lot of loans coming due this week in the eurospace, and the health of banks there (and in the U.S.) is far from certain.

Thus yields reflect banking fear in the short term, but long term… this is awfully silly. Opportunity to load up on our New Trade of the Decade, we say. The yield on the 2-year note is below 0.6% today — that’s never happened before, even during the worst of the 2008 crisis.

  “Now, you have to ask yourself this question,” Chuck Butler pondered over the 2-year note record pricing. “What do I have to gain from buying a Treasury that's yielding all-time lows?

“Think about that for a minute. If you buy a 2-year Treasury, the broker takes his pound of flesh for commission and you're left with about 0.50 or 0.5% yield. There's nowhere to go but up from here, folks… Sure, it could go do down more, but by more than the yield you own the 2-year at? Hardly! So it's a losing trade from the get-go!”

  With some deft timing Monday, our resource man Alan Knuckman told his readers to pick up a put spread on U.S. bonds… essentially, a bet that bond yields will go higher over the short-medium term.

“Bond exit sales combined with the record Fed debt auctions signal a downturn” Alan noted. “Near-record lows again in long-term interest rates, which are in inverse to high bond prices, signal significant eventual upside and a modest near-term climb back up from overdone levels.

“Treasury Bonds have been good to Resource Trader Alert (RTA) and an option spread play is the vehicle of choice to profit from an increase in investment risk tolerance and the flight to quality unwinding.”

Indeed. When Alan’s RTA readers used this same strategy to bet against U.S. bonds in April of 2009, they walked away with 152% profits in less than one month. If you want in this time around, subscribe here. It’s not too late to buy into this trade.

  Heh, but if you insist on investing in an asset with a nonexistent yield, you might as well buy something with inherent value… like a precious metal. Gold is holding strong today, despite dollar strength, at $1,245 an ounce.

At just under $19 an ounce, silver is sitting pretty, too… though in terms of proximity to recent highs, silver’s getting less investor love than gold lately. It’s still well below pre-crisis levels of $21 and the gold-silver ratio stands at 67 today. That’s pretty high, historically speaking.

So perhaps it’s not a bad time to pick up some silver.


  Worst -case scenario, you can resort to trying to pluck hairs from famous people and selling them after they’re dead.

That’s precisely what Denzil Ibbetson did a few centuries ago. A lock of hair Ibbetson took from Napoleon, while the diminutive general was in exile on St. Helena, sold for US$13,000 at auction this morning in New Zealand.

  “So is it now true that there is such a thing as global warming?” a reader responds “Can Al Gore actually be on to something? If not, then why risk money betting on oil development upon land in Greenland freed of its ice cap? And is that to be celebrated as a new investment objective?

“Yeah, do nothing and just watch our coastlines submerge beneath the rising oceans. Guess you damn conservative right-wingers want it every which way.”

The 5: What should we be doing? And, umn, who are you calling conservative?

  “If Al Gore really believes the seas will be rising from global temperature warming,” asks another, “why does he live in a sprawling estate on the coast?”

The 5: Funny. If you actually read what we published, we didn’t discuss Al Gore or global warming.

  “The 'recession' is a direct consequence of the reserve bank system,” a third reader asserts definitively on a different subject. “At the heart of the issue is this: Every dollar (or rand in my case) comes into the system as debt. There one can immediately see the problem: Debt incurs interest, i.e. more money has to be repaid than is in existence.

“Take this (very) simple example. I am the reserve bank. I create $100. I 'lend' it to a commercial bank. My interest rate is 10% per annum. At the end of the year, the bank has to repay me $10. After 10 years, I have my original $100 back. BUT the commercial bank still owes me $100 principal. Problem is that there now is no money in the system in order to do so (I only created $100!). The only way for the commercial bank to repay me is for it (or some other entity) to borrow more money from me. Money that would also incur interest….

“The outcome of this type of pyramid scheme is always going to be — wait for it…. a liquidity crisis! And because commercial banks are the primary lenders from the reserve bank, one of the symptoms is always going to be a banking crisis. The only way to get out of this situation now is for the reserve bank to inject liquidity (bad) and debts to be written down (good). This new liquidity is bad because it also now incurs debt (the cycle continues), causing problems later on. Thus, we need to address the root cause of the problem: incremental reserve banking.

“The reserve bank system is inherently flawed and needs to be abolished. While it is in place, we will forever have these cycles of boom and bust — there is no other possible outcome.”

The 5: Are you enjoying the World Cup at least?


Addison Wiggin

The 5 Min. Forecast

P.S. The Agora Financial Investment Symposium is officially sold out. We do, however, get cancellations from time to time, so if you’re still interested in attending, call Barb Perriello at (800) 926-6575  and see if there’s any space left. Otherwise, enjoy your summer. If you are attending, we’ll see you in three weeks.


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