One bear feeling good about deflation call

An investment letter that dodged the crash of 2008 is a current top-performer. It’s feeling good about its long-standing deflation prediction.

The Elliott Wave Financial Forecaster, edited by Steve Hochberg and Pete Kendall, is fifth of just nineteen of the 180-plus investment letters monitored by the Hulbert Financial Digest to have beaten the market in 2011 through September—up 5% by HFD count versus negative 9.86% for the dividend-reinvested Wilshire 5000 Total Stock Market Index.

This is, frankly, pretty unusual. EWFF has been relentlessly bearish for so long that many investors think it was always so, and any favorable mention gets vitriolic response.
…
Needless to say, 2008 was a great year for EWFF, especially because it also made one of its brief excursions into bullishness in time to catch the subsequent bounce. See April 2 column.

You can still see this in HFD’s monitoring: over the past five years, EWFF was up an annualized 0.7% versus negative 0.75% annualized for the total return Wilshire 5000.

But further out, the cost of prolonged bearishness has been horrific. Over the past fifteen years, for example, EWFF is down negative 3.43% annualized versus a gain of 5.4% annualized for the total return Wilshire 5000. It’s worth noting, however, that EWFF closes the gap significantly on a risk-adjusted basis.

Still, in the face of the 2008 crash, and the savage slump this summer, few investors can wholly repress the fear that, just maybe, the Elliott bears might ultimately be vindicated.

Well, not as long as there are people like Ben Bernanke with his hand on the printing press… As noted here on a number of occasions before, I’ve long thought that Elliot Wave Theory is nonsense and, basically, lost all respect for Bob Prechter when he predicted that the gold price would never surpass $400 an ounce about a decade ago.

For anyone who might be interested, here’s a recap of the last four years of annual prediction reviews:

• A review of 2006 predictions
• A review of 2007 predictions
• A review of 2008 predictions
• A review of 2009 predictions

As always, these are interesting to look back upon if for no other reason than to see where we’ve been. It’s funny to think about predicting the housing bubble would not pop in 2006 and that it would in 2007 (as measured by home price declines). One thing is certain, it did pop and has stayed popped despite the best efforts of the government and the Federal Reserve to re-inflate it.

This year, it looks like the Fed ruined many of my predictions at the Jackson Hole conference over the summer when they started talking about printing money and the prices of just about everything that doesn’t show up in the consumer price index began to rise.

They say, “don’t fight the Fed” – if I’d known that they were going to do what they did, I wouldn’t have.

Without any further ado, let’s begin, as always, with housing…

1. Maybe the Last Really Bad Year for Housing

It’s hard to understand how anyone can really think that the nation’s housing market managed to “stabilize” in 2009 when prices continued to decline on a year-over-year basis even after government support to this sector on a scale never before seen by Mankind.

Homebuyer tax credits, central bank purchases of mortgage-backed-securities, a sharp increase in FHA lending, and a host of other factors have merely “kicked the can down the road” and that road will be “uphill” in 2010. Mounting foreclosures, loan resets, and an increasing number of homeowners who simply “walk away” from underwater mortgages will cause a relapse in housing this year and month-to-month gains will turn back to losses.

As measured by the 20-city S&P Case-Shiller Home Price Index for October 2010 (to be released in late-December), home values will decline by another 8 percent. The U.S. government will extend the homebuyer tax credit again in the summer and late-2010 will be a good time to start looking to buy property in most parts of the country.

Grade: C

It seems the can that was “kicked down the road” in 2010 has about come to a stop, albeit much later in the year than I thought in January. Combine an extended homebuyer tax credit with freakishly low interest rates and the foreclosure gate scandal that temporarily stalled repossessions and we got a little stability in home prices, but it doesn’t look like that’s going to last.

Tuesday’s S&P Case-Shiller Home Price Indexes showed a year-over-year decline of 0.8 percent for the 20-city index, so, the 8 percent decline noted above was off by an order of magnitude, however, after the October decline of 1.3 percent, it looks prices are making up that ground at a brisk pace. As for another round of homebuyer tax credits, they didn’t happen last summer but there’s been more talk about them since Tuesday’s report and, after renting for six years, my wife and I finally bought a house, contributing in our own little way to October’s 1.3 percent drop in prices.

2. The Dollar Will Continue its Descent

The dollar fell modestly last year after a surprisingly strong 2008 and it will continue that slow, steady decline in 2010 after a surge of safe-haven buying in the spring after equity markets have another little hiccup, temporarily boosting the greenback’s appeal.

The trade weighted dollar ended 2009 at about 78 but will end 2010 at 72 after briefly dipping into the 60s and scaring the bejeezus out of the entire world as the long-anticipated “global currency crisis” once again looks like it is at the world’s doorstep.

The dollar weakness will be driven primarily by concerns about funding the U.S. budget deficit as traditional buyers become more scarce and the entire world begins to realize that the economic recovery in the U.S. will be very long and very slow.

Grade: C

After rising to almost 89 and then dipping to 72, the U.S. Dollar Index will end the year about one point higher at 79. The flight to safety came as expected in the spring and then the trade-weighted dollar moved generally lower throughout the rest of the year, but ongoing sovereign debt troubles in Europe limited the decline.

Though long-term interest rates have risen recently, they are still quite low by historical measure despite another $600+ billion in Federal Reserve money printing and almost $900 billion in tax cuts/stimulus announced in recent months. Will 2011 be the year that foreigners grow tired of funding our deficit? If so, it’s a good thing that the central bank hasn’t.

3. Stocks Will End the Year Lower

Broad equity markets in the U.S. will advance early in the year and then, peering into the future of the domestic economy and not liking what they see, have a relapse right along with the housing market.

Retail investors will continue to pull money out of stocks, in the process muttering Will Rogers’ famous words about the relative concern for the words “of” and “on” when they are placed between the words “return” and “principle”. Whatever or whoever drove stocks higher in 2009 will have much less success doing so in 2010, however, it won’t be a complete washout as the Dow will lose 10 percent and the Nasdaq 15 percent.

Stocks in China will get about half-way back to their 2007 highs before reversing and ending the year only modestly higher. Gold and silver mining stocks will fall in sympathy with other equity markets but will rebound faster and end higher than most other sectors.

Grade: F

This is only my second ‘F” in five years, so, I’m not sure if that’s a good thing or a bad thing. One thing that I am sure of is that I’m glad my personal investments and those detailed in the companion investment newsletter at Iacono Research aren’t focused on U.S. stocks because, if they were, I’d have been a big loser based on my early-2010 prediction. (As it is, it looks like the model portfolio at the investment website will end the year with a gain of about 27 28 percent.)

The spring rally came and then a multi-month swoon began in May, extending until Fed Chief Ben Bernanke started talking about money printing again in late-August and, here at year-end, we’re looking at gains of about 15 percent for the Dow and 20 percent for the Nasdaq. Had I known that later in the year, the Fed would add higher stock prices as a third mandate, I’d have reconsidered my prediction. Fortunately, the big gains in gold and silver mining stocks (that are part of both the model portfolio and my personal investment portfolio) make the sting of getting an “F” a little easier to take.

4. Short-Term Interest Rates Will Stay at Zero … Again

Like last year, short-term interest rates in the U.S. will end where they began – at zero – but the central bank will tack another $1 trillion onto its balance sheet.

Chairman Ben Bernanke will be re-confirmed for another four-year term as Fed chief but will receive the highest number of ‘No’ votes in history and many elected officials voting ‘Yes’ will regret their decision by summer as the economy sours and the mid-term election nears.

The Fed will stop buying mortgage backed securities in March and the housing market swoon will intensify. Bernanke and crew will then resume their purchases in May because no one else was willing to buy at anywhere near what the central bank was paying.

Grade: A

This might be my only “A” this year, so, please wait while I give myself a little pat on the back… Predicting the future of short-term interest rates has been like shooting fish in a barrel over the last five years (even when they were rising) and I don’t expect that to change anytime soon.

The Fed funds rate remains stuck at zero, not likely to move up any time soon unless we get a full-blown currency crisis and, perhaps, a new Fed chairman, the current one receiving the highest number of “No” votes in history as predicted. The Fed’s balance sheet only rose by about $200 billion and they resumed purchases of U.S. Treasuries, not mortgage-backed securities, so, not perfect, but still excellent.

5. Energy Prices Will Go Up and Then Down

After rising to $95 a barrel during the spring, the price of crude oil will dip to as low as $45 and then end the year at $65 a barrel. Peak oil will have to wait until global growth begins to post much bigger numbers and that won’t happen this year.

The price at the pump will rise from their current $2.70 a gallon to more than $3 a gallon early in the year and then retreat back to the low $2 range. Gasoline was one of best commodity investments last year, this year it will be one of the worst.

None of the green energy job initiatives will amount to anything and that’s just sad.

Grade: C

Once again the first half of the year went about as predicted, but the early-2010 crystal ball didn’t see Ben Bernanke printing up more money by summer time. The oil price rose to about $90 a barrel in the spring followed by gasoline topping $3 a gallon and then they both tumbled, but that Jackson Hole speech by the Fed chairman set the wheels in motion for renewed speculation in commodity markets and year-end prices of about $90 and $3 are 50 percent higher than I thought they’d be.

Oh well. For a number of reasons, it’s hard to make money on energy commodities anyway. While it looks like crude oil will post a gain of about 15 percent this year, related ETFs have low single digit gains or losses. It’s a slightly different story for gasoline where futures prices have risen about 17 percent while the United States Gasoline ETF (NYSE:UGA) is up about 15 percent, but, the only sure way to make money on energy commodities in 2010 was to be a Goldman Sachs trader.

6. Gold and Silver Will Soar … Again

The end of 2010 will mark ten straight years that gold bullion has ended higher than it began and most Americans still won’t own it, continuing to put their trust in the mainstream financial media that, for the most part, still doesn’t understand it or recommend it.

The yellow metal will make new all-time highs at just over $1,400 an ounce in March and then begin its every-other-year 18 month consolidation, ending 2010 at $1,300 an ounce. Silver will rise to $24 an ounce in the spring and end the year at $21 an ounce.

An increasing number of retail investors will eschew the advice of Money Magazine and buy gold and silver anyway, but a good number of them will sell it over the summer when metal prices correct. They’ll be back in 2011.

People will start talking about junior mining stocks at cocktail parties – just like internet stocks in 1997. (As noted the last couple years, I’m going to keep saying this until it’s true).

Grade: B

One of the most remarkable developments this year is actually a non-development – there has been no substantive correction for gold and silver prices. The predicted general direction for both metals prices was correct (well, actually, that part has been both easy and profitable over the years) and, for gold, a high of just over $1,400 an ounce was spot-on, but it didn’t come in the spring and the surge in the silver prices was woefully underestimated.

I saw silver prices rising as high as $24 an ounce and, believe it or not, it was just $18 when Ben Bernanke stepped up to the podium at the Jackson Hole conference in August. Of course, Bart Chilton’s comments about manipulation in the silver markets gave the metal a boost too and, as this is written, it looks like the poor man’s gold will end the year at almost $31 an ounce, a gain of over 80 percent. Amazing… As for junior mining stocks, stay tuned and start listening closely at cocktail parties.

7. The U.S. Economy will Barely Avoid a Double-Dip

Economic growth will stall by the second quarter as Congress finds it politically difficult to make additional stimulus funds available during an election year. Following an impressive growth rate during the fourth quarter of 2009, the first two quarters of the year will see rates of between zero and one percent with the economy posting a small negative number in the third quarter.

The overriding theme in the economy during 2010 will be the continuing revival of a more frugal lifestyle following the credit and consumption binge of recent decades and the savings rate will continue to rise, from about 4 percent in 2009 to 7 percent by year-end, still well below the pre-Reagan administration average of about 10 percent.

Grade: B

We saw annual growth rates of 3.7 percent, 1.6 percent, and 2.6 percent in the first three quarters of the year and avoided a double-dip recession, but the Fed-induced rally in the stock market seems to have given the rest of the economy a boost and everyone seems to be revising their growth estimates higher with only a few lonely souls continuing to talk about a “double-dip”. The “wealth effect” really seems to work (at least over the short-run).

As for frugality and the savings rate, that was only in fashion until Bernanke started talking about printing money in August. According to this chart at the St. Louis Fed, the personal savings rate rose to 6.3 percent over the summer, only to plummet back toward five percent when everyone started noticing their investment portfolios rising in value and then started spending money, just like Ben Bernanke wanted.

8. Inflation will Surprise to the Upside

Consumer prices will rise much more than most economists expect early in the year driven higher by continuing unfavorable year-over-year energy price comparisons and the government’s “official” annual inflation rate will reach a peak at over three percent as the grass starts turning green.

Then commodity prices will plunge and we’ll start hearing about de-flation again.

Grade: B

Inflation peaked at 2.7 percent in January, long before the grass started turning green in most parts of the country, but, from then on, inflation as measured by the government was another non-event for the year. Of course, commodity prices have risen almost 30 percent on average in 2010 and the cost of all domestic services continues to climb, but economists continue to be more concerned about de-flation than in-flation, which, given the recent calls for $5 a gallon gasoline is quite remarkable.

As was the case for many other predictions this year, the idea of plunging commodity prices was nixed by the Fed chairman over the summer as the year-to-date average decline for commodities in mid-July was about 5 percent – energy prices were down about 10 percent and base metals were almost 20 percent lower. It’s amazing to see what money printing can do, not only for stocks, but for commodities. It’s just a good thing that none of the commodity price increases show up in the CPI.

9. Only a Few Jobs will be Created

Next month’s benchmark revisions to the Labor Department nonfarm payrolls data will show an additional loss of 1.2 million jobs during the early-2008 to early-2009 period (greater than the currently estimated 840,000 loss) and there will be only modest net job growth in 2010 of about 500,000 jobs, all of it in health care.

The unemployment rate will reach a peak at 11 percent early in the year and remain above the 10 percent mark during all of 2010, save for a two-month dip in late-summer as millions of jobless become discouraged and stop looking for work.

Grade: B

Let’s see… I don’t recall what that benchmark revision number was, but I think it was close to the original estimate of 840,000 and, while not all the data is in, through 11 months, there has been a net increase of 951,000 in nonfarm payrolls with 369,000 coming from the Education and Health Services category – not too far off.

The unemployment rate has stayed between 9.5 percent and 9.8 percent, rising to its highest level of the year in last month’s report, well short of the 11 percent rate predicted a year ago, so, it could have been much worse. The year 2010 will probably be remembered as one where U.S. companies did a much better job of lowering the unemployment rate in other parts of the world than in the U.S.

10. The 2010 Elections will Be Shocking

As the economy turns from weak to bad again over the summer, there will be some surprising developments leading up to the fall elections as young and old alike express their displeasure with the status quo, namely, the cozy relationship between elected officials and the leaders of the FIRE (Finance, Insurance, and Real Estate) economy.

A record number of independents will run for and be elected to office and Washington will start to get the message, but Wall Street won’t.

Grade: B+

I don’t know … shocking? I guess Christine O’Donnell’s Delaware senate campaign was kind of shocking, but not in the way that I was thinking last January. The tea-party movement is one that doesn’t appear to be going away, however, instead of running as independents, they joined the Republican party, a move that they may reconsider next time around.

One thing that the United States needs desperately is a third major political party (and maybe a fourth and a fifth) since the two that we now have are so much alike in so many important ways that inhibit major structural reform occurring on Wall Street, which, looking back on the year just concluded, did quite well. As long as just Democrats and Republicans are casting votes in Washington, don’t look for major changes on Wall Street.

It’s pretty amazing when you think about it and, truth be told, the best of all possible scenarios for the Federal Reserve who, yesterday, affirmed its plans to print upwards of another $1 trillion to buy U.S. debt through the middle of next year. You see, commodity prices are up more than 20 percent on average this year  – energy costs are more than 10 percent higher, corn and wheat are both up 42 percent, and soybeans are up 24 percent – yet, the consumer price index is only one percent higher.

Of course, much of this has to do with the monstrous housing component (accounting for 42 percent of the CPI) continuing to be a drag on the index, last month posting a 0.0 percent change for the month and a 0.0 percent change for the year as shown below.

A housing bubble that will likely continue to deflate for at least another year or two will play a big role in keeping the consumer price index anchored around the one or two percent level despite how much it costs you to buy gasoline and pay for tuition and medical care.

Says Martenson: “The Continuous Commodity Index is absolutely screaming inflation at this point in time over the past eight or nine year timeframe, but, at the same time, we’re seeing houses decline in price, we’re seeing a number of other things – asset prices – move lower, which, I think is what the Fed is most concerned about at this point in time. So, I think we’re going to see both”. He’s also convinced that a double-dip recession is imminent.

One thing is certain, they both can’t be right and, at some point in the not-too-distant future, stocks and bonds will stop rising together. What would really stump market analysts is if they both started falling together… Oh Dear… Maybe I shouldn’t have brought that up…

The old bogeyman of deflation has re-emerged as a worry for the U.S. economy. Here’s something else to fret about: After studying more than a decade of deflation in Japan, economists have slowly realized they have no idea how it works.

Deflation is usually associated with a Great Depression-like drop in demand. Consumer prices, incomes and asset prices fall. Interest rates go to zero, as low as they can go. As prices and incomes fall, the cost to borrowers of servicing debt does not, sucking life out of the economy and pushing prices down further. A bad situation, in short, gets worse.

In 1932, U.S. consumer prices fell 10% and between 1929 and 1933 they fell 27% in all.
…
Economists don’t have good answers. “We don’t know how deflation works,” says Adam Posen, a member of the Bank of England’s monetary policy committee who has been studying Japan since 1997. “We don’t have a way of rationalizing steady, several-year flat deflation,” he says.s.

Whatever deflation is or does, Fed Chief Ben Bernanke plans to make sure it doesn’t happen here and, given how he’s managed to crank up the printing press over the last couple years, he should probably be taken at his word.

BTW – That graphic looks to be incorrect as the 1930s deflation is portrayed as a relatively modest affair when there were, in fact, double-digit declines as noted in the report.

Here’s the chart:

Have I just not had enough coffee this morning or is this just plain wrong?

The big question is, “Why isn’t the Fed doing more to help an economy in which inflation is lower than the Fed wants it to be and unemployment is much higher?”

On a year-over-year basis, the government’s measure of annual inflation fell from 2.0 percent in May to just 1.1 percent in June, the lowest level since last October when the price index first pushed back into positive territory after almost a year of negative numbers.

Much of the reason that the inflation rate reached as high as 2.8 percent six months ago had to due with sharply higher energy prices when compared to the year-ago period, that is, during the depths of the recession in late-2008 when a barrel of oil sold for as little as $35.

Now, those big annual increases have all but disappeared as indicated in the modest 3.0 percent gain in the energy index below, leaving domestic services such as medical care and education as more important positive influences on the overall index.

If energy prices fall from their still lofty levels of almost $80 a barrel for oil and $3 a gallon for gasoline, look for a speedy return back into negative territory for the overall consumer price index and more de-flation fears amongst central bankers.

Surprisingly, within the Transportation category above, the price of automobiles plays an equally important role as the price at the pump for the overall 4.9 percent increase from a year ago. According to the Labor Department data, the cost of used cars has risen 16.1 percent over the last 12 months. Moreover, the cost of public transportation has risen 10.9 percent from a year ago, two areas of rising prices that you don’t hear much about.

Get Ready for a Cataclysmic Market Crash! (Or Maybe Not)

_
Could the Dow really drop 90%?

Earlier this month, in an interview that was widely circulated online, market analyst Robert Prechter predicted that the Dow Jones Industrial Average will fall below 1000 within the next six years. The Dow promptly surged back above 10000, but it is worth asking whether Mr. Prechter might be right anyway.
…
Mr. Prechter is a technical analyst who studies the past price performance of the markets for clues to the future. He also believes that investors move in and out of the market on predictable waves of optimism and pessimism. “Because the mania [the bull markets of 1982 to 1999 and 2003 to 2007] was so terrific,” he told me this week, “it will be followed by a negative trend in social mood that will lead to a complete retracement.” That would put the Dow back to its levels in 1982, below 1000.

“In a deflationary environment, the last thing you want is to own any financial asset,” Mr. Prechter added.

Yeah, and gold will never go over $400 as Prechter famously wrote early in the last decade.

Damien Hoffman over at Wall Street Cheat Sheet had the far superior Prechter column this week when he asked, Is Elliott Wave Theory High Priest Robert Prechter Certifiably Insane?

To dampen the fun being had by the younger WSJ crowd on what looks to have been a giddy, half-staffed Friday morning in Manhattan when this video was taped, David Wessel is brought in at about the six minute mark to talk about the impact of lower consumer prices on corporate profits and everyone’s favorite summer topic – de-flation.