FSO Editorials: Never Forget the Big Picture by Robert B. Gordon 01/08/2004

Never Forget the Big Picture
Where We Are & What Lies Ahead
by Robert B. Gordon, Sc. D.
January 8, 2004

Millions of Americans have jumped back into the stock market in recent months, convinced that the bear market is over. Of course they are not alone for Wall Street "experts" are also very bullish. The history of all previous manias is being repeated but in relative slow motion due to the much greater magnitude of this Grand SuperCycle Wave IV which may take many decades before it ends. At this writing, the Dow is completing Primary Wave 2 which will lead directly to a sizable bearish wave 3, which will surprise many of our bulls.

A very small number of readers have given up on the EW Theory as a result of its inability to call the end of the current bear market rally. This is a true fact, which has to be admitted, since Elliott’s gift to mankind is all about the form of a completed wave and not about the time to complete it. So, an EW user must be satisfied with learning the direction of the next move. This is just as useful to a short term trader, working with very short waves as it is to a long term investor.

Elliott discovered that stock market waves are hierarchical which means that they are identical in structure at all time levels from very short to very long. It has now been proven by other workers, that stock market waves are a natural phenomenon and obey rules seen in nature like in a broccoli plant where the main trunk and smallest branch have the same structure. It’s of interest that Elliott waves are identical in form for every stock market in the world and for every form of investment from stocks, bonds, commodities etc.

There is one part of the Elliott Wave story that attracted me from the very start when I saw the result of the research that enabled experts to trace the 1990’s bull market back to the South Sea Bubble in London in 1721. That huge Mania involved the London City Council, the King of England and even Sir Isaac Newton and, when it ended, virtually every stock company on the London Exchange went out of business. That mania was Wave I of the Grand Supercycle. Wave II was a 62 year long bear market that ended in1784. Grand Supercycle Wave III of this long bull market sequence started in 1784 and ended 215 years later in 1999 at the top of the current mania. We are now four years into bearish Grand SuperCycle Wave IV which can easily equal the 62 year length of Wave II, or more if it chooses.

How many people in the U.S. do you imagine know and understand the significance of the previous paragraph?. The number, in my view, is much fewer than one percent. In the 70 years since Elliott’s great work, there has been just one paper from many thousands of college economists discussing and supporting Elliott’s contribution. The author is Hernán Cortés Douglas, Professor in the Catholic University of Chile. With his permission, I had a copy of his essay placed in the FSO archive. The neglect of our university economists means that none of the experts available to our government have been able to understand the great disaster ahead.

So, based on the information above, I am very pessimistic about the length and depth of this biggest bear market in recorded history which may run for many, many years. If you need a possible example, look at the sad situation in Japan, which in the ‘80’s, was a showcase with the best economy in the developed world. Its bear market is now in its fourteenth year and there seems to be no end in sight after trying many failing solutions.

Saturday January 3, 6:29 pm ET By Kevin Krolicki
SAN DIEGO (Reuters) - U.S. Federal Reserve Chairman Alan Greenspan said on Saturday that policymakers have been proven correct in their decision not to try to prick a 1990s stock-market bubble that subsequently broke on its own.

"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful," Greenspan told the annual meeting of the American Economic Association in San Diego, Calif. Greenspan cited the "exceptionally" mild nature of the eight-month 2001 recession despite a series of shocks to the economy that included plunging stock prices, the Sept. 11 attacks, corporate scandals and wars in Afghanistan and Iraq.

In defending the Fed's tactics, Greenspan said if the Fed had stepped in to curb stock prices by raising rates, it might have done damage to the entire economy in the process. Stock prices collapsed in early 2000, wiping out trillions of dollars of investors' wealth. Now in his 17th year as chief of the U.S. central bank, Greenspan stressed that sound policymaking requires judgment and can be helped, but not fully guided, through simple rules. He said the U.S. economy's resilience and ability to quickly adapt had also increased its ability to weather adversity.

CLAIMS POLICY CREDIT
"Much of the ability of the U.S. economy to absorb these sequences of shocks resulted from notably improved structural flexibility," Greenspan said in a relatively academic address. "But highly aggressive monetary ease was doubtless also a significant contributor to stability." He said the idea that the Fed could have brought the 1990s stock bubble to a gentle decline by ratcheting interest rates up -- as some critics have suggested it should have done -- "is almost surely an illusion." In a question-and-answer period later, Greenspan said policymakers could have halted the rise in stock prices by hiking interest rates until it happened, "but it would bring the whole economy down with it." The Fed chief made no comment about current U.S. economic conditions and offered no hint about how soon U.S. central bank policymakers might move interest rates up from 45-year lows in the face of mounting evidence of a broad-based pickup in U.S. economic activity.

Building on a theme he addressed last August at a Jackson Hole, Wyo., conference, Greenspan said policymakers had to choose between a variety of possible events in setting a course for interest rates.

"A central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path," he said. He said such judgment was a factor in the Fed's decision to take a low interest-rates stance to limit the risk of deflation, a potentially dangerous fall in consumer prices, even though such an outcome did not appear to be in the cards.

EASE IF MUST
"Such a cost-benefit analysis is an ongoing part of monetary policy decision-making and causes us to tip more toward monetary ease when a contractionary event ... seems especially likely or the costs associated with it seem especially high," he said. The Fed lowered interest rates by a whopping 4-3/4 percentage points in 2001 after the stock market's collapse and the Sept. 11 attacks, and by another three-quarters of a percentage point by the end of June 2003 to the current 1 percent, the lowest rate since 1958. In a reference to inflation-targeting regimes used by some other countries' central banks, though not the Federal Reserve, Greenspan suggested they could not replace a solid record of sound policy guided by judgment.

"As yet unresolved is whether the mere announcement that a central bank intends to engage in inflation targeting increases the credibility of the central bank's inclination to maintain price stability and, hence, assists in the anchoring of inflation expectations," he said.

BAD BETS - BILL BONNER COMMENTS
The Daily Reckoning, London, England, Monday, 5 January 2004
The big financial story of '03 was the drop in the dollar -- which dwarfed all other trends put together. All U.S. assets are priced in dollars. If, all together, they are worth about $50 trillion -- Warren Buffett's estimate -- last year, Americans lost $10 trillion (measured in gold or euros). This followed a similar loss the year before. But neither Greenspan nor Bernanke bothered to notice... or stooped to wonder what it might mean. "There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful," said Greenspan to the annual meeting of the American Economic Association. Success, in the Fed Chairman's view, is demonstrated by the "exceptionally" mild correction will be followed by the most extravagant bubble the world has ever seen. Despite terrorist attacks, stock market scandals and war consumers just keep trucking their way to the poorhouse. Mr. Greenspan did not mention it, but since he has been head of the Fed the average American has spent a higher percentage of income -- from 75% to about 85% -- trying to keep up appearances while not falling behind in his debt service payments. Greenspan acknowledged that he might have raised rates to prick the bubble. But that would have meant a real correction rather than a phony one. A falling stock market would "bring the whole economy down with it," warned Greenspan. The Fed chief declined to explain why avoiding a correction by increasing consumer debt was a good thing... nor did he explain how debt might someday be eased without a correction... or what would happen when his debt bubble, now at higher altitudes, eventually blew up. Nor did he bother to reflect on what would happen when foreigners lose confidence in the debt-puffed dollar.

But leave it to Ben Bernanke to rush in where even Greenspan feared to tread. The newest Fed governor said he saw "little risk" of a dollar crisis. Instead, the risk Bernanke sees is the menace of not enough inflation. Inflation is "at the bottom of the acceptable range," he said, and explained that the Fed would make sure it moved higher, not lower. These remarks seemed to push the world's lenders closer towards the risk Bernanke couldn't see. "Dollar drops to record low against euro after Bernanke's comments," Bloomberg reported. An American who earned $20 per hour in 2001... earned the equivalent of only $12 last year. In terms of real money, Americans are losing income faster than at any time since the Great Depression. Pity no one mentions it.

RBG Comments - Bill Bonner, in his daily commentary, sure knows how to use words that really bring an issue to its head. There could be a revolution in this country if the general public would hear and understand what is really happening to everything we hold dear. But, of course, their interest is on many other matters as always. I suggest that everyone now go back and reread Bonner’s very scary words. God save America!

Yes, it's over, but the real correction of the Mania is still ahead. The 3 huge bubbles in stocks, debt and real estate are still going strong as we write. Over the past two years, we have been stating that Greenspan, his staff and thousands of economists in the country had no inkling of the Elliott Wave Principle and the huge bear market and depression it was predicting. A few readers have replied that of course he knows but he doesn‘t want to panic the country. I did not believe that idea then and do not now. The incredibly bad record of economists in predicting just 25% of our recessions tells me that they know nothing about the EW Principle and its great record on predicting stock crashes and depressions. The truth on this matter will finally appear in the coming big down leg in the stock market.

Of course, the minor recession Alan Greenspan is so proud of is over. Every fact and expert opinion that I read has convinced me that the real drop in our economy will be a severe depression that lies ahead when the bears are in full control of the stock market. It is not my knowledge of economics that brings me this understanding but my knowledge of the Elliott Wave Principle. Ralph Elliott was the first man to recognize that stock market cycles are the basic cause of major events in other human activities. Stock market events are dominant and once a mania has developed, anywhere in world history, it brings on a decline in the economy whose depth is related to the size of the prior stock mania. Since this mania was world wide and the greatest ever, I expect we will have to undergo a depression greater than that after 1929. That is what I have been telling my readers, my children and my grandchildren for quite a few years.

We try to help investors with all levels of experience and this time we’ll give some suggestions to help our more advanced investors. We decided to address the question of how one decides on the appropriate balance between stable and volatile asset classes that provides a good return but with few if any sleepless nights. Drawing on our own life experience, we decided to suggest an experimental approach, specifically to provide the data, so that you can decide what is best for yourself.

We are in the process of running a rather large experiment for the benefit of our sons who will inherit our estate. The experiment involves 3 portfolios which, although similar, involve several variables: Total number of asset classes, stable and volatile funds, and names of stocks and funds in various asset classes and finally the ratio of stable and volatile classes. This test could easily end in a draw some years hence. This would mean that the difference built into the 3 portfolios was too small to make any difference. Actually this would be an acceptable answer and indicate that the differences were not significant.

To answer the question of the ratio of stable to volatile asset classes that is best for you, we suggest proceeding as follows

1. Plan two separate portfolios, differing only in the ratio of stable and volatile asset classes
2. Run these portfolios over a period of several years to see which one has the best record.
3. Based on the results, either change the ratio or keep one of the test ratios in the future.

Asset Class	Percent of Asset Class
Asset Class	Lower Risk	Higher Risk
US Treasury Bonds	30%	20%
Foreign Government Bonds	30%	20%
Total Stable Assets	60%	40%

Short S&P Index	10%	12%
Short NASDAQ Index	10%	15%
Gold Fund	10%	20%
Energy Fund	10%	13%
Total Volatile Assets	40%	60%

The range specified above from 60-40 stable to 40-60 volatile is the widest range I would be interested in studying. You might select a narrower range in your experiment.

A reader has asked what exit strategy should be used with a combination stable/volatile portfolio. My answer is that a properly balanced portfolio built from the best of suitable asset classes should be good for the life of the bear market unless one of the funds requires replacement for any reason. It is important to realize that this type of portfolio is renewed every time it is rebalanced. And, at the same time, temporary gains in the volatile classes are made permanent thru transfer to the stable components.

If sufficient care is made in the initial planning, the stable/volatile concept can be made to meet any need from very conservative to as speculative as the investor wishes. The concept is both sound and flexible. For best results, the investor should select the best components available for each asset class. In the next section we will try and help you choose the best.

For the past two years, I have tried very hard to stress the great importance to all readers in their personally choosing the funds to buy. My efforts have been universally ignored and I still get many requests that I do not answer. Knowing how to do this is extremely important for investors at all levels of experience. There is nothing more basic in an investor’s education.

There is more involved than picking the current "hot" fund which is why you need a chart of the past two or three years to see the longer term trend. There are at least five or six internet sites that can provide a variety of charts, some better than others.

My personal source of information on fund performance is from the FastTrack database and charting software. There are other sources that are available but my readers will have to find them on their own. It may be difficult at first but there is nothing more important than learning how to select stocks and funds likely to do well in the market ahead. Please go to the suggested web sites and take enough time to really evaluate their capabilities which vary quite a bit. I have briefly checked five internet sites that can provide a variety of price charts, some better than others. Please make a serious effort to check out the capabilities of Bloomberg, Morningstar, Quicken, Yahoo and Zack’s and develop the method that suits you best. You need to start with a performance ranking of a group of similar funds, eg. gold funds, and then check out the better performing no load funds by inspecting their charts over recent periods.

Copying names of funds from others may get an investor started, but the only way to long term success is to learn how to separate the few winners from a host of run-of-the-mill funds. There are never too many outstanding funds within a particular category, so pick the best you can find and stick with them as long as they perform well. Some categories of funds like gold funds tend to lose performance with growth in asset size since the smaller, fast growing gold stocks no longer have a large impact on the overall portfolio.

As a final note to all readers, the most important factor in the portfolio success is in picking the right asset classes and then in choosing the right time to rebalance the portfolio. For the best return, it is necessary to know when profits in volatile classes need to be transferred in order to prevent their loss in a later price decline. To do this well, investors need to keep track of the price swings in the volatile assets by using hand made price charts or by going to the internet sites given above. The stable funds will rarely need charting, just a monthly record of prices.

Do not be turned off by the work outlined above. Just about everything worthwhile in life takes some effort. But when you see the rewards, you will realize it is worth doing right. We wish the best future success to all of our readers.

Investing your hard earned money to increase your assets should be fun not drudgery. But we are no longer in a market where gains are almost automatic. Taking unwise advice from others could be a real disaster. My goal is, and has been, to help readers improve their market awareness and investing skills. Please let me know what else I can do or what specific help you need.