The following is an excerpt from Richard Russell's Dow Theory Letters
"Charlie Munger and I have not learned how to solve difficult business problems. What we have learned is to avoid them." Warren Buffett
A Critical Concept -- I want my subscribers to be acutely aware of the very BIG picture. The big picture can be understood if you fully understand the yield cycle. Throughout stock market history, the yield on the Dow has run from tiny yields to high yields, and back to minuscule yields again, and then back to high yields. The yield on the Dow is now a minuscule 2.62% (indicative of a bull market top). Ultimately, in this bear market we will see the Dow decline to an area where the yield on the Dow is 6% or more (indicative of a bear market bottom). The only way we will see high yields on the Dow is for the Dow to head down. I don't know HOW the Dow is going to go down. But I do know that the Dow will not head straight down. The Dow's downward path to 6% or more yield will be erratic and difficult to follow. The downward path will probably include several cyclical (abbreviated) bull and bear markets. If you can understand what I write in this paragraph, you will know roughly what to expect in the (perhaps many) years ahead.
I keep harping on this one particular subject. With the inclusion of Asia (China and the emerging Asian nations) into the global economic mix, the world is now producing more goods and merchandise than it can use or buy. Basically, this is the formula for deflation, the more so since this massive amount of Asian merchandise is being exported at viciously competitive prices.
As the world gets "squeezed," the price of everything comes under pressure, and this includes commodities. The commodity chart below illustrates what I am talking about. But the cost of services holds steady or even moves higher. This is the reason why prices have been increasing in grocery stores and supermarkets. I have wondered how the Trader Joe's chain can under-sell the big chains like Safeway. I buy a long list of groceries at Trader Joe's, and it seems as though my total is about half of what the same items would have cost at Safeway. Of course, Trader Joe's deals in specialties that it prices very competitively.
Another major area that I have been concentrating on is China, which is the current economic locomotive of the planet. I'm worried about the Chinese situation. If China slows down or sinks into recession, the rest of the world will almost surely sink with it. China has cut its basic interest rate twice in the last few months in an effort to stir up business. The two charts below are cause for worry. The first is the important stock exchange of Shanghai. Here we see this index slumping and more recently sinking below both its moving averages. Not good action.
The chart below I include as a confirming chart. This is the Chinese "Dow." and it doesn't look good to me. What we see here is a series of declining tops, and then a serious breakdown below both moving averages.
China must “unswervingly” continue its property price controls and prevent prices from rebounding, Premier Wen Jiabao said yesterday, after the central bank cut interest rates and triggered a surge in property stocks. Russell Comment -- China, learning from the US housing's surge and later collapse, is making certain that the same thing doesn't occur in China.
Question -- If a butterfly waves its wings in China, will the rest of the world suffer hurricanes?
CONGRESS -- not the president nor the Fed decides on government spending. Congress -- not the president nor the Fed draws up the US tax code. And Congress alone decides the US debt ceiling.
PROBLEMS --
(1) The US debt limit. This is a cap that Congress placed on the US government debt, a cap that puts a limit on government borrowing and spending. The US debt limit was placed into law in the year 1917. It's a disgrace that the debt limit has been raised by Congress 91 times since 1940.
(2) Fiscal Cliff. What do they mean when they talk about the "Fiscal Cliff"? It's an economic precipice that was placed into law last summer -- it starts on January 1st, 2013. The Fiscal Cliff threatens to plunge the US into an even deeper recession. It consists of fiscal cuts of up to 0 billion over time, starting on January 1st, 2013. At the same time, a host of tax cuts will also expire. The fiscal cliff also includes the onset of .2 trillion in spending cuts. Russell Comment -- The Fiscal Cliff, if it occurs, is the perfect formula for turning the current recession into a depression. Now it's all up to Congress!
Sequester -- This is an ugly word and an ugly process. These are the mandatory spending cuts to come as part of the fiscal cliff: 0 billion must be cut in defense, another 0 billion must be cut in domestic programs. All these cuts must be completed by January 1st, 2013. If Congress can't find comparable cuts by then, these mandatory cuts are intended to force Congress to reduce long-term deficits. So far, Congress has failed to make the mandatory cuts.
Below is a daily chart of the sinking euro. What would it mean if the euro were to collapse and fall apart? Germany's popular Der Spiegel magazine answers the question as follows: "Now Europe is back to thinking the unthinkable... it would be a dream for nationalist politicians, and a nightmare for the economy. Everything that has grown together in two decades of euro history would have to be painstakingly torn apart. Millions of contracts, business relationships and partnerships would have to be reassessed, while thousands of companies would need protection from bankruptcy. All of Europe would plunge into a deep recession. Governments, which would be forced to borrow additional billions to meet their needs, would face the choice between two unattractive options: either to drastically increase taxes or to impose significant financial burdens on their citizens in the form of higher inflation."
Russell Comment -- The world has entered into its current mess by over-leveraging, over-borrowing, and living beyond its means ever since WWII. It has been able to do this through an explosion of credit -- better known as a "credit bubble."
The solution to today's credit troubles has been addressed by the various central banks. The antidote they have chosen is more liquidity and a drive to increase the use of credit. Of course, this solution will only worsen the problem through time.
Comment -- Last Friday's market was the broadest down-market that I have seen this year. True, the Dow was down only 124.20 points. But ALL 19 of the sectors that Dow- Jones posts every day closed down. That's the first time this year that I've seen this occur. The sectors that D-J posts daily include the Nasdaq, the S&P 600, the Housing Sector, the Bank sector, the D-J total market sector, the D-J Utility sector, the oil service sector, the gold/silver sector, and so on.
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