Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

  1. Looking Back on Japan
  2. Markets Remain Mixed

1. Looking back on Japan:  Below are two long-term charts.  See any similarities? One is of the Nikkei 225 (from 1980 to present) and one of the Dow Industrials (from 1982 to present).  Both markets had their manic ascents at one point in time, but the Dow, unlike the Nikkei, has yet to experience the aftermath.  Since Japan’s mania (which was primarily a real estate mania) ended in 1989 , the Nikkei has fallen from its high of roughly 40,000 to its current level 20 years later of 9,500 for a 76% loss in value.  Real Estate in Japan has performed in a similar fashion over the same time period.   The Dow peaked out in 2007 at 14,000, just after real estate in this country rolled over in 2005, and now sits at 10,000 only 3 years later.

Screen shot 2010-07-10 at 12.13.52 PM

If we can draw a rough comparison, the Dow could potentially still lose another 6,500 points before it reaches Nikkei-like levels – bringing the final resting place of the Dow to 3,500.  Could it happen?  Well, maybe.  The primary reason for this possibility is that all manias are the same in design.  Excessive credit leads to an excessive loss of value in the productive asset markets.  And since the debt stays (it is still owed, no matter what) governments are forced to “save” the system by printing money to pay off the debts and keep the economy moving.  The result produces an even greater loss of  value for productive assets, and even more solvency issues down the road.  This is why Japan’s markets have floundered for years and why, if we don’t change our monetary policy, we can see the same fate for stocks here in the U.S..

2.  Markets Remain Mixed:  Stocks continued their rally this week (though not breaking the bearish pattern yet).  They did so primarily in anticipation that earnings in the 3rd quarter won’t be as bad as expected − even though earnings growth is likely to be the worst since the stock rally began in March 2009.  Rumors of a Fed Quantitative Easing (Part II) and a heavy short squeeze could also be to blame for the rally.  Subsequently, the tape is now beginning to write the news as well, as headlines are now back into full “recovery” mode.  Treasuries are also off, and the metals seem confused as a result, with gold holding around the 1200 level for now.

This will most likely prove temporary, as we believe the movements are predominantly technical.  The fundamentals we’ve been discussing in past commentaries are still in decline, and will ultimately have a negative impact on earnings and the general asset markets at large.  How the metals behave amid cries of “deflation” will be interesting to see. We have stated before that corrections in gold may prove soft in comparison to 2008’s slide.   The big difference is that most folks are predicting gold will fall (unlike 2008, when most thought it would rise).  The  Hulbert Gold Newsletter Sentiment Index now reads 9.2% bullish, the lowest reading since August, 2009.  That was just prior to a 20% increase in gold’s price.  Something to ponder….

Have a wonderful weekend.

David Burgess

VP Investment Management

David McAlvany

President and CEO