Here we go again!
Even the most cursory examination of any commodity, currency or equity market makes it very clear that prices seldom go straight up or straight down, and yet most financial analysis ignores this simple and undeniable fact. Worse, financial journalists have shorter memories than their front-page colleagues - it seems only sports reporters have any interest in what happened five years ago, much less 50.
In early 2000, tech stocks were a sure thing. I knew many people who had never invested in the stock market before and were taking flyers they could not afford - up to 80 percent of their savings - on profitless companies and stocks with price-earning ratios of 100 or more. This behavior is characteristic of a mania, and indeed, the enthusiastic involvement of investment rookies is an inevitable sign of a market in its final stage.
When the Federal Reserve slashed interest rates to prevent the economy from absorbing the full impact of the March 2000 to October 2002 equity meltdown, the hot money was given an incentive to move from the stock market to the real-estate market. A 40 percent reduction in mortgage rates since 2000 has resulted in a 34 percent increase in the number of new houses sold annually, and I have read that 36 percent of all residential home sales in 2004 were not primary residences, but were intended as investment or vacation properties. Nationwide, home prices have increased 50 percent in the last five years.
I find it an ominous sign to hear real-estate agents now echoing the same assertions of a "new economy" that stockbrokers and financial market cheerleaders were making in 1999. But their self-interested arguments in favor of a permanent real-estate bull are nonsensical, as market movements demonstrably driven by low-interest debt financing are not going to be supported in the long term by a limited housing supply. People in Japan need housing every bit as badly as Americans, their residential property stock is much smaller and yet these factors have not prevented their residential real-estate prices from declining more than 40 percent in 14 years.
As a wise financial sage once said, the trick to making money is determining which argument is based on false assumptions and betting against it. While the newcomers to the real-estate market will almost surely get burned in the same way their stock-market counterparts were five years ago, the real-estate permabull is only one of the more significant false assumptions currently operative.
Less noticeable to most, but perhaps equally important is one at work in the currency markets. I, too, have been guilty of subscribing to it in the past, assuming that because it is worthless paper debt being created at historically high rates on a daily basis, the dollar is doomed to fall inexorably over the next few years, thus driving up the price of commodities such as oil and gold. The fact that this perspective worked very well for the last five years, plus the comments of Fed governor Ben Bernanke, widely considered a possible successor to Alan Greenspan, about how the digital printing press is powerful enough to overcome any potential price deflation, only made the long-term hyperinflation scenario look more credible.
But I was forced to recall my 2004 interview with Robert Prechter, who has been insisting that the dollar will rise into the 94-99 range since it was down around 80, (it's now at 86.10), after receiving the following spam a few months ago:
The U.S. dollar has fallen to an all-time low against the euro. The euro hit a new high of U.S. $1.3646, exceeding the record U.S. $1.3643 set in European trading. Now is the time for you to take advantage of the opportunities the Euro has to offer.
The subsequent 6 percent fall in the euro against the dollar suggests we should consider adding a spam corollary to the contrarian magazine cover theory, which states that the appearance of an investment trend on the cover of a mainstream magazine is a strong indication that the trend is at an end.
In closing, I leave you with the words of a man who has forgotten far more about investing than I will ever know, Richard Russell:
"Look, we don't have to get into the theory of why deflation can or cannot occur. I go by what I see in the markets and in chart action. The fact is that the stock market has been deflating all year. Now the stock market has been joined by oil, commodity prices, copper, steel, aluminum, gold, Goldman Sachs Natural Resources Index, materials in general ...
"All debt must be paid off, some debt paid off in a hurry and some paid off over time. But you pay off debt with dollars, and if there's too much debt outstanding and there's pressure to pay off that debt - that's going to create a demand for dollars. The greater the debt, the greater the potential demand for dollars to pay off that debt."