We bought equities on July 21st, and have remained long of equities… basic, dividend paying, old-guard, boring companies that produce steel, or copper, or ball bearings, or girders, and if they do not make them, they move them; the things that if you drop them on your foot will hurt as we like to say…until only just recently, having taken to the sidelines on Friday – Dennis Gartman For a Trial Subscription go to The Gartman Letter)

The Dawes Premonition

–When a blind mathematician exits the market because an ominous technical omen indicates a crash ahead, what do you make of it?

–Last week the whole internet was abuzz with the phrase “The Hindenburg Omen.” The “Omen” is actually a convergence of technical and momentum indicators which, when sighted, usually leads to a big market correction. Its creator Jim Miekka has used it to forecast major market tipping points. And this week, Miekka told the Wall Street Journal he had heeded the warning and was out of the market completely.

–Miekka is right that September is historically a lousy month for stocks. Just why this has been the case is disputable. Is it well-rested and tanned North Atlantic fund managers getting back behind the desk and putting their brain in a psychologically defensive mode as the autumn and the winter approach? Is it cyclical? Is it random? Is it aliens?

–Add to the Hindenburg Omen the “Dawes Premonition.” Writing over in Money Morning today, Dawes (the editor of Slipstream Trader) concludes:

The weekly charts show a market that has crashed between 2007-2009 and then turned and rallied to the 50% Fibonacci level of 5000 over 2009-April 2010.

If the market does crack under this 4,400 level then I wouldn’t be surprised to see the market swan dive to 3,900 in a matter of weeks.

–What about days? Today’s opening hasn’t been so flash. And with the news on the political scene getting increasingly bizarre – a unity government with Tony Abbot as Prime Minister and Kevin Rudd as a front-bencher and Foreign Minister – investors might start to get a bit nervous about what the political class is up to.

–Our suspicion is that it is better to have the political class bickering like children with one another than cooperating toward some common goal. That common goal – defined by them and not you – will probably include spending more of your money, raising taxes, and improving the planet in some undefined and unproven but costly way. We’d rather have them at each other’s throats than clutching for ours in tandem.

–At least Australia is not America, financially speaking. That economy appears to be circling the great historical drain. Economists told Bloomberg they expect existing home sales to have fallen by 12.9% from June. This shows that the recession in America never really ended. It just got papered over by asset inflation driven by Fed policy and government stimulus that lulled people into somnambulant complacency.

–Yet it’s clear that ordering extra gravy on your fries will not make you thin. For example, the arguments implying that stimulus spending “saved” Australia from the recession persist and are taken as a gospel truth by most in the media. But even if they are technically true – in the sense that you define recession as two consecutive quarters of a contracting economy – what has really been engineered?

–A recession is the natural way of correcting bad investments made at the end of the business cycle or a credit boom. Those bad investments are failed businesses or mis-allocations of credit that didn’t produce jobs, income, or a net economic benefit. Or sometimes people just don’t’ want to eat at Barnacle Bill’s.

–Preferences change with time. And time changes with time. The market economy – a complex adaptive system – sorts the wheat from the chaff and generally delivers consumers more choice and lower prices. When credit excesses emerge, the recession wipes away the slate and puts the economy and the job market back on a sound economic footing where real growth based on real demand from real savings can begin again.

–Maybe Barnacle Bill’s will make a comeback. Or the next big thing will be Mexican food. Or organic salads made from produce grown on sustainable farms. It will be something, but only if you allow recessions to do their work.

–Not that we’re arguing in praise of recessions, although maybe we should. But preventing them is a wilful denial that any bad investments were made in the previous boom. It’s like saying you don’t need to burn calories to lose weight. You just need to eat more and let fitness come to naturally, while you gorge on Tim Tams on your couch and watch Master Chef.

–To deny the necessity of a correction to bad investments and misallocated capital is to deceive people into behaving as if everything were fine. Instead of saving and building up the household balance sheet, people take on more credit and spend.

–This, in fact, is what “avoiding the recession” accomplished in Australia. It encouraged Australians to believe the world is not as financially dangerous place as it actually is and to continue with behaviour (taking on mortgage debt) which makes them even more vulnerable to the next credit shock. That is not “saving” anyone. That’s leading them straight into the waiting room of the next financial slaughterhouse.

–It would be nice if eating chocolate didn’t make your ass big. But it does. Each financial decision has consequences to. A government stimulus program is an attempt to avoid the consequences and costs for financial behaviour by passing them on to someone else. It feels good doing it because you’re avoiding pain and rewarding yourself by borrowing money someone else must repay.

–That might feel good, but it doesn’t seem very ethical. But postponing an inevitable day of reckoning by deceiving people about the real state of things might be the sort of thing Big Brother or the Nanny State prefers to do. It’s easier to spend what’s not yours. And it makes people more complacent and dependent, when their financial lives are destroyed, on the government. But perhaps that was/is part of the plan, too.

–In any event, nothing much has changed overnight in on our beautiful blue planet with its brittle and complex financial system. Bond yields remain at historic lows in one of the great ironic developments of the last fifty years (as investors confuse government bonds with safe financial ground). A great deal of confusion about corporate earnings is now making the picture for equities very murky. And the Federal Reserve has quietly begun monetising U.S. debt.

–Our view is that mild deflation will simply be the prelude to a defacto debt default/devaluation in the U.S. This event will be massively inflationary and lead to much higher global interest rates, much lower asset prices, and a premium bid on tangible assets. Speaking of which, it’s time for lunch. Brownies anyone? Until tomorrow!

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Dan Denning:   Dan Denning is the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.