The optimist will point to the fact that we are now up against the short term down trend line, and therefore a break to the upside could indicate a short term rally.

Of course, the pessimist will show you a longer term chart:

Longer term, it’s quite obvious we are in a bear market. We are well below the 50 and 200 day moving averages, and there are lots of down trend lines to break before the market can be said to be going up.

As you know, I am a pessimist, and I have yet to see any indication that things will change in the near term.

We live in a credit based economy. Since the bottom of the last depression in 1932, we have lived in a society based on credit. It all started with FDR’s New Deal, where government deficit spending was used to create jobs in periods of high unemployment. A Keynesian approach would perhaps work if governments would run deficits during recessions, but then pay off those debts completely during boom periods. Unfortunately, human nature being what it is, the surpluses in boom times are never enough to repay the recession era deficits, and we are left with permanent government debts in most, if not all, industrialized countries.

Individual consumers are no different. It is not at all unusual to meet someone heading into retirement with a mortgage on their house, or with credit card debt. We follow the government model of deficit financing for our entire lives. Now we are paying the price. The “price” is the interest we are paying on past consumption, and it is a significant drain on all of us.

Sadly, as the credit bubble implodes, we may well be facing a deflationary period. We most certainly are now in a period where prices are falling. The price of oil is down two thirds from it’s peak of a few months ago. Gold and most other commodities are also down, as the recession shrinks demand. Real estate prices are collapsing in many parts of the world.

Falling prices lead to more falling prices. If I want to sell my house I have to drop the price because there are limited buyers, which causes a further drop in prices. It’s a vicious cycle. If consumers expect prices to continue falling, they stop buying in anticipation of future price decreases. It becomes a self fulfilling prophecy.

Even worse, we are in a credit bubble, where most of us, including the government, are carrying too much debt. I can’t refinance my mortgage at the bank, because the security for my mortgage, my house, is now worth less than it was when I got the loan. The sub-prime crisis in the United States has been well documented. Less well known is the mortgage crunch happening in Canada right now. In most cities house prices are at their lowest level in over two years, so anyone who bought a house within the last two years has lost money. Even worse, some mortgage lenders are pulling out of the market. A big American mortgage lender moved into the Canadian market two years ago, and last month begin notifying customers that they will not be renewing their mortgages. These “sub prime” borrowers can’t find a mortgage lender to replace their existing mortgages, and many of them will end up losing their houses.

As prices fall and debts become more expensive to repay, the risk of default increases, and bankruptcies increase. In Canada, personal bankruptcies increased by 30% in September, 2008, as compared to September, 2007. They are only up 7% year to date, which means the number of bankruptcies filed has accelerated significantly in the last few months. That’s bad news for the economy.

And bad news for the economy is bad news for the markets.

Now, many of you may agree with everything I have just said, but you may counter with the thought that “it’s all baked in”, meaning the collapse has happened, and the worst is over.” Perhaps, but what indication do you have that the worst is over?

Do you believe that the real estate market has bottomed?

Do you think there will be no more government bailouts?

Do you believe that the automotive industry is back on track, and won’t need to restructure?

Do you believe we have avoided the credit card crunch, where banks experience massive bad debts on their credit card portfolios?

I don’t. I believe it is more likely that the real estate market is not anywhere near the bottom, that there will be more government bailouts, that at least one of the “Detroit Three” will fail, and that over the coming months banks will report massive losses on their credit card portfolios (requiring more government bailouts, of course).

Then, as the massive government spending works its way into the system, we will get to experience inflation, which will mess everything up once again.

For 2009, I am, therefore, a pessimist.

Of course, I could be wrong. I may be wrong. I hope I’m wrong. But if I am wrong, what am I missing? Where is the flaw in my logic? What is the piece of information I am not considering that will turn everything around?

Let me know on the Forum, since I would prefer not to be a pessimist.

For those interested in such matters, the October 27 bottom of around 8,145 on the Dow is the current support level, so the close at 8,497 on Friday leaves us very close to that level. If that support level doesn’t hold, I assume we will get to 7,500 very quickly.

As regular readers will know, I am a pessimist at this point in the market’s cycle. The euphoria surrounding the election of a new President lasted about 24 hours, and that occurred about 1,200 points ago.

GM will likely go bankrupt, which will take down a big segment of the economy. I realize that Congress will attempt a bailout of the automotive industry, but unless Congress can fix what’s truly wrong, I doubt it will make any difference.

(What’s wrong, in case you were wondering, is that the cost structure at the Big Three is way out of whack; automotive workers are not worth $120,000 per year, and building big cars in an age of high gas prices is stupid and short sighted, something which Congress can’t fix. Guess what car is the best selling vehicle in Canada? The Honda Civic (read why here); that tells you something, doesn’t it? Congress will take your money to support bloated and inefficient manufacturers; if they wanted to spread money around, shouldn’t it go to the efficient producers like Honda that produce vehicles people actually want to buy???? But I digress).

I’ve said it before, but I’ll say it again: here’s my guess at the future:

On Monday, the G20 will announce some kind of coordinated effort to save the world and the markets will rally, and gold will fall.

Briefly.

Briefly as in for one day, like happened right after the election.

As I said, I’m a pessimist. The G20 can’t really do anything. The government can’t create wealth. They can’t restructure broken companies. All they can do is print money, and that hasn’t worked. If printing money won’t work, what else can they do? Simple, change the money.

As you know, I am of the view that Franklin D. Roosevelt was perhaps the worst president in U.S. history, and the effects of his horrible decisions are still being felt today. His scariest decision was Executive Order #6102, that went something like this:

All U.S. citizens were given three weeks to deliver all gold coin and bullion in their possession to the Federal Reserve, or face up to ten years in prison. They were paid $20.67 per ounce of gold, which was the then official price. The Fed then set the price of gold, for the purposes of supporting the dollar, at $35 per ounce. That meant that the U.S. dollar, which was exchangeable for a set amount of gold, was immediately devalued by 41%.

Now of course it won’t be just the U.S. pulling a stunt like this; it’s more likely that the entire G20 will be in on the game.

Am I suggesting that on Monday Lame Duck President Bush will sign an Executive Order to seize everyone’s gold? No, I’m not saying that at all. He doesn’t have the stones to pull that off.

However, what’s to stop the world leaders from simply creating a bunch of new currencies, and assigning them whatever value they want? They’ve been doing it in Zimbabwe for years. You take the U.S. dollar, and create something new, say the “U.S. Note”, which is worth ten old U.S. dollars. The Euro could do the same. The amounts would be fixed, and they would stop allowing exchange rates to float. Simple.

Of course if you devalue a currency, the underlying asset values appear to go up, but that’s fine, because you can now repay your debts in less valuable dollars. Beautiful. End of debt crisis.

Of course that then really screws the savers that hold the debts, so the governments would need to throw money at them to keep them happy, so it’s not a perfect solution. But you get the idea.

Am I suggesting that the result of the G20 conference will be a new currency? No, I don’t think that will happen, but it is food for thought.

For the record, I think what will happen is what usually happens: the government will inflate their way out of this mess. If you keep printing money you have more dollars chasing the same number of goods, which causes inflation and deflates the currency. You then take that depreciated currency and use it to repay your debts. Problem solved. (Of course it kills the economy and prevents anyone from wanting to hold your dollars, but you get the idea).

I believe we are entering a pivotal week, and the results of the G20 meeting will tell us a lot about what’s to come.

Me? I’m holding on to all of my gold and gold stocks, and I’m holding on to my short plays on the market. I’m a pessimist. I think we see Dow 5,000 before we see Dow 11,000, but I hope I’m wrong. (I’m not alone in this view; check out this interview with Danielle Park on BNN this week).

In other matters, due to spam, I have put a stop to new registrations on the Forum and on this blog. Since the election is now over, I have also put a stop to overt political discussions. (Yes, yes, I know, I just spent this whole blog posting on an overt political discussion; however, it’s my blog, and the purpose of the discussion was not to bash anyone, but rather to prepare us for what’s to come so we can structure our investments accordingly). Hopefully I can re-open new registrations in the future; I’m working on ways to keep spam to a minimum

Thanks as always for reading; let’s hope my outlook is wrong, for the sake of the economy.