Let the Double Dip Begin

by JDH on June 5, 2010

Sorry, but that’s how I see it. The double dip has commenced. Yes, yes, I know, everything is great. From March, 2009 to April, 2010 the Dow was up about 70%; you can’t get a better “bull market” than that! Yes, the Dow is down 13% since then, but the talking heads will tell you that that’s just a normal correction in a new bull market.

You can interpret the price action of the last four years however you want. Yes, we obviously had a massive correction, and yes, we obviously had a recovery off the lows. (A few trillion in stimulus spending certainly helped that process). But the uptrend from the lows was broken months ago, and the Dow is once again below 10,000.

You know, 10,000, that level that was so cool when we first broke through it in March of 1999. For those of you who are math challenged, that’s more than 11 years ago. The Dow is lower today than it was more than 11 years ago. Want more charts?

It’s obvious from this one year chart of the S&P 500 that the 1025 to 1050 level is very important support. We are currently at 1098, which is only a big one day drop away from smashing through that support. Remember way back on March 27 I wrote about Gold Heading Higher, Market Heading Lower?, and I showed this chart:

The S&P 500 had peaked at around 1,561, and then dropped to around 683. A bounce back by 61.8%, which is a key Fibonacci level, would bring the market back to somewhere in the range of 1,225 to 1,230, depending on the exact data points you use. My point then was that to confirm the rally and demonstrate more conclusively that the new bull market had begun we needed a close on the S&P of around 1,230 We got close, but then that was it.

On Friday the S&P 500 closed at 1,065. I guess we don’t have to worry about key Fibonacci retracement levels any time soon. We aren’t even close.

If you like outside the box technical analysis, consider this (you can read the full article, with charts to prove the point, on the dailyfx commentary web site):

In 1929 the initial leg of the decline lasted 23 days, followed by a five day correction, then the next down leg, which lasted 12 days. The initial low was broken on the 6th day of the 3rd down leg and the decline began to accelerate considerably on the 8th day. At the crash low (12th day low), the DJIA had shed 45% of its value from the September 1929 top. The 11th day was the first “Black Monday”.

In 1987, the first leg of the decline consumed 19 days and the following correction lasted 8 days. The initial low was broken on the 6th day of the 3rd down leg and the decline began to accelerate considerably on the 8th day (I didn’t have to change that sentence at all). At the crash low, the Dow was off 38% from its August high. The second “Black Monday” was the 12th day.

Now, in 2010, the first leg of the decline consumed 21 days (as opposed to 23 and 19) and the following correction lasted 6 days (compared with 5 and 8 days). IF the Dow continues to follow the ‘crash path’, then the May low would be broken late next week (the 6th day is Friday the 11th). The decline would accelerate the following next week. 12 days for the crash leg of the decline and 40% (compared with 45% and 37%) would result in the Dow at 6755 on June 22nd. Interestingly, June 21st is a Monday.

Source: DailyFX – Dow Approaching the Cliff

Interesting. I guess we might want to keep a close eye on the market over the next few weeks.

For a more conventional view of the end of the world as we know it, all one needs to review is Friday’s employment report, or lack thereof.

431,000 new U.S. jobs were “created”, and “created” is the correct word, because 411,000 of those jobs were “created” by the government in the form of Census hirings. That means that 95% of new jobs are temporary. Only 41,000 private jobs were created, which at this stage of the “recovery” is anemic. And that’s why I don’t see this as a recovery; I see it as a “double dip”.

The average duration of unemployment is up to 34.4 weeks, from 33 weeks in April, and 46% of the unemployed have now been out of work for over half a year. So much for the talking heads who expected great things; it’s not a surprise that the markets crashed on these results.

Jobless claims tend to a leading indicator. If consumers aren’t working, consumers aren’t spending, and that negative impacts corporate sales,and profits, and eventually the stock market. It’s quite simple, really.

The government cash-for-clunkers program is over. The government’s tax credit support for the housing market is over (which explains why mortgage applications for new home purchases dropped at a 90% annual rate in May, putting us back to 1997 levels).

If you were a consumer, and you have lost your job, or you think you might lose your job, or you are working but your wages have been reduced, what would you do? If you were the average baby boomer, now about 55 years old, and thinking about retirement, with currently diminished job prospects, what would you do? The answer, if you are a rational human being, is you would reduce your consumption, and increase your savings rate. Even if you are not rational, you probably have no choice; lenders aren’t lending, so you can’t be borrowing to spend.

Savings are good, and over the medium to long term savings can be re-invested in technology and new companies, and that’s what will save the economy. We have proven that massive government stimulus isn’t the answer. Savings probably will be the answer. But not today. It takes time. Which is why I see the double dip.

How do you play it?

Continue the move to cash. I currently only have 25% of my portfolio in cash, with most of the rest in precious metals stocks. That’s not enough cash on hand, so I will be placing orders this week to sell my losers, and reduce my exposure on the winners. I’ll maintain a position, but a lesser one.

Government spending leads to inflation, but today I’m not worried about inflation. In the short term deflation is more likely. If everyone is losing their jobs and not spending, there’s no upward pressure on prices. Yet. So holding cash, today, is not a bad idea. Fortunately I’m Canadian, so my cash holdings are in Canadian dollars, which is probably more stable than the American version.

Beyond that, I still like gold, although some weakness over the summer months would not be unexpected.

Diligence is important, so increase cash, and prepare for the next wave of the double dip.

Thanks for reading; see you next week.

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