US Heading For Recession, Dow Theory Stocks Sell Signal and Flight to T-Bonds Continues

By: Anthony_Cherniawski

Last week I missed a possible headline grabber. On November 15 the Federal Reserve had lent $47.25 billion to fellow bankers, in what may be the largest single day loan to member banks in its history. Folks, the problem isn't going away. On November 2, I reported that the Fed had lent $41 billion, which was the largest daily sum since 9-11.

Bank Reckoning Day came and went with no fanfare.

One of the items that missed the press' radar was the passage of FASB rule 157 . This new set of rules was meant to get banks to fully disclose the inherent risks of various assets that they own. Which means that questionable assets must be " carried at fair value on a recurring basis in financial statements. " Unfortunately, at the last minute, a deferral was allowed for certain non-financial assets for another year. What is meant by that phrase is still in question, but it appears that full implementation of FASB 157 is being delayed because bank balance sheets are not strong enough to withstand the added pressure of “fessing up” to the full extent of their problems. You can assume that the problems will slowly leak out over the next twelve months until Judgement Day finally arrives on November 15, 2008 .

Does our country need a recession?

Back in August, The Economist took a hard look at the then emerging subprime/credit crisis: "The policy dilemma facing the Fed may not be a choice of recession or no recession. It may be between a mild recession now, and a nastier one later." The job of an economist is truly dismal.

Why are economists talking about a recession ? Because the economy cannot only go up. There is an ebb and flow in the economy, called the business cycle, which allows weaker businesses to phase out while freeing resources for newer and stronger businesses. By not allowing the business cycle to do its job, malinvestment takes place, where precious resources are wasted on businesses that cannot adapt to the new environment. Please read the attached article. While I personally don't agree with all of the seventeen reasons why America actually needs a recession, I do agree that any form of tinkering with the economy leads to unintended consequences.

Dow Theory is official, “Sell signal has arrived.”

Two weeks ago I commented that a famous Dow Theorist, Richard Russell was getting very nervous about the markets. Today he had reason for his jitters. The Dow Jones Industrials closed below its mid-August closing lows of 12845, officially putting our domestic markets on a confirmed sell signal. Folks, this is not happy news for many, but being forewarned is forearmed.

Bonds are taking the news in stride. 

While investors are questioning the quality and risk exposure in other bond markets, U.S. Treasuries are still the bond of choice. Treasury bond yields have dropped to levels not seen in over three years as investors are piling on to what is perceived as the only safe haven. The market is getting considerably overbought, but as long as stocks persist in their decline, bonds will likely be viewed with investor favor.

Gold is losing its luster.

Gold briefly rose above $800 per ounce, but fell back below that marker. Gold has investor appeal as a hedge against inflation, but it can be overdone. Once a rally has run its course, it has also lost its safe haven appeal as well. Staunch supporters of gold will often simply dollar-cost-average their investment in gold during good times and bad, but this is not a cure-all for an extended downturn. The chart suggests more selling to come.

Take a Minsky Moment, will you?

(WSJ, August 18, 2007 ) “ Hyman Minsky , who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.” Mr. Minsky, your moment has arrived.

Happy Thanksgiving!

Due to the long holiday weekend, I am sending your newsletter early. I hope you have a happy and Blessed Thanksgiving with all of your families!

We're on the air every Friday.

Tim Wood of www.cyclesman.com , John Grant and I have had a running commentary on the markets again this week. You may listen to our comments by clicking here .

Please make an appointment to discuss our investment strategies by calling Claire or Tony at (517) 699-1554, ext 10 or 11. Or e-mail us at tpi@thepracticalinvestor.com .

Regards,

Anthony M. Cherniawski,
President and CIO
http://www.thepracticalinvestor.com

As a State Registered Investment Advisor, The Practical Investor (TPI) manages private client investment portfolios using a proprietary investment strategy created by Chief Investment Officer Tony Cherniawski. Throughout 2000-01, when many investors felt the pain of double digit market losses, TPI successfully navigated the choppy investment waters, creating a profit for our private investment clients. With a focus on preserving assets and capitalizing on opportunities, TPI clients benefited greatly from the TPI strategies, allowing them to stay on track with their life goals

Disclaimer: The content in this article is written for educational and informational purposes only.  There is no offer or recommendation to buy or sell any security and no information contained here should be interpreted or construed as investment advice. Do you own due diligence as the information in this article is the opinion of Anthony M. Cherniawski and subject to change without notice.

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