Sunday Musings: Short-Term Correction, Long-Term Disaster?

Some have readers have pointed to Paul Farrell’s recent story titled “Obama’s ‘predictably irrational’ economic policies.” In case you missed it, here are some highlights:

First: Kiss the rally good-bye, says Jeremy Grantham, legendary CEO of the $101 billion GMO money-management firm.

Why? The market is overvalued 25%. A minimum 15% correction is coming in 2010, putting the Dow in the 8,000-9,000 range. The S&P; 500? Not at 666 like last spring; maybe 800. Why a top? Black Friday? Dubai? Tiger Woods? All the dark films? The “2012” end of civilization? The post-apocalyptic “The Road?” Stop guessing, timing market turns is irrational.

Grantham’s shift from bull to bear appears rational. Remember, earlier this year the Dow was near 6,000, banks near bankrupt, and we were praying for the new untested president to change America. In his latest editorial Grantham reminds us why his prediction made sense in the spring: “Regardless of the fundamentals, there would be a sharp rally. After a very large decline and a period of somewhat blind panic, it is simply the nature of the beast.” Get it? A rally was predictable, based on the history of cycles.

Trust Grantham? 100%. Back in early 2007, he warned: “The First Truly Global Bubble: From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; it’s bubble time. … Everyone, everywhere is reinforcing one another. … The bursting of the bubble will be across all countries and all assets … no similar global event has occurred before.”

Grantham was one of a small group of industry leaders who saw a crash coming as early as 2000. But political leaders were ideologically blind: Fed Czar Ben Bernanke said the collapsing markets were “contained.” Our devious Treasury Czar Henry Paulson was misleading Fortune and all America: “This is far and away the strongest global economy I’ve seen in my business lifetime.” Worse, former Fed Czar Alan Greenspan was busy writing his memoirs bragging about how he invented a “New World” out of Reaganomics, Ayn Rand’s New Age wishful-thinking and an unregulated $670 trillion derivatives market.

Three clueless leaders.

Grantham bearish, short-term correction, long-term disaster

Now Grantham’s warning us again: America’s irrational nightmare will repeat. First, the short-term correction, 15% to 25%. But then long-term, a deadly warning: Disaster ahead. Why? Because America has “learned nothing,” we are “condemning ourselves to another serious financial crisis in the not too-distant future.”

Yes, Americans are predictably irrational, doomed to repeat history: Grantham points us to a key chart, his “favorite example of a last hurrah after the first leg of the 1929 crash.” The similarity between 1929-30 and today are obvious: “After the sharp decline in the fall of 1929, the S&P; 500 rallied 46% from its low in November to the rally high of April 12, 1930, then, of course, fell by over 80%.”

Familiar? You bet. We’ve had our rally. Next, the plunge. Our irrationality plus history guarantees another … only bigger.

A year ago America came dangerously close to the Great Depression 2. We “learned nothing.” When psychologist Daniel Kahneman won the 2002 Nobel Prize in Economic Science for his work on irrationality in 2002, the sense was that behavioral economics would help Main Street become “less irrational,” that behavioral sciences would make us all better investors, better consumers, better citizens.

[Emphasis added]

From my point of view, Jeremy Grantham is right on with his observations. I have in the past pointed to charts by Dough Short showing some of the similarities of past bear markets and bear market rallies leading to similar conclusions.

However, while forecasts such as Grantham’s may have merit, they are a terrible timing indicator. This is where trend tracking can come to the rescue by getting you out of equities and to the sidelines before real damage occurs.

I have found over the past 20 some years that long-term trends don’t change all of a sudden. There is what you could call a “leading up to” period, where the markets pull off their recent highs, rally again and slowly move into retreat mode, which eventually accelerates to the downside.

If you work with sell stops, you have plenty of time to get out of harm’s way. Articles such as the above should not prompt you to exit the market right now because you can never be sure if there is more upside potential.

Let the trend runs its course until the end when it bends and triggers your stop loss points. That is your best indication that a reversal maybe in the making with the added benefit that it totally eliminates emotional decision making and guesswork on your part.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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