Where is the bottom?

Over the past several days I have been asked two questions over and over. Where is the bottom, and where would I invest? They are difficult questions, and I don’t have great answers.

It has taken the market 4 months to reach the lower target for the Dow Jones that I called for on November 18th 2008. Once it reached that point I expected another 500 point drop, which took a week. At this point some 55% of my predictions from last year have happened. And that is a conservative estimate.

Since that time I have spoken with many former stockbrokers, business owners, and investors. And from all these discussions, the political environment, and what I believe, I can say the following with confidence in my mind.

The Dow will flounder between 7100 and 6600 for as long as the next 9 months.
Any upside movement in the market will be temporary.
If any global political events heat up in the next 9 months, things may get far worse.
Gold and oil will run sharply first.
A major bank will fail.

Since the start of 2009, the Dow Jones Index has lost 20% of its value. This was predicated on a liberal Democrat taking office as President, a Democrat-run Congress, the addition of $800 billion (not including interest but rounding up slightly) in spending called a stimulus package, and the fact that some $350 billion of authorized bailout is pending use.

None of this is a positive for the economy. Every large investor and institution could see that. I believe that major investors took the time from October until December to pull out most assets from the market. December was a time when small investors entered the market, and some short seller closed their positions. Which led to an artificial rise in the markets, seen by small investors and some media as confidence in President Obama.

From Jan. 2nd and on (at the latest), I believe large investors have shorted the market – if not just before that time. I believe that they foresee little opportunity for an investment over the next 18 months. Bonds are worthless at these interest rates (especially if inflation grows even half as some expect). Corporations are troubled by negative growth for at least 2 more quarters, and the continuing credit squeeze. Thus stocks are inadvisable, generally.

But I do not see large shorts to close their positions yet. They are waiting for a signal from the Oval Office and Congress. IF the Obama Administration goes forward with creating a nationalized healthcare, costing tens of billions of dollars to start, and Congress goes forward with the currently whispered 2nd stimulus (of the Obama Administration), then the shorts will increase and the Dow will go far lower.

The result of continued spending is that tax rates for the “wealthy” and corporations must increase. Where else will the money come from? And wealthy is a relative term. Because as the just passed stimulus package has made clear $75,000 for singles and $150,000 of couples is the threshold. And since corporate taxes were promised to increase 10% during the Presidential campaign, that cuts the current profits. Including transaction costs and taxes, the Dow would need to go down roughly 800 more points to give a decent net profit. If the cost of the Government is increased the assurance of who will pay grows exponentially.And thus the profit needed must as well.

But a friend mentioned something interesting to me. The market is always wrong at the top and bottom. With maybe some 90% of the market negative currently, we must be near or at capitulation. Which I agree with. Except normally at the top or bottom of a market there is an obvious near or mid-term expectation. There is none now.

There is virtually no sector of the market that can be observed to have an obvious benefit under the current political plans. Nor in the current private markets. Thus there is no area for capitulation to rush forward to. Thus it will not happen.

When the markets do reach the profit point of acceptance, and close their positions, where will they invest?

It is my expectation that the safest and smartest positions to create are in oil and gold. Only in those 2 arenas are we able to see assured continuous demand. Every other sector is questionable on time and return. Especially in this political environment.

There are companies in these sectors, or related ones, like Alcoa that trade at below book value now. This is an interesting value. But expectation of near-term growth is null. Yet at some point the vital raw goods will be needed, and demand plus speculation must drive the prices higher. And as that price rises, without another sector to compete with any real assurance, there will be a run – latter to be followed by another crash in those sectors.

At the very best, I expect some sectors of the market to show better than expected numbers in the 3rd quarter. Those that took short positions and closed out long positions in mid-2008 might have the same result for the 2nd quarter, but that will be far fewer companies than in the 3rd quarter.

This is a recipe for very flat to downward trends in the market.

Still there is hope. But it takes a lot of patience, building of positions in small steps, and no expectation of a reward (ie a return of 15 – 25%) for 18 to 30 months from now.

There is my answer. Take it as you will.