This Is Probably A Bear Market

This may not be the Bear Market when all is said and done, but all of the signs

that I see are pointing to it.

In the last week, we have had a historic up and a historic down day. History

tells us that that since 1985 every single one of the top 20 biggest up and

biggest down days occurred during a bear market. We had one of each this

week! (See chapter 11 of my book Buy, Hold, & SELL! for a detailed

discussion.) This could be the first time in 30 years that these big up and

down days do not occur during a bear market, but I doubt it. During that time,

we have had four bear markets, three of which were of historic proportions.

Those bears were 1987, 2000, and 2008.

All of those bears produced devastating losses and people that experienced

them will never forget them. Can you afford to experience a bear market?

Our clients are mostly over 50 and for them the answer is NO! As you know,

we hit our trigger point a week ago and have recommended to our clients that

they sell all equities. As you will see below, I believe that the risk now is too

great to take a chance.

There are two disturbing facts that point toward trouble ahead, according to

Mike Larsons August 27th MoneyandMarkets.com newsletter:

First, the amount of spare cash on the books at U.S. mutual funds just sank

to 3.2% in early August. Thats the lowest in history.

As a percentage of stock market capitalization, fund cash levels are also

hovering right around the record low set in 2000. You probably dont need me

to remind you thats when the Nasdaq topped out and subsequently crashed

by around 80%.

Second, big money investors havent just been burning through all their spare

cash to buy stocks. Theyve been borrowing gobs of money to buy even more.

As of April roughly where the broad markets peaked investors had racked

up a whopping $507.2 billion in margin debt on the New York Stock Exchange

alone. That was the highest in U.S. history, and more than two-and-a-half-

times the $182 billion outstanding when the current bull market began in

March 2009.

Take a look for yourself. Were practically off the charts compared with the

previous peaks from the dot-com and credit market bubbles:

Not familiar with margin borrowing? Then heres a quick primer: Its when you

borrow against your stock and bond portfolio to buy even more stocks, bonds,

or other assets. The amount youre allowed to borrow depends on what kind

of assets you own, and which broker you use.

The net effect is to boost your leverage. The more the market goes up, the

more money you make much more than if you just bought with spare cash.

But when markets tank, so does the value of the collateral backing your

margin loans. Brokers have built-in risk thresholds that require them to issue

margin calls if the value of your collateral goes down. When you get one, you

either have to put up more cash, or your broker will start selling your assets.

See the problem here? Falling markets force margin calls, which result in

brokers selling customer assets. That puts more selling pressure on the

markets, triggering even more margin calls and even more selling. Its a

self-fulfilling process that helps exacerbate ugly days in the market like weve

just had.

I could not have said it better myself. It is also a concerning fact that this is

exactly what happened in 1929. Record borrowing to invest in the stock

market was a precursor to a massive sell-off.

Do you wonder why the Chinese stock market has been mysteriously going

up? Where is this buying coming from? According to Bloomberg, the Chinese

government has said that they want the stock market to look good ahead of

their big military parade on September 3rd. There is much speculation that the

Chinese government is doing the buying behind the scenes so as to continue

the false impression that all is well. After all, we cant have their stock market

in freefall during that very patriotic day, can we? Would not be good for the PR

machine.

China has also been secretly selling about $40 billion of US Treasuries a

month for the last few months. Why would they do that? I believe it is because

they are in worse shape than they are saying, and they need the money.

The next global recession may be made in China.

The view that a global recession is coming from the emerging countries is

being shared by investors around the world and is reflected in the outflows of

money from those countries. They pulled $2.7 billion out of developing

economies on Aug. 24th

. That matches the Sept. 17, 2008, sell off during the

week Lehman Brothers went bankrupt. While the circumstances are different

today than they were then, we all remember what happened to global markets

during the months after that.

The counter argument is that the US economy is growing and that no

recession is on the horizon, and all of this is a tempest in a teapot. The US

will, just like it has in the past, pull the rest of the world out of recession. Or

will it?

The federal government reported two very different estimates of the U.S.

economys growth rate in the second quarter. The Gross Domestic Product

(GDP) and the Gross Domestic Income (GDI). The one that got all the media

attention was the strong GDP number that came in at an annualized rate of

3.7%. Not many people noticed that the GDI increased at an annual rate of

just 0.6 percent.

Since both measure the same thing: the size of the economy, that is a big

discrepancy. The GDI number is telling us that the US economy is barely

above recession. Which one is correct? Time will tell.

One thing is for sure, we are barely able to create the jobs that we need in this

country, let alone create the jobs for the whole planet!

1. What Caused The Big Sell-Off?

2. Beware Of A Big Up Day In The Market

3. Communication Is Our Mantra

4. You Said Dow 19K; Now You Say Sell. What Gives?

5. Estate Tip: How To Set Up A Trust For You Spouse

What does all this tell us? It tells us that our sell strategy, which has been

triggered by every bear market going back to, and including, the crash of

1929, has a lot of empirical data validating that this time is probably for real.

Certainly, this could be a false alarm. Our strategy does give us those, but it

will take time to find out.

In November of 2007, our sell trigger was hit. The market climbed from there

for two weeks and actually got close to our buy point! It then went back down

and then climbed back up again over the next two weeks. It wasnt until

January of 2008 before the market got under our original sell point. We all

know what happened next.

The whole process took over 6 weeks to play itself out. We are now only

a week in.

The 2008 bear market wiped out 12 years of gains in just 17 months. I do not

want to see that happen to anybody. It is why I write this email

I believe that avoiding large losses is the single most important thing that we

should be concerned about as investors.