Hi, this is Jennifer from the Discount Silver Club. I hope everyone in the Northeast survived the blizzard without too many problems! I want to thank our newest members, M.J. from Massachusetts, D.S. from N. Carolina, and N.S. from California.
Will 2005 Be a Good Year for Stocks?
You may have heard the statistic that the fifth year of a decade has been a good year for the stock market for over a century. However, other traders believe the adage that a poor January signals a bad year for the market. This has been true 19 out of 20 negative Januarys since 1950. So which prediction is likely to be true, and why?
To determine what the stock market is likely to do, you have to understand where the economy is in the business cycle. After the crash of 2000, the Federal Reserve predictably lowered the discount rate. This liberalization of credit usually causes a boom in the economy, during the early expansion phase of the cycle. Tax credits and further rate cuts to 1% were attempted to stimulate the economy in the late expansion phase. However, these remedies seem to have yielded a disappointing recovery. The job market is still shaky, the dollar has dropped 30%, stocks are still below their year 2000 highs, and the U.S. trade and budget deficits have hit record levels. (For a good chart of this cycle, see http://www.financialsense.com/Market/puplava/2005/0124.html).
As we reach the business cycle peak, Alan Greenspan has declared the economy healthy enough to withstand credit tightening. The Federal Reserve has already raised the discount rate 6 times in the past year, in order to slow the rate of price inflation. Since 1950, this rate raising cycle has inevitably triggered a recession. CNN/Money journalist Alexandra Twin describes this cycle well. She wrote, "Stocks have risen for two years as the economy recovered from the last recession. Now corporate earnings growth is set to slow, making stock valuations lofty; economic growth is also expected to slow down, and at the same time interest rates are set to keep rising."
Another sign of the economy weakening is the recent rash of mergers in the news. For example, SBC bought AT&T, and Proctor & Gamble acquired Gillette in the last month. This may help the stock market in the short term as speculative capital flows into the "hot" equities. Unfortunately, mergers lead to job losses as companies consolidate and attempt to cut costs. Recession eventually follows, as merging corporations don't buy new equipment, and unemployed workers can't afford expensive purchases.
Although a typical business cycle averages 4 years, secular bull markets can be much longer. As Jim Rogers points out, the commodity bull markets of the twentieth century averaged 17 years apiece. They occur because stockpiles are low from the previous bear market. Companies couldn't afford to maintain necessary infrastructure because investors were chasing profits in paper assets, not buying commodity stocks. Rogers launched his own Raw Materials Fund in 1998 to capitalize on this trend, and his fund has increased 185% to date. Barry Bannister, ananalyst for Legg Mason Wood Walker, reinforces Rogers view on the markets. His research shows that commodities and equities have trended in opposite directions during the past 130 years.
If you find it unbelievable that the stock market could perform poorly for over a decade, then you were probably too young to remember the 1970s. In February of 1966, the Dow reached 995, a level that seems amazingly low today. So when did it cross 1000? Later that month? No, the Dow didn't reach that milestone until November of 1972, over 6 years later. A new leg of the bear market started in January of 1973, seemingly mirroring the scandals and Middle East instability during the second Nixon Administration. Even the elite stocks of the time, the "Nifty Fifty," suffered brutally. The Dow bottomed in December of 1974 at 577. It didn't cross 1100 until 1983 - 17 years after the start of the secular bear market!
Now that we know our economy is peaking and heading toward a recession in the next year, how should you invest? In this environment, commodities and the stocks of companies who produce them will prosper. According to a study by professors Gary Gorton of Wharton and K. Geert Rouwenhorst of Yale, energy, industrial materials including silver, base metals, and food equities performed outstandingly during the transition to a recession. Marc Faber notes that commodities also appreciate during wartime, and it seems that the U.S will maintain a military presence in Afghanistan and Iraq for some time.
Due to government intervention, and inflation of the money supply, I think it's likely that the stock market will establish a long trading range similar to the 1966-1982 bear market. Steep drops will be followed by bear rallies. However, some stocks will appreciate even as the general market struggles. Undervalued energy and precious metals equities should skyrocket over the next few years, as investors become disillusioned with mainstream stocks.
However, Jim Rogers' research indicates that commodities outperformed their associated stocks by 300% during the last bull market. Although you might be lucky and buy shares which appreciate over 1000%, many exploration firms will go bankrupt when they fail to find mineable resources. You could hold futures contracts instead of equities, as Rogers suggests in his new book, "Hot Commodities." However, silver investors have a simpler solution. Instead of worrying about the short term fluctuations on the COMEX, you can simply buy and hold. Accumulate small amounts regularly, and save some cash to stock up on price dips. You can even sell some silver on price spikes to realize your gains, and use the money for household expenses. Be careful not to sell all your metal prematurely, though. This bull market still has a long way to go.