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Elias: Why I Divested from the Dow

By Barry Elias   |   Thursday, 06 May 2010 08:12 AM

On March 17, 2008, Bear Stearns was taken over by JPMorgan with U.S. government assistance.

That day, I divested from the market when the Dow Jones industrial average stood at 12,000 (It subsequently fell to 6,500).

When asked if I recommended selling assets when the Dow was 6,500, I said the event already occurred; therefore, do not sell.

During this period, I accumulated real assets such as gold, silver and oil, with realized average returns of more than 50 percent per annum.

This past week, I divested from the equities market when the Dow stood near 11,000, capturing a 70 percent gain over 14 months.

While there remains a potential upside during the next few months, I am satisfied to remove gains from the market and reassess the market over time.

I still hold real assets such as silver and gold; a reflection of market uncertainties (e.g., deflation, inflation).

The reason for my actions include weak market fundamentals and diminishing technical indicators (which incorporate behavioral psychology in the demand and supply functions).

The parameters that suggest weakness include low values for the following: VIX (volatility index), trading volume during a bull market, put/call ratio, and bearish sentiment (less than 20%).

Important to note are the positive corporate earning reports that may be inflated due to accounting changes (e.g., elimination of mark to market: balance sheet asset prices need not be "marked down" to reflect real market values).

Macroeconomic indicators are also not favorable to the market: inflationary expectations exist in the medium term (2 to 3 years).

Prices of equities tend to fall in inflationary environments to preserve an effective rate of return to investors.

High debt service requirements for governments across the globe suggest an upward pressure on interest rates. Higher rates translate into increased business expenditures, which tend to be reflected in higher consumer prices.

Governments have begun monetizing the debt through monetary creation (e.g., "printing" money as transfer payments). This increases pressure on transaction demand, which can be inflationary as well.

Moreover, government spending tends to be less effective than private sector spending (possibly 50 percent) in generating economic growth; this results in less income (GDP), a lower tax base, lower tax revenue, higher deficits, and greater debt (perpetuating the negative feedback system).

Monetization of debt tends to be politically desirable, since it can be performed by unelected, unaudited entities in an opaque, amorphous environment.

Another consideration is the possibility of reduced oil supplies (given recent events), which may lead to increased energy prices and consumer prices in general.

Deflation in the U.S. is unlikely: the underlying dynamics in Japan are different than those in the U.S.

Inflation can coexist with anemic global growth (Zimbabwe has hyperinflation with a severely high unemployment rate). These dynamics can result due to fixed demand for subsistence commodities (e.g., food), irrespective of income as well as unrealized economies of scale in the production process.

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On March 17, 2008, Bear Stearns was taken over by JPMorgan with U.S. government assistance. That day, I divested from the market when the Dow Jones industrial average stood at 12,000 (It subsequently fell to 6,500). When asked if I recommended selling assets when the Dow...
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2010-12-06
 

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