We’ve had almost four years of relative calm in the financial markets. Corporate earnings have rebounded from the depths of the 2000 — 2001 stock market collapse. There have been no terror attacks on U.S. soil. Interest rates have remained artificially low.
But now, even as foreign economies are gaining in strength, the U.S. economy’s second-breath — as I call it — is ending. Coming next — a series of shocks in the Dow Jones Industrials that could catch investors with their pants down.
I’ll give you some steps to take in a moment. First, let’s start with what I see for the Dow …
Dissonance in the Dow Does
Not Bode Well for 2007
Take a look at the Dow Jones Industrials index (bottom of the chart) vs. the Dow Jones Transportation index. Notice that the Dow marched to record highs at the end of 2006, while the Dow Transports turned lower.
This is called a “Dow Theory non-confirmation,” and it’s especially bearish for most U.S. industrial stocks. Historically, some 80% of Dow Theory non-confirmations have ended in disasters, with the Dow indices losing as much as 40% of their value. The same is possible this time around.
What could set this off? One possibility is a crash in the dollar, which is already starting. A plunge in the dollar could force overseas investors to yank their money out of the U.S., setting off a row of financial crises:
- Banking, already starting to hurt from falling property values and rising mortgage delinquencies and defaults, will get killed.
- Currency markets could enter a period of extreme volatility, setting off disasters in the highly leveraged hedge fund industry.
- Big U.S. companies already in deep financial doo-doo (think Ford, GM, Delta) could go bust.
I’m seeing subtle but important confirmations that these forecasts are going to be right. For example …
Investors Are the Most Complacent
They’ve Been in 12 Years!
Crises rarely hit when investors expect them. Instead, they show up when investors are complacent. And that’s exactly what we have right now.
Look at my chart of the Volatility Index, or VIX. This index effectively measures investor complacency.
When the line in this chart is declining toward the bottom, it means investors have no fear. They think everything is hunky-dory, so they buy stocks with almost reckless abandon.
Right now, the VIX Index is at 12-year lows. It’s lower than it was before the 1997-1998 financial crisis … lower than it was before the Long Term Capital Management collapse in 1998 (which almost took down the entire U.S. banking system) … lower than it was at the peak of the greatest stock bull market in history.
This is extreme complacency — the kind that crises love to feed on. It’s how the stock market peels money away from unwary investors. And it’s how smart, savvy investors pile up wads of profits.
I expect the Dow to tank, and transport stocks to get killed. At the same time, I expect key sectors — especially those driven by the boom in Asia and the rise in natural resources — to soar.
Remember, the U.S. is no longer primarily a manufacturing country. And many of our service industries have been outsourced, too. For instance, tech support and IT services have gone to India.
What this means: When the dollar falls, we do not gain a competitive edge. Instead, everything we’ve outsourced gets more expensive. Hardly anyone is talking about this. But the weaker dollar is not going to rescue American industry.
Here are the other consequences I see:
- Inflation will accelerate higher … much higher.
- China and India will gain greater influence over the global economy.
- Gold — now trading at nearly $645 an ounce — will head to new record highs, well above $740 an ounce.
- Oil will hit $100 per barrel. In the malaise of the poor economic environment that will emerge in 2007, the crises with Iraq, Iran, North Korea, and terrorism will all sadly get worse.
Prepare Your Portfolio:
Consider Taking These Steps Now!
First, minimize your exposure to the Dow. In my opinion, this is the perfect time to get out. You won’t have to pay taxes on your capital gains for the next 15 months. More importantly, I think we’re very near the Dow’s peak, and I believe the risk of staying in far outweighs the potential rewards.
Second, get out of long-term bonds. A tanking dollar virtually guarantees that the bond markets are going to get hit across the back of the head with a baseball bat.
Third, don’t buy any real estate right now. Later this year, when the dust from the dollar’s plunge starts to settle, you may see a major bottom in real estate prices. And you’ll see foreign investors — especially wealthy Asians — come rushing back into the U.S. to buy properties on the cheap with their stronger currencies. But until then, residential real estate prices could easily fall another 20%.
Fourth, most of your keep-safe money should be in liquid, short-term investments such as money markets.
Fifth, don’t ignore gold! In my view, the best way to get a stake in gold is through the streetTRACKS Gold Fund (GLD). Each share represents 1/10 of an ounce of gold. The fund eliminates storage and shipping worries because the gold is held in trust for you.
Or, check out my Real Wealth Report’s two favorite gold mutual funds, DWS Gold and Precious Metal (SCGDX) and Tocqueville Gold (TGLDX). Also consider the Market Vectors Gold Miners ETF (AMEX: GDX). This single investment holds ten of the largest gold miners in the world.
Stay safe and cautious,
Larry
About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Amber Dakar, Wendy Montes de Oca, Kristen Adams, Jennifer Moran, Red Morgan, and Julie Trudeau.
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