What's Happening In Europe Right Now Is A Preview Of What Could Happen Here

Flying is the time we give up the most control over our lives. 

I can understand why people are afraid to fly. 

You have no control over what happens to you up there. 

All you can do is trust that the pilot knows what he is doing and has a plan to safely reach your destination. 

Make no mistake, we are living in unique and very difficult times. 

Europe is on the verge of a collapse, the US can’t get its fiscal house in order and the stock market is bouncing around wildly.  All of this “turbulence” can be downright scary for some people. 

Only those that can keep their wits about them can hope to succeed by trusting their “pilot.”

This report will put the current market into context and serve as a reality check on some of the current flawed strategies.

It should also reinforce some of the sound strategies that can put an investors mind at ease. This should allow him to trust that his Financial “pilot” should be able to navigate through the “turbulence.”

The Current Market In Context

Short Term Volatility
Recent stock market volatility is up significantly.  The chart to the right shows that it has not only increased significantly, it has become unpredictably random. 

Huge down days are followed by huge up days, which are followed by huge declines. 

It is almost impossible to put together any short term trades with a reasonable assurance of a short term trend in either direction.   

We believe the market moves are based on external influences. 

The European fiscal drama is one of the key influences.  On the days Europe looks like it is cobbling together a bailout deal for Greece (and several others) the markets explode upward.  On the days the deal looks like it will fall apart, the markets collapse.

The American Fiscal problems (the Budget Deficit Reduction) will take centre stage in November, so we don’t expect volatility to calm down any time soon.  

Sell Signal
Over the past 15 years, the market has given 3 clear sell signals. 

One was in late 2000, the other was in late 2007, and the last is happening right now. 

The chart below shows the S&P 500 since 1997. Below it is the MACD chart. This is the Moving Average Convergence Divergence chart.  It measures the fast and slow moving averages (MA) and looks for where they cross over. 

When the fast (black line) crosses below the slow (red line) it is interpreted by technical analysis as a sell signal.  When the black crosses above the red, it is a buy signal.  

There were minor cross-overs from 1997 – 2000 and 2005 – 2007.  These were false signals because of the angle at which the crosses happened.  The reason 2000 was a sell signal was because of the black line’s steep angle of decline. 

The same can be said of 2007, the black line had a steep angle of decline.  Today, the black line again has a steep angle.  It is a sell signal, if history is any guide, but does not guarantee that the market will go lower.  A sharp rally here would negate the signal.  

What do we know?
At times like these there are two things we know for certain.

The first is that nobody knows exactly how things are going to play out.  Anyone that says they have it figured out is full of baloney. 

There are too many variables and players with their own interests. But there are a range of possible knowable outcomes for Europe and America’s particular Fiscal Crises.  

That leads to the second certainty – We know what we know.  This is not as cute as it sounds.  Many investors (and politicians) are willing to ignore the facts of the current Fiscal Crisis.  We know how difficult (impossible) it will be to significantly cut the Federal Budget Deficit (without negatively impacting the economy). 

We know what the Federal Reserve’s Strategies are for handling the Fiscal Crisis, for handling the slowing economy, for handling the real estate collapse, for handling the banking crisis and for helping our canary in the coal mine – Europe.  (Europe is the Canary because America’s Fiscal Crisis is as bad, if not worse than many countries in Europe.  What is happening there is a preview of what could happen here.)  

We know, for instance, that the Fed’s policy is to print dollars for whatever ails the economy.  They do this when the economy slows. They do this when banks have problems. They do this to support the real estate market. 

They print Dollars by buying bonds in the open market and by adding reserves to the banking system.  Creating Dollars from thin air is inflationary because it devalues each Dollar already in circulation. 

So far, the Fed has injected about $1.6 trillion into the banking system and have bought over $1.5 trillion in treasury bonds and mortgages according to Fed data.  Another $400 billion Treasuries will be bought in Operation Twist.  

We know that the Congress will come up with some kind of plan to reduce unemployment and to stimulate the economy.  Neither of these objectives will be accomplished without some amount of money going into the economy. 

Whatever that amount is, it will be more than we can afford and will probably add to the national debt, making deficit reduction even harder.  Excuse us, Mr. Federal Reserve Chairman, it looks like the Congress is going to need your Dollar printing press for a while.

Europe’s problems will cause the European Central Bank and the IMF to lend more to troubled countries and inject stimulus money into the European economy. 

rumours have it that they are planning for an additional $1 trillion in debt and stimulus.  Printing euros is no less inflationary than printing dollars, so expect the developed world to have to deal with inflation for some time to come. 

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