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THE OTHER TWIN TOWERS - Dan Denning, DR

THE OTHER TWIN TOWERS - Dan Denning, DR

Jul 14, 2003


The Shocking Case for Another Depression

Remember how you felt the day the World Trade Center came down?

Remember the sick feeling in the pit of your stomach... the grief... the rage... the fear of where they would strike next?

Well, there's another set of twin towers -- you can see them for yourself in the chart above. And this time, you're in the towers.

Think of how you'll feel if you lose your job. Maybe even your house.

Think of how you'll feel if your stocks go down another 70%. What life will be like if your bank says you can't access your accounts -- you'll have to wait until the government sorts everything out and decides how much you get.

Thousands of banks closed during the Great Depression. On a smaller scale it even happened in the early 1990s.

There's a lot of yada-yada these days about a double-dip recession, a possible depression, or even a powerful recovery with a 40% jump in stocks. Who needs another opinion? I don't. I prefer facts.

So let's look at the facts. The chart shows every penny Americans owe.

It's expressed as a percentage of Gross Domestic Product (GDP) -- the total of everything we produce in a year. At the end of 2002, we owed $31 trillion -- that's "T" as in "Trillion" -- which is about three times our GDP of $10.5 trillion.

The only time things were this bad was during the Great Depression of the 1930s.

What's your share of the debt? About $110,000.

How about a family of four's share? About $440,000.

Of course, those are the averages. Maybe you're rich and it doesn't sound like a lot. But half the families in America make less than $42,000 a year, so trust me, $440,000 is a lot. You may be in great shape yourself...for now...but your stocks, your home value, and your source of income are not secure if the nation goes bust.

From the chart you can see that for the whole period from 1940 to 1980 things were under control, more or less. Not any more. We're piling it on, and the only time it's happened before was the Great Depression.

As you can see, the debt has been going practically straight up since 1980.

If you just project the trend, the debt will go to $40 trillion or even $50 trillion really fast. In reality, that's not going to happen. It can't. We will go broke before it does. We won't even be able to pay the interest, much less the principal, and nobody will lend to us anymore.

Look at the chart and study the first tower, the one from the Depression.

The debt came down, and pretty darn fast. It didn't get paid; it got written off. The lenders lost nearly all that money. Bank accounts got wiped out, stocks went nearly to zero, real estate values plunged.

We Predict the Worst Is Yet to Come

As I write this, the Dow is off more than 29% from the all-time high it hit over three years ago. The number one question on every investor's mind is whether we've seen the bottom and recovery is on the way, or whether we're going to see the second dip in a double-dip recession.

They're asking the wrong question.

The right question is whether there has been a fundamental change in the long-term trend. The right question is whether this is an average bear market or a historical turning point.

We say it's a major turning point. If we are right, most American stocks will fare poorly for a long time to come. That is true even if there is a rally right now that takes us almost back to the highs. In fact, we expect big rallies. We'll even play some of them. But they don't change our basic stance one bit.

More important: If we're right, your livelihood and everything you own is at risk. Even your personal safety -- and that of your loved ones -- is at risk since a major economic catastrophe may result in civil disorders.

How Can We Say This?

We can say the bottom will be so incredibly low because the highs were so incredibly high. You see, we study the past, and we've observed an empirical fact. The losses that follow the bubble almost exactly match the gains made during the boom. Economics isn't an exact science, but this comes close to being a law. The higher the markets go, the lower they fall.

How Low Can the Dow Go?

The average bear market in the last century has given back over five years of gains from its highest point. If the present bear market is an average bear market, the S&P 500 will decline to around its 1995 level -- about 450. That would translate into 4,000 on the Dow Jones Industrial Average.

That would be an additional 50% drop from its level as I write this.

Now, I don't go overboard with technical analysis, as this sort of thing is called. If investing was as easy as just applying mechanical rules like this, we could all hang out at the beach while our computers made us rich.

Right now, technical analysis gives us a prediction of 450 on the S&P 500 and 4,000 on the Dow if this is an average bear market. But...

You'll Wish It Was an Average Bear Market

The problem is this is not shaping up as an "average bear market," but as something far more serious. First off, the 1982 - 2000 bull market wasn't an average bull market but the longest bull market in U.S. history.

Second, its incredible rise was driven by a colossal debt expansion. The debt-to-GDP ratio is far larger than ever before in the history of the United States. (See the chart at the beginning of this report.) Worse yet, we get less and less bang for all those borrowed bucks. During the 1990s boom, each 4.8 dollars of debt bought us only one dollar of increase in GDP.

What's more, the boom-time stock valuations were far higher than ever before. At its peak, the Nasdaq sold for 180 times its earnings. People were paying in advance for 180 years of earnings! Even though stock prices have come way down, P/Es have remained stubbornly high because earnings have fallen right along with prices.

So what can we expect?

Following the 1929 peak, the market gave back 15.5 years of previous gains. The brief 1970 bear market gave back seven years of previous gains, and the severe 1973 - 74 bear market gave back eight years. If you look at the charts for Japanese stocks and gold, you can see similar "retracements," as technicians like to call them.

At Strategic Investment, we believe the current situation is closer to that of 1929 than to the average post-WWII bear market. But let's be as optimistic as we can. You should expect the S&P to give back a minimum of the average bear market -- that is, a decline to the 1995 level around 450.

But it is far more likely to surrender previous gains going back to around 1990 (13 years), which would take the index down to 300. The corresponding level for the Dow Jones Industrial Average would be around 2,500!

Don't keel over. In a moment I'm going to tell you about the Next Big Thing -- the powerful bull markets of the next 10 years. Invest in these markets and you can multiply your money by a factor of five or 10.

Look again at the Tower of Debt. Clearly, there's no precedent for these debt levels except the Great Depression. Nothing else even comes close.

In the 1950s, mortgage debt was only 15% of the value of our homes. We owned the other 85%. Now mortgage debt is 57% of the value.

Mortgage debt grew 60% faster in 2002 than in 2001. Refinancings last year were a hundred times their 1990 levels.

Mortgage loan delinquencies are up 79% from four years ago. Defaults on FHA loans, mainly to low income buyers, are at an all-time high. And remember, unemployment hasn't even reached recession levels yet. What will loan defaults be like when it does?

It gets worse. Four out of 10 of us own our homes free and clear, so all the debt is carried by the other six guys. Their average mortgage is 80% of their home's value. A mere 20% drop in housing prices wipes them out.

Personal bankruptcy filings have been growing at double digits. They currently hover around 1.5 million per year. Credit card charge-offs of bad loans are at an all-time high.

Credit rating outfits like Moody's are breaking all records when it comes to downgrading the debt of American companies.

Total debt has surged 52% in the last five years. As I write, the most recent figures show it's growing at 7.7% per year. These growth rates will put total debt at $41 trillion in four years, compared to $31 trillion now. In 1980 the debt was only $4 trillion.

A lot of people will dismiss all these worries. Doom-and-gloomers have been haranguing us about debt for a long time, and we're still here, right? The world hasn't ended.

The answer to that is this: A lot of people predicted in the spring of 2000 that the stock market would continue to rise, based on the fact that it had been going up for 18 years in a row. No problem! Just take the trend and extend it into the future. All you need is a graph and a pencil.

Look at the debt chart and ask yourself if you really believe it's going to continue to go straight up. The truth is obvious, don't you think? This is not a routine bear market. This is a change in the Big Trend.

StrategicInvestments.com


ABOUT DAN DENNING
Someone has to pull all the strings together. For the team at Strategic Invesment , that man is Dan Denning. You may remember Dan from his earlier investment advisory service. Especially since his focus on little-known stocks - predominately small caps - led investors to profits as high as 5,182%. Today, Denning is the architect of Strategic 's winning portfolio up across the board, while Wall Street's finest take it on the chin.

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