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-- Posted Tuesday, 13 January 2009 | Digg This Article | Source: GoldSeek.com

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 11^th January 2009. 

A scenario favored by many analysts is that a new bull market commenced last November. This view will undoubtedly gain traction if the stock market continues to strengthen over the next few months (as we currently expect), but it has almost zero chance of being proven right.

Ironically, one of the main reasons why this long-term bullish outlook will most likely be proven wrong is the extraordinary effort being made by governments throughout the world to stimulate their respective economies. The government does not produce any wealth of its own, so every dollar it spends must be extracted by some means or other from the private sector. The government takes money from the private sector, uses a significant portion of this money to pay its own costs, and then uses the remainder less productively than the private sector would have used it. As an inevitable result, the more money the government spends in an effort to boost economic growth the poorer will be the economy's long-term performance.

Making matters even worse, when attempts to stimulate the economy via increased government intervention and spending achieve the opposite of their intended effects the most common assertion within the ranks of economic advisors will be that the government needs to do MORE. In other words, it will be claimed that the economy's failure to respond as predicted was due to INSUFFICIENT intervention and spending on the government's part.

Another potential scenario, one that tends to be favoured by most deflationists and long-term bears, is that the stock market is positioned similarly today as it was in early 1930. In this case, the rebound that began last November will be followed by a relentless 1-2 year decline that takes the senior stock indices a long way below their 2008 lows.

This scenario has a much higher probability than the bullish one mentioned above, the reason being that the credit bubble of the 2000s was much bigger than the credit bubble of the 1920s while the mistakes being made by today's policy-makers are similar to the mistakes that were made in the 1930s. The early-1930s stock market parallel should therefore be seriously considered by anyone making long-term investment decisions, but we don't think it represents the most likely outcome.

The most likely outcome, in our opinion, is that the US stock market will continue to perform in similar fashion to the way it performed following its 1937 peak. Under this scenario the start of a new long-term bull market is still years into the future, but in nominal dollar terms the senior stock indices will not drop far below their respective 2008 lows. We favour this scenario over the early-1930s parallel because:

a) There was a 30% contraction in the money supply during the early 1930s, whereas the rate of money-supply growth is currently robust (the year-over-year rate of M2 growth is now over 9%) and looks set to accelerate over the coming months. This means that from a monetary perspective the current environment has a lot more in common with 1938-1939 than 1930-1931.

b) Given what policy-makers have already done, just imagine what they would do if the Dow threatened to break below its November-2008 low. Up until now the Fed and the Treasury have targeted their direct monetary support at the debt market, but the threat of another breakdown in the stock market would likely prompt the monetisation of equities. Due to its ability to create an unlimited amount of new money the central bank would be quite capable of supporting stock prices if it chose to do so, with, of course, negative ramifications for the longer-term viability of the official currency.

c) Many stock markets around the world, especially those in Asia, have reached valuation levels that are typically seen near the ENDS of major bear markets.

Below is an updated version of our chart comparing the 1937-1942 bear market with the bear market that began in 2007. The chart's vertical axis shows the percentage decline from the peak and the horizontal axis shows the number of weeks from the peak.

-- Posted Tuesday, 13 January 2009 | Digg This Article | Source: GoldSeek.com

Regular financial market forecasts and analyses are provided at our web site. We aren’t offering a free trial subscription at this time, but free samples of our work (excerpts from our regular commentaries) can be viewed at: http://www.speculative-investor.com/new/freesamples.html

E-mail: Steve Saville

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