Since it peaked in 2007, the UK stock market lost 60% of its value. As of yesterday, it had recovered half of what it had lost.

All over the world, the story is about the same. Markets have recovered half or more of what they gave up.

The US is a laggard. While the S&P is up 60%, the Dow isn't yet at the halfway point. Some foreign markets, meanwhile, have 100% + gains.

Fund managers who missed the rally are kicking themselves. They've failed to keep up with the benchmarks.

Even before the market headed up in March we echoed Richard Russell's words: "One of the surest phenomena in the financial world is the bear market bounce," he said. We also guessed that the bounce would go to about half the previous losses. We based that on what had happened after the Crash of '29.

Well, we're still not there. But an analyst from Morgan Stanley tells us that markets tend to do better than that. The typical bounce is about 70%, says he.

Whew! That's a pretty serious bounce. If we'd known it was going to be that big we would have encouraged dear readers to bet on it. Instead, we judged it a dangerous countercurrent...like a back eddy or rip tide. Yes, it can take you places...but not necessarily where you want to go!

Our outlook here at The Daily Reckoning is very long term. We don't like betting on countercurrents...even important ones. Instead, we like to go with the flow...and keep going with it until it arrives at its end.

That's not as easy as it sounds.

In 1999, it looked like the bull market had come to an end. We thought so. We told readers to get out of stocks...and stay out. Gold was a better place to be.

Investors made nothing in stocks for the next 10 years. In real terms, the stock market decline began in January 2000. Prices went down. They bounced...such a big bounce that it looked like a genuine new bull market. But after inflation, there wasn't much left. Adjust for purchasing power and investors were worse off every year. Even now, after a 7-month bounce and a 45% gain, Dow investors are still down 30% to 40% from the highs set in 1999.

Dave Rosenberg...

"The only thing we really learned in this extremely flashy, seven-month, 60%, nine-point multiple expansion-led rally, is that momentum investing never did become extinguished this cycle. It is really a fascinating commentary on human behavior that so many 'investors' are lamenting about how 'the train has left the station' without them. Please, give us a giant break! The train has left the station countless of times in the last 10 years but obviously none of these trips lasted very long because the reality is that equities have failed to generate any positive return over this time interval.

"As for the here and now, there is another reality. Price gains in the stock market have generally occurred with low volume. There are limited buyers - hedge funds and flash traders - but no sellers (not yet, anyway). And, we saw in yesterday's decline that volume climbed across the board, and the number of high-volume selloffs is a major red flag that should not be ignored."

The typical major bear market lasts 15-20 years. The last one began in 1966. It wasn't until 1982 - 16 years later - that the next major bull trend began.

This bear market is already 10 years old. Perhaps it will end in 2015. Maybe in 2020. We don't know when. We only know how it will end - in misery.

Now, despite 10 years of stinkin' returns, investors still believe in stocks. They still hope to find the 'next Google.' They still punish fund managers who hold back. They still read the financial press. They still watch CNBC. They still want to know what stock to buy.

Yesterday, they bid up the Dow 131 points. The price of stocks to gold is about 10 to 1. When this trend began ten years ago, we predicted that the Dow and gold would go all the way to 1 for 1. We guessed it would happen at the 3,000 to 5,000 level. We'll stick with that prediction until it proves correct...or it makes us look like a fool.

Bill Bonner
for The Daily Reckoning Australia

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But let's start with sovereign wealth fund of China, the China Investment Corporation (CIC). CIC was set up in 2007 with US$200 billion of China's nearly $2 trillion foreign exchange reserves. It's been shopping ever since, with mixed results. Last year, for example, CIC stood pat and only invested US$4.8 billion outside China. It preferred to ride the bubble in Chinese bank stocks, which worked out pretty well for it.

Yesterday, however, Reuters reports that CIC is now cashed up to the tune of $300 billion and ready to buy again. "It will not be too bad this year," says CIC chairman Lou Jinwei. And here's the good part. "Both China and America are addressing bubbles and we're just taking advantage of that. So we can't lose...We have to be in everything because you never know what's going to happen in this world."

Come again?

There's a charitable way of reading these comments and there's a straight forward way. The charitable way is that Lou and the rest of China's economic mangers know that their $2 trillion in forex reserves (which are mostly in U.S. dollars) are in perpetual danger of devaluation. If you had a pocket full of $300 billion in monopoly money, trading it for anything-anything at all-would be the sensible strategy.

You'd want to trade it for a real tangible assets or equity before asset sellers started treating your money with disdain. This is why CIC "can't lose." Better to trade it for something now then watch it turn into nothing later.

The straightforward interpretation is that the Chinese wealth fund managers have lost their marbles. Counting on more bubbles to increase your wealth is a portfolio destruction strategy. Chinese fund managers may end up being every bit as stupid as the hedge fund managers and bankers and CEOs at U.S. banks who ran their respective institutions into the ground making the worst leveraged bet of the century on U.S. housing.

The only real difference, as far as we can see, is that the U.S. bets were made with borrowed money (often borrowed from Chinese creditors, we reckon), whereas China is investing the fruits of its productive labour over the last twenty years. It is a massive gamble. The U.S. managers, who may have been criminal rather than stupid, did tremendous damage to their country's economy. Will China's managers replicate the feat?

This also makes you wonder how much the emergence of China itself is a function of a global bubble in fiat money since August of 1971, when Richard Nixon took the U.S. dollar off the gold standard. Sure, there are tens of millions of Chinese people working in real factories making real products out of real raw materials (many sourced in Australia). These people have real dreams, ambitions, and economic aspirations, not to mention real savings (in gold and paper money).

But is it possible that China's time at the centre of the global economic stage is limited because China's economic model itself always depended on cheap credit and fiat money? Yes, yes. It goes against the whole "next economic empire" way of thinking. But if China's official asset managers are counting on bubbles to make them wealthier, you wonder how sound the model is, and how long the wealth will last. We wonder anyway, which is our main job at the DR.

Empires. They sure don't make them like they used to. Rome lasted a good long while, with a big lead up as Republic. The 1,000 year Reich didn't last ten years. The economic and political clock seems to be speeding up these days.

That would be something. A twenty-year global boom from fiat money that simply accelerated the depletion of natural resources and the misallocation of capital to projects that are uneconomic at lower levels of household and business debt. Hmmn.

Speaking of resources, two notes that prove oil is still out there, but getting harder to find and more expensive to produce. PetroChina will spend $2 billion to buy a 60% stake in the MacKay River and Dover oil sands projects in Canada's Athabasca oil sands. Canadian sources reckon there are 5 billion barrels of bitumen on the properties. But turning bitumen into oil isn't easy or cheap. It takes lots of water and energy, neither of which are money.

The other note is that BP says it has found as much as three billion barrels of oil in the Gulf of Mexico. It found it by drilling 10,685 metres below the Gulf of Mexico, or 35,000 feet. So BP drilled the equivalent of a Mt. Everest underwater to find the oil. Actually, Mt. Everest plus another six thousand feet.

This is ample evidence of Peak Oil. It shows that oil is getting harder to find and more expensive to produce. Technology has improved, of course, allowing exploration companies to look further afield than ever before. Oil companies can increase reserves this way. They're finding oil. But it is not the cheap, easy, free-flowing stuff once found in the oil fields of East Texas or Saudi Arabia.

By the way, if you're wondering what could cause a second dip in the global recession, we have an answer: government stimulus. Yesterday was full of stories on how the stimulus spending by the Australian federal government made the recession less worse than it might have been and produced positive GDP growth. This has everything backwards, although it's being swallowed whole by the financial press.

A rebound based on monetary inflation and government spending isn't a real rebound at all. It gives the appearance of normalcy and economic health through rising asset values and more transactions in the economy (which GDP itself measures). But unless there's a big pick up in private investment, the economy is not on any sounder long-term footing.

In fact, it's worse. The illusion of prosperity created by stimulus spending induces people into maintaining debt loads they might otherwise reduce. Consumption patterns which ought to change in order to put the household and corporate balance sheets back in working order aren't changed at all. And when the government stimulus is withdrawn later---as it must be before higher fiscal deficits lead to rising interest rates-the economy reverts back to its pre-stimulus levels of growth-only without the underlying issues of over consumption and too much debt having been addressed.

Or the short version: there is no easy way out of this mess. The government can't create wealth by borrowing money or taxing people and spread the lucre around to favoured groups at the expense of others. That's theft and it's immoral. But the real issue is that the whole economy needs to reduce leverage. The housing bubble has to pop. And the nation has to quit living above its means (we remember writing this about America five years ago).

How about some reader mail?

Hi Dan,

Gene A.

Not this first time we've heard this and won't be the last. We write about outliers and Black Swans. Those topics are controversial, which is why the mainstream media is afraid to express a real idea about them. What's more, getting people's attention in this economy is tough. Sorry you don't like the ads. But don't expect them to change.

For one, we have to pay the bills. As much as we like writing the DR, there's an entire publishing operation to support that provides research to paying subscribers. Secondly, we wouldn't describe any of our publications as "loopy get-rich quick schemes." We know how much time and research goes into each monthly report. We stand behind all the ads and have a hand in a fair a few of them to make sure they're telling the stories we think you can profit from. If you really don't like them, you can always just ignore them.

--Hi Dan

Aidan

--DR

John

Dan Denning
for The Daily Reckoning Australia

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Of course, just because an economist or a central banker says something, it doesn’t make it so. And when a central banker who is also an economist says something, it should be treated with the skepticism of an airline schedule.

“I am obviously biased, but I find it sad to conclude that the role of serious economists in financial institutions is very limited today,” said Han de Jong, Chief Economist at ABN Amro Bank to the Financial Times on February 21, 2008. “We are little more than clowns, whose purpose is to entertain clients....”

Mr. de Jong is too modest. Economists are essential to the financial industry. They distract the customers while the boys on the sales desks pick their pockets.

We say that not in contempt but admiration; the role of the financial industry – like the contemporary art market or like Las Vegas – is to separate the punters from their money. Economists help them get the job done.

This they did in the last two decades with a variety of gaudy theories. It didn’t seem to matter that the theories were contradictory and absurd. On the one hand, prices were said to move randomly – permitting them to ‘model’ risk and sell extravagant securities. On the other hand, private equity experts and fund managers pretended to know which way the ‘random’ movements would go; they claimed to be able to produce “alpha” – above market returns – on a such a regular basis they could charge “2 and 20” for it.

But while economists are usually wrong about things, the burden of the present essay is that Mr. King is right this time.

Last week, we argued that ‘alpha’ was a mountebank. The financial industry doesn’t often add much value, we pointed out. Instead, fair winds and convenient tides are what usually get investors’ little barks where they want them to go. Most of the results investors get depend upon setting sail at the right hour, from the right place, in other words, not in having a Wall Street hotshot at the tiller. Put an alpha-seeking whiz-kid out in a storm and he’ll sink along with everyone else.

In the 20-year period ’83 to ’03, for example, the price of oil barely moved. Sheep could graze peacefully in the Mideast, confident of being undisturbed. Now, everywhere they go, someone’s setting up an oil rig. The latest figures show oil exploration up 400% since 2000.

Almost a whole generation of investors got nothing from that greasy sector. Then, all of a sudden, in the following 5 years the roughnecks suddenly had money in their pockets and the wind at their backs.

Likewise, in America, you could have held residential housing for 100 years – from 1896 to 1996. You would have gotten nothing for your trouble but leaky roofs and cracked paint; prices rose only as much as consumer prices. Then, the next ten years, a tide of easy credit rushed into the residential real estate market; prices rose 70% in real terms.

Behind both these booms is a story too long to tell here. But the moral of it is simple enough. The average investor makes far more by accident than by fund manager. And here we venture a guess: of all the times and places in which a U.S. investor might hope to get a decent return on his money, this is not one of them.

But the beauty of capitalism is that people get what they’ve got coming – not matter what they think. NICE is an acronym for “non-inflationary consistent expansion,” according to Mr. King. It is his way of describing what other economists called the “great moderation,” a period so agreeable that they gave themselves credit for it. Macro economists believed they had finally mastered the art of central banking – so perfectly manipulating the credit cycle as to produce growth without causing the consumer price inflation that typically accompanies it.

If economic wizards were really responsible for the Great Moderation, it would be reasonable to think they could keep it going. Alas, they can no more sustain it than they can claim credit for it. What really happened, over the last 25 years, was a unique series of events and trends that now seem to have run their course. Labor rates fell as millions of new workers entered the modern economy. Now, even in China and India, salaries are rising fast. Logistical expenses declined as computers and just-in-time inventory systems were put in place; now inventories (and associated costs) are rising again. Outsourcing, globalization, deregulation, capitalization, securitization – all these trends helped keep prices down; now, all seem to have played themselves out, gone into reverse, or backfired.

Finally, the cost of money has fallen for the last 27 years. Sometimes it fell naturally. Sometimes it fell unnaturally, even grotesquely – such as when Alan Greenspan lent the Fed’s money at below the inflation rate for more than a year. Normally, cheaper money creates boom-like conditions. But normally, it comes at a cost: consumer prices soon begin to rise. As the economy “heats up,” the domino of labor costs falls over; workers are in demand so they ask for more money. Then, that domino knocks over consumer price stability; prices rise. Then, a whole line of dominos topples over. Bond investors run for cover, for example, forcing up interest rates. Then, the economy “cools down,” as the cost of money increases.

That was what was so nice about the ‘nice’ years. The dominos wouldn’t budge. Thanks to so many things working so hard to keep prices down, the normal process of self-correction broke down. As demand for labor increased, new, cheaper workers were found overseas. And even though the supply of dollars increased twice as fast as GDP, the domino with the CPI on it stayed right where it was.

Alas, those happy days are over. The Great Moderation is finished. This week, oil rose over $130 a barrel. T. Boone Pickens said it would hit $150 this year. And America’s core producer price index registered its biggest increase in 17 years.

Of course, the real level of consumer price inflation is probably far higher than the official numbers. The raw data suggest price increases closer to 10% per year than the 4% the US Department of Labor confesses. But the economists have their ways of making the numbers say whatever they want. In March, for example, the consumer price index was “seasonally adjusted” from 0.9% down to 0.3%. In April, wouldn’t you know it, another seasonal adjustment took the number from 0.6% down to 0.2%. We don’t know what the real number should be; no one does. But Mervyn King is right; the season has changed.

Bill Bonner
for The Daily Reckoning Australia

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