July 1, 2002 – Over the past several weeks, the stock market has taken a severe pasting. The Dow Jones Industrial Average has declined six weeks straight, which is a relatively rare event.
In fact, because it is rare I was compelled to test my 23-year database of the Dow to see how many times it has happened before. The answer is five times, and the loss on the Dow during these declines ranged from -7.2% to -15.0%.
The decline during the last six weeks has been -10.7%, which also happens to be the median of the previous five declines. The average decline was 10.5%, so the current slide is very much in line with historical experience. The real question though is what happens next?
The first three slides ended in March 1980 at 777.65 (the Dow actually was down seven straight weeks during this slide), in February 1984 at 1148.87 and in August 1990 at 2532.92. Each of these turned out to be key reversal points.
It is interesting to note that after each of these slides, the Dow climbed from these levels and never looked back (except in 1984, because a few weeks later the Dow actually dropped 47 points lower, or 0.4%). These lows at the end of these protracted slides not only turned out to be a point in which the Dow reached extremely oversold levels, but they also proved to be important lows that the Dow would not re-visit. Compare this experience to the last three slides.
The Dow slid six weeks in a row to end at 10,273.00 on October 1999, and seven straight weeks to end in July 2001 at 10,252.68. And the current slide – six weeks long so far and still counting – has reached 9243.26 as of this past Friday.
The different result between the first three slides and the last three arises from the fact that the last three slides occurred while the Dow has been in a bear market. The steady uptrend of the 1980’s and 1990’s has ended. Or has it?
Take a close look at the accompanying two charts, which present the Dow Jones Industrial Average over the same time period (from 1979 to the present). But these two charts measure and report the Dow in terms of two different currencies. I last presented these charts in April, but we have been watching them develop long before then as well.
The top chart presents the Dow as we usually see it, in terms of Dollars. The second chart presents the Dow from a different perspective. In this chart, the Dow is presented in terms of GoldGrams. These are one gram of gold and the currency of GoldMoney,(www.goldmoney.com).
These two charts are important to my view that we are now in the early stages of a flight out of the US dollar. As this flight accelerates from here, blue chip stocks I expect will become a refuge for capital. And that outcome is precisely what these two charts are now illustrating.
As measured by both moneys, the Dow has been in a bull market for two decades. But look at the last few years. Note that the Dow Industrials Average in these two charts reached its peak at different times. In Dollars, the peak was reached in January 2000. In GoldGrams, the peak was reached in July 1999.
It is more important to note, however, that the performance of the Dow has been different in these two currencies since reaching each respective peak. In dollars, the Dow has declined 21.2%, from 11,723 on January 14, 2000. But in GoldGrams, the decline has been more severe. The Dow has dropped 33.0% from 1369 in July 1999 to 917 at present.
This difference arises because the demand for dollars is declining. As evidenced by these two charts, a flight from the dollar is beginning, resulting in an unusual result for the Dow.
Not only did the Dow peak sooner in terms of GoldGrams than Dollars, but look carefully at the lower chart. The big uptrend that marked the bull market in stocks for more than twenty years is being broken. But it is not yet breaking down on the upper chart. So far at least, the long-term uptrend line and the big uptrend channel remain intact.
Therefore, my expectation that selective blue chip stocks will provide a refuge for money moving out of the Dollar is now being put to a test. I expect that the uptrend channel on the top chart will not be broken, while the Dow in terms of GoldGrams will continue to fall.
To make clear this shift in dollar demand, I would like to quote from my letter of April – ‘The Momentum of Truth Rapidly Approaches‘, in which I made a comparison of Argentina today to the United States in the 1930’s Great Depression.
“The Dow Industrials tanked in the 1930’s, falling nearly 90% from its 1929 high. But the stock market in Argentina is soaring. I’ve drawn attention to this phenomenon before. In Letter No. 299 (“Argentina Falls Over”) I quoted from The Wall Street Journal which accurately observed that “...investors bought [Argentine] stocks as a sort of safe haven amid fears of future declines in the Argentine currency.” Those declines have now happened, and the currency continues to decline. In local currency terms, the Argentine stock market continues to soar. It is “sort of” a safe haven.
It’s not the best safe haven, as investors would be much better off if they had been holding GoldGrams rather than stocks. But they’re doing a lot better in stocks than they would be if they were holding increasingly depreciated Argentine pesos.“
Now change this last sentence to read US Dollars instead of Argentine Pesos and the Dow Industrials instead of Argentine stocks. That (1) the Dow in dollar terms that is still in its uptrend channel along with a (2) Dow in terms of GoldGrams that is breaking down from its uptrend channel together indicate that blue-chip stocks are a safe-haven from bad money. This trend began in July 1999 when the Dow peaked in terms of GoldGrams. This trend is picking up momentum now that the GoldGram Dow is breaking its long-term uptrend channel.
I expect these two trends to continue diverging. The GoldGram Dow will continue to fall while the Dollar Dow will remain within its uptrend channel. Though stocks are losing purchasing power in GoldGrams, I expect that in nominal Dollar terms the Dow Industrials Average will continue to hold around/above the 10,000 level. Though we are currently below that level, the Dow will probably bounce higher from here.
The rapidly depreciating US Dollar is now showing – like the Argentine Peso has shown before it – that there will always be a flight from a currency into safe havens to escape ‘bad money’. And select blue-chip stocks are emerging as one of those safe havens, but – and there always is a ‘but’ – I would like to explain why I am less certain about the above analysis than I was even a few months ago. To do this, I refer to the chart below of the S&P 500 Index.
The S&P 500 is now completing a massive head & shoulders pattern, which can be clearly seen on this chart. I always pay keen attention to H&S patterns. They are surprisingly reliable, and this time I am paying even more attention than usual.
Readers will remember my call on GE, which formed a similar H&S pattern and then collapsed below the neckline at $40. The H&S on a big-cap stock like GE was meaningful to me, and patterns tend to repeat. So GE’s result may be an indication that a H&S top is about to be completed in the S&P 500.
The weak link broke first, namely GE. Now the whole chain may be ready to break, or at least the S&P chain. And if it goes, I expect that the Dow Jones Industrials won’t be far behind. And if that happens, the uptrend channel on the first page will break, undermining my expectation that select blue-chip stocks will emerge as a safe haven. Therefore, it will be important to see whether or not the Dow and S&P 500 bounce from here.