“Rapid Plunge in Price of Oil May Fuel Growth”. That was the headline on Friday’s lead story in The Wall Street Journal.  The same day, I received a link to an article at FinancialSense.com asserting that the stock markets had been “worn thin by lower oil prices.”  If this seems paradoxical, the author of the piece, one Jan Allen, further declaimed that “when the stock markets do go down, the Nasdaq is going to experience a fractal break like it did in May of this year…to the great reward of those who are selling it short.”

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Perhaps. But how many of us would be eager to bet on it?  In truth, anyone who believes the stock market is about to collapse has probably been married to that scenario since the last time it collapsed – which, to remind you, was almost 20 years ago. I can tell you that although I was a permabear back then too (unfortunately without Hidden Pivots to produce the bland, emotionless forecasts you know me for), I did not get rich when the DJIA crashed more than 500 points on Monday, October 19, 1987. Quite the opposite, in fact. I actually got clobbered, having bought stocks hand-over-fist on Friday, October 16, when the Dow Industrials fell a little more than a hundred points. Aren’t we supposed to buy stocks when there's blood running in the streets?  It sure looked like it, since the Industrial Average had never before fallen by a hundred points in a day.  How was I to know that the pebbles and shards that tumbled to my feet that Friday were warning of an avalanche on Monday?

Anyway, forget about the “great reward” that Mr. Allen has promised to patient bears (as though there might be a bear left with money to blow on a bunch of put options). Sure, the "fractal break" he's talking about could happen -- absolutely will happen at some point, although no one can say exactly when. But bet on it? You've got a better chance of making a killing buying a hundred Powerball tickets every week. Or drilling for oil in YMCA basements. I know, because I've been watching put options mostly expire worthless for more than 30 years, twelve of them spent on the trading floor. You'd think I'd have learned my lesson by now. Not quite, for I am about to watch thousands of dollars worth of January 42 QQQ puts in my trading account expire worthless next Friday. However, I much expected this when I bought them, having already forecast that the Dow Industrials would rally to at least 13045. That target, which lies about four percent above Friday’s close, still stands, but my mechanically-induced bullishness will not stop me from buying still more puts to replace the ones that are about to go to their grave. At least I will do so without the illusion that I can somehow reap a “great reward” by nailing a top that has eluded every pessimist since 1929.

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Deflation’s Logic

 Here are some more thoughts on the subject of deflation from our friend Jas Jain. Anyone who believes the Fed will be able to “print money” to keep deflation at bay does not understand how the economy works:

I wish to emphasize one thing in particular: Inflation is not just a monetary phenomenon (very long-term, it approximates it), but primarily a real economy phenomenon: production, consumption, wages (especially wages after taxes and interest payments), savings, etc., when looked at over a shorter period of, say, five to ten years.

Mounting household debt has been supplementing wages after taxes and interest for spending purposes, causing consumption to heat up. When it finally cools -- and in the face of 20% decline in home prices, it would cool by 5-10% in a mere six months or so -- production capacity wouldn’t  fall by that amount for at least 6-12 months. This mismatch would result in serious drop in prices not seen in 60 years. The Fed will not be able to boost consumption when home prices are falling. Why would home prices continue to fall? Because of the supply-demand mismatch. It is the worst ever for the period for which we have data.

Deflation will be wholly due to the real economy phenomenon of gross supply-and-demand mismatch. I can’t wait so see what the Fed will do about that. (How will it get extra spending money in the hands of strapped consumers?) Until the middle of 2006 we had the greatest combined monetary and fiscal stimulus since the New Deal. The latest stimulus, of course, worked through lending to households by private banks and various mortgage agencies.