To be blunt, I don’t know what these guys are smoking. The US is entering the worst recession in 20+ years. The Feds are cooking up an inflationary storm of epic proportions. In the meantime, financial markets are experiencing their first taste of real deflation since the Great Depression. And the financial crisis still hasn’t been fixed.

This last point is key. The Federal Reserve’s moves have established the Fed as the backstop for every debt market imaginable (including non-secured commercial paper)… but you cannot fix a debt problem by issuing more debt.

Bernanke spent his entire academic life studying the Great Depression and doesn’t see the difference between that crisis and this one: that was a liquidity crisis THIS is a solvency crisis. Speaking of which…

History is decidedly against a sustained rally or the renewal of a bull market in stocks too.

The market has experienced four October crisis in the last 100 years: 1907, 1929, 1987, and 1997. Following each of these, the market staged a sharp, short-term rally (much like last week’s) before rolling over to either test its recent lows… or break down to new lows entirely. Again, every time an October crisis ended, there was a short, sharp rally followed by stocks rolling over to test or break through the Crises’ lows.

Most importantly, the two times that the market only retested its lows—1987 and 1997—the US economy was strong. In contrast, the two times that the market broke through its lows—1907 and 1929—the US was in a recession… just like today.

As you can see in the above chart taken from the October crisis of 1987, stocks rallied strongly in late October, before beginning a slide back to re-test their lows in early December. But remember, this was at a time when the US economy was strengthening, not contracting like today.

Combining all of these elements—rampant bullishness from money managers with ever-worsening fundamentals AND worsening economic conditions—I believe the odds are that stocks will roll over sometime in November. I wouldn’t be surprised to see new lows in the S&P 500. We certainly should at least see the market re-test its October lows.

However, I must stress that the US Government’s current nationalization/ interventions are unprecedented. Put another way, there is no historic US precedent for analyzing what is occurring in the financial markets. Because of this, pinpointing exactly what will happen is impossible. History gives us a rough road map, but the roads today are different than before. But the important thing to note is that fundamentals—both on a financial and economic scale—are worsening. And this increases the likelihood of historic developments—the market rolling over in November—coming to fruition.

I suggest you prepare accordingly.

Best Regards,

Bill King

Last 5 posts by Graham Summers

• We're Soooooooo Close! - October 9th, 2009
• Kiss the “New Bull Market” Theory Good-bye - October 8th, 2009
• The One Investment That Might Be About to Bottom - September 30th, 2009
• What the Fed Doesn’t Want You To Know About US Debt - September 30th, 2009
• How to Prepare For China’s Coming Derivative Default - September 13th, 2009

About Graham Summers (http://gainspainscapital.com) Graham is Senior Market Strategist at OmniSans Research. He, along with Brian, is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets. Graham also writes Private Wealth Advisory, a weekly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500. Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and worked in Europe, Asia, the Middle East, and the United States. Graham travels extensively in search of investment opportunities. He received his formal education from Oberlin College.