Commentary for November 1, 2004

| November 1, 2004

The stock market is one of the most complex, dynamic systems ever conceived. It is a living, breathing entity that both fascinates and infuriates those who wish to tame it, and its secrets remain elusive to the vast majority of its participants. The market is so difficult to understand because it is composed of millions upon millions of thinking participants whose ideas and decisions continually redefine its behavior. Further, these participants make decisions based upon both thoughtful, rational observations and highly irrational emotions, and a system that is defined by both logic and illogic simultaneously can be the very definition of unpredictable. To wit, the market is a prognosticator’s worst nightmare, but therein lies the challenge that drives those of us who seek to reliably, profitably understand its behavior.

Due to its inherent complexity, there are very few analysts who have such an understanding. One analyst whom we highly respect is John P. Hussman, head of Hussman Funds. He attacks the problem of market analysis from the viewpoint of a scientist, as do we, and we almost always find his commentary to be insightful. Dr. Hussman often discusses the relationship between savings and investment and the implications of the current environment of historic deficit spending and debt, and today we’d like to do the same.

The savings-investment identity tells us that all domestic investment must be funded by savings of some kind, either private, government, or foreign. Without those savings, domestic investment simply can not grow, and the next bull market cycle has no fuel to even get started, which is precisely why the outlook for a new, sustainable economic expansion remains so poor. Private savings are at historic lows, and the government looks to continue its recent policy of massive deficit spending, so the only source currently available is foreign savings. This inflow of foreign capital is essentially the only thing keeping our fragile economy afloat at the moment, and if our international benefactors ever lose confidence in the US marketplace in a meaningful way, our economy will be in real trouble.

Unfortunately, until policies are put into place the begin to reduce the historic triple deficits and encourage private saving, the situation is unlikely to improve. We have yet to truly correct the excesses of the last secular bull market of the 80s and 90s, and until we do there will be no foundation for the next expansion. The government continues to print money in the hopes of washing away the bear in a sea of liquidity, but until the imbalances are ultimately corrected, we can not make real progress. The country is drowning in an ocean of debt, and every debt must eventually be repaid, one way or another. As they say, the biggest problem with an unsustainable situation is that it cannot be sustained…

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Category: Commentary, Market Update

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