Most sentiment indicators are at or very near historic extreme bullish levels. Overall market sentiment is just about as "good" as it gets:

The latest Investors Intelligence report shows Bulls leading Bears by 62.9% to just 19.2%, more than a 3 to 1 ratio. This ratio is at a 17-year high. The 62.9% bullish reading is the highest since pre-crash 1987.

The American Association of Individual Investor's survey hit a record 55% bulls a couple of months ago. The prior all-time high was in January 2000, right at the all-time peak in the DJIA.

The latest Market Vane's Bullish Consensus reads 73 percent bullish, higher than it was at the all-time market tops in the 1st quarter 2000.

The Daily Sentiment Index hit a record high of 89.3% in November, higher than it was at the all-time peaks in the 1st quarter of 2000.

Jay Shartsis, writing for our friends at the Daily Reckoning, has analyzed the put/call ratio on options trades of ten or less contracts. He reports that call buying surpasses put buying by nearly 3-1. The little guy is extremely bullish.

In Business Week's annual survey, 58 of the 67 market analysts surveyed (93% of them) are looking for an up year in 2005. Only three of them are looking for the DJIA to close below 10,000. Only three think the Nasdaq Comp will close below 2,000.

Addendum 01/04/05: One of Wall Street's most admired bulls, Ralph Acampora of Prudential Financial, came public with his forecast for 2005: 13,000+.

The Wall Street Journal reports mutual fund cash asset levels are very near historic lows, at 4.2%. The last time it was this low was April 2000, again right at the all-time peak of the S&P 500 and just a month beyond the bursting of the Nasdaq bubble.

The VIX options volatility index continues to hover near nine-year lows, closing the year at 13.25.

Consumers as well as investors are exultant. The Conference Board's Index of Leading Indicators fell 5 out of the last 7 months, but the latest report for December surged nearly 20 points. Santa Claus must have been very good to all these optimists.

We can find only a handful of bearish advisors and analysts out there, and virtually no one beyond the usual "cast of characters":

• James Grant of Grant's Interest Rate Observer

• Alan Newman of Crosscurrents

• Robert Prechter of Elliott Wave International

• Arch Crawford of Crawford Perspectives

• Dr. Martin Weiss of Weiss Money Management

• The cast and crew of Daily Reckoning

• Don McAlvany of McAlvaney Intelligence Advisor

It's lonely at the top, the top of a bear market rally, that is.

VALUATION
To echo the mainstream's mentality with regards to market sentiment, many anal-ysts claim that valuation "doesn't matter anymore," (They said the same things back in the Spring of 2000.) On an historical basis, stocks are still expensive. They're certainly not as expensive as they were at the peaks in 2000, but that doesn't make them cheap now.

Ciovacco Capital Management has put together a short presentation titled "Why Should Investors Care About Current P/E Ratios". Check it out at: http://super95.com/sys-tmpl/value11/

• The dividend yield on the DJIA is near an historic low of 2.06%.
• Jeremy Grantham estimates the S&P 500 is overvalued by 35%.

GALLERY OF MARKET CONDITIONS
For those in need of a more visual representation of what we've been saying....

The fact that the 2003-2004 rally was as large as it was offers some important information for the bigger picture. From the March 2000 all-time high, the Nasdaq has declined in a clear five wave pattern. This completed wave A. The rally from the March 2003 low has formed a clear three-wave A-B-C counter-trend rebound, potentially completing wave B, now. What lies dead-ahead should be another devastating decline, most likely including that "historic crash" we've been anticipating.

CAUTION: As we've demonstrated in the past, it's pretty damned difficult for anyone to pick a market top in real-time, and we may indeed be wrong yet again. Invest carefully, at your own risk. Please read the disclaimer.

If (we think when) The Crash comes, there may or may not be a specific identifiable cause for it. A devastating terrorist attack would be a prime suspect. A panic sell-off in the US dollar might do it (more below). A derivatives implosion would certainly do it. Or, it might be some other seemingly remote event, a tsunami perhaps?

Or, it may take nothing more than a seemingly insignificant flap of some financial butterfly's wings. The specific "cause," if there is one, won't be the issue, the markets' reaction is what's important.

The ultimate question remains: Is our bearish perspective still onto something, or are we just on something. 2005 will tell.

MISC. MARKET MARKERS
If the infamous Crash of 1929 had a theme song, it was "Blue Skies," the classic little ditty penned by Irving Berlin.

THE ECONOMY
The horrific tsunami that struck last week is to be taken seriously; very seriously. An estimated 150,000 people were killed, Five million have been displaced, are homeless, or worse. All citizens in the region are facing potentially widespread disease. It is a horrible, historic tragedy that will have consequences for years to come.

If you've followed Grizzly's Growlings over the years, you know we've been a grinch on the state of the economy. We've harped on the fact that government economic statistics cannot be relied upon to be an absolute, accurate reflection of the state of the economy. This is not out of some dark and dangerous conspiracy, but out of the outdated, obsolete and ineffective methodologies used by the government to measure, calculate and analyze all the data.

Most government economic calculations are but a figment of some bureaucrat’s imagination. They are riddled with all kinds of subjective estimates, seasonal adjustments, biased surveys, filters, bureaucratic interference, and "CYA" fudge factors. Nevertheless, these are the number that matter to those who keep score, so we do need to keep an eye on them.

As we enter 2005, the expectations of mainstream and Main Street economists are for the perfect "Goldilocks" scenario: the economy will not be so hot that inflation will accelerate, and nor will it be so slow that jobs will be lost or another leg of recession develops. Things just don't get any better than Ms. Goldilocks. (Remember, she hangs out with Three Bears!)

The consensus for 2005 as reported by both the Wall Street Journal and Business Week magazine is for 3.5% growth and about 2.3% inflation. In the Business Week survey, 56 of the 60 economists polled (93% of them), are looking for growth of more than 3%! Such near-unanimous consensus forecasts rarely turn out to be correct. They have a terrible track record. Moreover, not one economist surveyed, and almost no other mainstream economist we know of, think anything resembling a recession is coming.

So, can the majority be so right? Can the alleged economic recovery continue? Sure, it could, but most chickens seem to want to come home to roost when no one is out looking for them.

There are a few notable exceptions to the near-unanimous bullish conclusions of the majority economists. Stephen Roach of Morgan Stanley is perhaps the most prominent and well-respected of the bears. In this Boston Herald article, Roach sums it up by stating "America has no better than a 10% chance of avoiding economic Armageddon."  We concur.

We believe the economy just isn't healthy enough to "keep on keepin' on" into these historic headwinds:

• Record high budget deficit
• Record high trade deficit
• Record high household indebtedness
• Record high housing prices
• Record low national saving rate
• Rising interest rates

Moreover, there are no arrows left in the economic stimulus quiver:

• The one-time economic bounce from 2001-2002's tax cuts has been spent, literally.
• The housing re-fi ATM is empty, or nearly so. Nearly everyone who can re-fi has already done so, many more than once. There's precious little equity left in the Home bank. (More on real estate below)
• At the height of a housing bubble, the ratio of household assets to total household liabilities stands at a record low of just 6:1.
• Unprecedented piles of money continue to be sucked out of the country and poured into trying to control Iraq. Most of it is going right down the economic drain.

Sir Alan of Greenspan and His Merry Monetarists have raised short-term interest rates five times over the last seven months, from 1.00% to 2.25%. If the value of the dollar (more below) does not at least stabilize, and soon, the Fed will be forced to keep raising short-term rates to prevent a meltdown of the entire system, the economy and the stock market be damned. The infamous inverted yield curve will result, bringing on recession and likely worse.

As discussed further below, the US dollar has been slipping and sliding for over four years now, yet contrary to mainstream economic doctrine, the trade deficit has not only not decreased, it has continued to soar to new records each quarter. The "cheaper" dollar was supposed to stimulate the US economy by making our exports "more competitive," but that just hasn't happened.

Actually, it's been the exact opposite. Over the past four years, the US dollar has lost nearly half, that's right half, of its value against its closest competitor, the Euro. If a 50% drop in the dollar isn't enough to turn things around, just what will it take? As the dollar dropped, the US current account deficit continued to soar to new heights, hitting $165 billion in the 3rd quarter 2004. That's in the neighborhood of a $700 billion annual rate, more than 5.7% of GDP!  Stunning. Amazing. Ridiculous. Dangerous.

China, with its currency pegged to the US dollar, is a problem, not the problem. Let's even forget about China altogether for a minute. Excluding China, the U.S. still ran a $375 billion net deficit with the rest of the world in 2003!

The whole house of cards is supported only by the recycling of dollars from Japan, China and other Asian countries that have huge trade surpluses with the US. If they ever stopped buying US Treasury notes and instead started to buying, say gold, all bets are off, for both the dollar and gold.

So, do these huge trade deficits really matter, or is it all just a big bucket of econo-drivel?  We think size does matter, and "big, really big" deficits really do matter - a whole lot. As Paul Van Eeden explains it this way:

The good news is that large trade deficits can be eliminated. The bad news is that a large trade deficit is almost always followed by a recession, the magnitude of which is proportional to the trade deficit. Given the size of its trade deficit, it would be a pleasant surprise if the United States can eliminate its current trade deficit by a mere recession. The magnitude of the deficit suggests a depression is more likely.

Unfortunately, we concur.

Just how bad are things getting? We're not comfortable with the company, but we actually agree with the International Monetary Fund on something. The IMF, funded mostly by US taxpayers, has issued a scathing report against its main benefactor. From the New York Times story on the report:

The United States is running up a foreign debt of such record-breaking proportions that it threatens the financial stability of the global economy.

The U.S. is in worse financial shape than many third-world countries.

DEBT
America is deeper in debt than ever before. The total amount of US debt across the board (consumer, business and government) now stands at over 300% of GDP, It was "only" 265% in 1929.  USA Today estimates that the average American household has $84,454 in personal debt! On top of that, the family's share of the US federal government's $4 trillion debt is another $473,000!

Plus, let's not forget the unfunded liabilities of Social Security, Medicare, Pension Benefit Guaranty Corp (PBGC) and all the other alphabet soup welfare-state programs, totaling an estimated $53 trillion, That's an additional half a million dollars for every single American!

In fact, because of all this excess debt, mega-money manager Bill Gross of Pimco has questions about the Triple-A credit rating of US government paper.

An estimated 81% of the country's pension plans are under-funded. More than 1,200 plans were terminated in 2004. The plans insured by the PBGC are under-funded by at least $450 billion, an increase of $100 billion in just the last year!

All this, despite, or even perhaps because of, the alleged economic recovery of the last two years. Conventional wisdom has it that debt gets paid off in an economic recovery, when consumers are supposedly prospering. Instead, the opposite has happened. Consumers have spent and spent and then piled on new debt at a record pace. Maybe it's because consumers are being enticed, almost compelled, to buy, buy, buy everything, especially the things they really don't need. And they're especially compelled to buy it all on credit.

Do you know anyone who paid cash for a new car?  Automobile sales don't matter any more, but automobile financing does matter a great deal. GM, Ford and DaimlerChrysler lose money on every car they sell in America, but they more than make up for it on the financing (on those cars as well as on housing, credit cards and just about anything else you can think of). Higher interest rates will put an end to all the free-wheeling and dealing financing. At 10 or 12% interest rates, that 2001 SUV in the driveway suddenly doesn't look so "old" to most people.

Zero percent financing on those new wheels not a good enough deal for you? Car dealerships across the country are offering "Buy One Get One Free" sales: Buy a top-of-the-line SUV (at full price of course), and you get a bottom-of-the-line no frills econobox for your spouse or kid, for free. Such a deal...

Furniture stores are offering zero down, zero percent financing for three years - for a kitchen table! You can get zero down, zero percent financing on Lasik eye surgery, Botox treatments and hair transplants. Need to shed a few dozen pounds but you're a little light in the wallet? No problem, get your liposuction with zero down, zero percent financing.  On and on it goes...

The U.S. savings rate is virtually non-existent, just 0.2% in the latest reporting period. Only ten years ago  Americans were saving about 9% of their earnings on average.

Think about it this way - a family earning $50,000 a year is currently saving at the rate of  just 37 cents a day, a grand total of only $100 a year. That's it - the equivalent of dinner for two at a "moderately priced" restaurant in New York City, one day's skiing at Aspen, one fill-up of the RV, or one month's-worth of Starbucks'. That's it! -  the grand total net accumulation of wealth after a year's efforts (and a year's taxes). The American consumer is maxed out, to the max.

With nearly zero domestic savings, America must rely upon the steady flow of funds from the rest of the world to finance our consumer binges. CNBC estimates that 75% of our record-high trade deficit is due to consumer goods. America imports about $2.6 billion of foreign capital each day .to finance everything from Hummers to hummus. (Almost all supermarkets in the US now accept credit cards.). In doing so, the US absorbs 80% of the rest of the world's net savings. If this flow dries up (for whatever reason), the rug would be pulled out from underneath and the house of credit cards would collapse.

REAL ESTATE
Bubble? What bubble? In a market where 40-acre plots of desert scrubland trade on eBay like shares of eBay on the Nasdaq, many even doubt the existence of a bubble. For a comprehensive analysis of the state of affairs in the real estate and credit markets, we highly recommend Doug Nolan's Credit Bubble Bulletin at prudentbear.com.

As we've discussed in prior reports, the bubble was inflated over the past three years by historically low mortgage rates (actually negative real rates, net of inflation). It will be deflated by higher interest rates. It may not be the same dramatic, sudden "pop" and plunge as with stocks or bonds, though many will be surprised by how quickly the market turns.

So, can the housing bubble continue to inflate and expand even further?  Sure, it could, but we think that's highly unlikely going into the headwinds of higher interest rates. Nearly half of all new mortgages are variable rate. When rates begin to rise, the jig's up. A divorce, a job layoff, a medical emergency - most people have little financial cushion, no ability to absorb higher mortgage payments. People who speculated with their homes will be stuck. There will no "greater fool" to come along and take their house of their hands, at least not at higher prices.

Early warning signs of the housing deflation are rolling in:

• The inventory of unsold existing home rose has risen for 5 months in a row, to the highest level since August 1979.
• The inventory of new homes on the market recently hit a 25 year high.
• New home sales dropped by 12% in November, the largest drop in at least 10 years.
• The median price of home sold in November fell by nearly $20,000, to just over $200,000.
• Housing starts fell by 11% in November, the largest drop in 11 years. The decline was broad-based, with starts falling in all regions of the county except the South. Starts mini-crashed by 39% in the Midwest and 28% in the West.
• Lumber prices have plunged 30% over the past few month.
• The earnings of leading mortgage lender Countrywide Financial fell by 47% in the latest quarter.
• Foreclosures in metro Denver are running at the highest rate in 16 years. Foreclosures have nearly quadrupled in the last 4 years.

In our discussion of the scandals at Enron, et al two years ago, we stated:

So where and when will it end? We certainly don't know, but you can bet there will be many more "disasters du jour" unfolding in the coming weeks and months. We even expect that a major U.S. state and eventually the U.S. federal government will be found guilty of accounting fraud and of deceiving us taxpayers. It's just a question of when and how much.

While they're not actually part of the federal government, mega-mortgage lenders Fannie Mae and Freddie Mac (F&F) are about as far separated from the Feds as are Siamese twins from each other.

A few days ago Fannie shocked, utterly shocked, the financial world by disclosing that it had cooked its books, to the tune of $9 billion. Seems that Fannie's profits were overstated by about 33% over the last four years. Ooops.

Oh well, it was all for a noble purpose. Indeed, F&F take pride in the fact that they have helped extend the American Dream of home ownership to those in the lower economic strata. A worthy goal indeed, but home ownership and wealth cannot be created at-will. Many of these first-time home-owning families are "at-risk," extreme risk. The US Census Bureau reports that nearly 5% of all "sub-prime" mortgage loans are in foreclosure, versus 1/10th that rate for prime loans.

The Fannie Mae scandal may just be the tipping point, the tip of the iceberg that is, for the deflation of the real estate bubble.

THE DOLLAR
The most significant economic story of 2004 was the continued collapse of the US dollar. The Fed's rate hikes throughout 2004 failed to generate the desired effect of boosting the buck  It's been nearly straight down-hill.

Our discussion of the dollar at this time last year stands pretty much as-is for 2005:

Remember that little blip on the charts called "The Crash of '87?" It was probed and investigated and analyzed and researched to death. About the only tangible "market factor" the experts could agree upon as a "cause" of the Crash was the collapsing value of the US dollar.

At the time, the dollar was under extreme pressure due to the large and still accelerating US trade deficit and budget deficit. (Sound familiar?) In the days just prior to the Crash, Treasury Secretary James Baker tried to gently "talk down the dollar." Not only did that not work, it backfired. Foreign investors intensified their selling of US assets, and it turned into a global panic and Crash.

It could be "deja vu all over again" (again). The dollar has been sliding relentlessly for the past two years. The Euro closed 2003 at a record high of $1.26. [$1.35 close for 2004.]

The dollar's decline is getting so bad that OPEC is mumbling about starting to take payments in Euros rather than dollars. Current Treasury Secretary John Snow has already tried (in vain) to "talk up" the Yuan (the Chinese currency). We'll see how well he handles the Europeans and the Arabs.

As we enter the new year, nearly everybody is bearish on the dollar. Everybody includes the greatest investing legends of our times: Sir John Templeton, George Soros, and most recently Warren Buffett. With Buffett's public acknowledgement that he is "buying foreign currencies," a lot of Chickens and Sheep on The Street are not only following his lead, they're taking the plunge head first. The buck is sorely oversold now, and it's due for at least a minimal "dead-cat" bounce.

...[The Fed ultimately will have to at least try to defend the dollar, and the biggest weapon in that arsenal would be higher interest rates. But the currency markets are larger than politicians and bureaucrats. The Japanese have been buying dollars as fast as the Fed can print them and the dollar just keeps on sliding. Keep in mind that George Soros made the bulk of his fortune betting against the side of government intervention.

As we enter 2005, virtually everyone is still bearish the dollar. The Daily Sentiment Index (DSI) hit a record low 8% bullish on the dollar a few weeks ago. Jim Grant wrote recently of how even Columbian drug lords are demanding payment in Euros rather than dollars.

With this much extended and extensive disdain for the dollar, a counter-trend bounce that surprises the experts and analysts is highly likely. Either that, or a total collapse of our currency and a global crisis is next.

The U.S. Treasury and the Bush administration continue to talk out of both sides of their mouths, claiming to support a "strong dollar policy," yet allowing the dollar to continue to slide to all-time lows against the Euro.

Japan and China together hold nearly $1 trillion of US government treasury securities. With the US dollar's fall from grace since 2001, Japan and China have absorbed losses in the neighborhood of $200 billion. That's one heckuva price to pay for loyalty and political posturing.

Year-end financial publications are chock full of advice as to how to protect your portfolio from a further decline in the dollar  Virtually no one is talking about how to profit from a dollar rebound. We'll stick with what the crowd is not hyping.

THE METALS
We're confident in the long term benefits of holding an above-average stake in the precious metals in a portfolio. But bull markets don't run in straight lines and at this juncture, gold looks and feels as if it is ready to at least take a breather in the $430-$450 area, if not undergo a sizable pull back

Since its lofty peak in January 1980, gold has shown a clear 8-year cycle, which is now due to turn down.  We think a prudent thing to do would be to protect the gains you've accumulated over the past three years with a fairly tight stop under the market. We suspect that a break of $415 or so would confirm that a cycle top is in, and a trade-able pullback to at least the $350 area was underway  But cycles break, often, so it certainly could be different this time.

The long-awaited Gold ETF finally arrived, on November 18th. Gold surged in advance of the ETF launch, anticipating a boost in demand for the bullion. Indeed, StreetTracks Gold Trust has been a huge success, and that may be a problem. Everybody is bullish gold. The Daily Sentiment index hit a record high of 90.4% about six weeks ago, But since the launch, GLD and the price of gold have slipped a bit.

Metals prices are strongly correlated (inversely) to the unit used to measure their price, i.e. the US dollar (discussed above). Indeed, we think much of the recent price appreciation of gold (in US dollar terms) is just the flip side of the dollar's weakness and devaluation. That gold bar of yours tucked away wherever you have it tucked isn't really worth more, it's the little green pieces of paper that you used to buy it that are worth less (though not yet worthless).

In fact, when measured in Euros or Australian dollars, the price of gold is right about where it was three years ago. However, gold is 68% higher when measured against the US dollar. A fundamental bull market in gold will be measured in all currencies.

Despite our current caution on metals prices, we know that holding the metals is about much more than making a profit on them. They're a security blanket, a sleep-well-at-night comforter, a nugget of piece of mind. If you're going to stick to your "buy and hold" approach, considering hedging with some puts. Long-term gold holders, if nothing else, just condition yourself to gold potentially dipping back to at least the mid $300s as the US dollar stages a rebound from its deep, four-year plunge.

MORE FAR OUT STUFF, MAN
Before continuing, we need to emphasize that we are not Armageddonists, honest! But managing your money in a bear market is about managing all of the risks, including those risks seemingly too far-fetched to even consider.

We've discussed previously the seemingly remote probabilities of a destructive external event, such as an asteroid collision, solar flares wreaking havoc with satellites and the magnetic field, volcanic eruptions, etc. (We didn't think to even consider a tsunami.)

No, they didn't cover this story on CBS, NBC or even CNN just a few days ago, but on December 20th, planet Earth barely dodged another speeding bullet. From the Space.com report:

The asteroid passed under the orbits of geostationary satellites, which at 22,300 miles (36,000 kilometers) altitude are the highest manmade objects circling Earth. [Asteroid] 2004 YD5 is the second closest pass of an asteroid ever observed by telescope... The closest involved a rock that flew by last March and was not announced until August.

The important point is that like many near-misses, this one wasn't discovered until after it whizzed by the planet. The rock came at us from a point in the sky very near the sun, making it virtually undetectable. No warning whatsoever.

According to recent reports aired on the History Channel, each morning the Earth faces a "1 in 20,000 chance of being struck by an asteroid at least 1/2 mile wide," The precise physical characteristics of any one given space rock are more or less random. The December 20th rock could very easily have been 50 meters across instead of 5. Its orbital path around the sun could very easily have been different by just 0.0001%. Its speed could very easily have been just 0.0001% faster (or slower) than it was.

Planet Earth won this latest round of cosmic dodge ball. We will likely win the next one, and the one after that, too. But sooner or later, planet Earth will have to absorb the impact of a sizeable space rock. It's not a question of if, but when. Maybe in five hundred years, maybe next Tuesday. Only the gods know.

"Expect the unexpected."
-- Heraclitus  500 BC

Thanks for listening, and be on the lookout for the new-look bearmarketcentral.com, coming soon!  -- Grizzly

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