It was shortly after midnight on April 15th, 1912 when the unsinkable did the unthinkable. Built and labeled as unsinkable, the Titanic was the most advanced and largest passenger steamship of its time. Even though the Titanic's crew was aware that the waters were iceberg-infested, the ship was heading full-steam for a destination it would never reach. Today, many investors find themselves invested at “full steam” even though the economy is maneuvering iceberg-infested waters. Is the danger of a financial shipwreck real? Let’s pull out the binoculars and look at what kind of icebergs are floating around. Iceberg #1: No “wall of worry” According to the old adage, bull markets climb a wall of worry. Wall Street today may be noticing financial problems as a large wall to scale, but the recent past would indicate otherwise.
Up until a few weeks ago, stocks (NYSEArca: VTI) were rallying on all news – good news and bad news alike. Unemployment, high foreclosure rates, (initial) Greek bailouts, all didn’t matter; stocks moved only up. In fact, at one point, the stock market had gone almost three months without a decline of more than 1%. Investors were about as worried as a kid in a candy store. Aside from price performance, there are more academic ways to disprove a wall of worry. Below is a small excerpt from a long list. 1) CBOE Equity Put/Call options ratio had dropped to an all time low.
2) Volatility Index (Chicago Options: ^VIX) had fallen to a 33-month low.
3) The percentage of bearish advisors (according to Investors Intelligence) had dropped to the lowest level since 1987.
4) Mutual fund cash levels had dropped to an all-time low.
On April 16, the ETF Profit Strategy Newsletter warned that “the message conveyed by the composite bullishness is unmistakably bearish. The pieces are in place for a major decline. We are simply waiting for the proverbial first domino to fall over.” The Dow Jones (DJI: ^DJI), S&P (SNP: ^GSPC) and Nasdaq (Nasdaq: ^IXIC) topped a few days later. The May 6, thousand-point Dow (NYSEArca: DIA) decline seems to have been the first domino. Aside from the early stages of this 13-month rally, there’s been no wall of worry. The extreme pessimism that surrounded the ETF Profit Strategy Newsletter’s strong buy signal on March 2, 2009 quickly gave room to ever-growing optimism. Iceberg #2: Problems bigger than expected A 2008 study from the Congressional Budget Office (CBO) estimated taxpayer losses from the Fannie Mae and Freddie Mac bailouts to reach $25 billion. This month, the Associated Press reports that the Fannie and Freddie rescue is turning out to be one of the most expensive after effects of the financial meltdown. Late in 2009, the Obama administration lifted an earlier $400 billion cap and pledged to cover unlimited losses through 2012. Fannie Mae reported another $8.4 billion loss last quarter. According to a trade publication, government backed institutions (like Fannie, Freddie and the FHA) supported nearly 97% of leans in the first quarter of 2010. How come the private financial sector (NYSEArca: XLF) doesn’t even touch the mortgage market? It’s a losing proposition. Why? Housing is still overvalued. The chart below shows housing valuations according to Robert Shiller’s Real Estate Index. Prices are still 30% above their historical average. If we are in a Great Depression-like cycle, real estate (NYSEArca: IYR) is about 50% overvalued. 
Unlike income statements and balance sheets of financial corporations (NYSEArca: IYF), real estate prices are transparent and can’t be massaged by crafty financial engineers. Iceberg #3: Sovereign debt defaults World leaders have gone from bailing out corporations to bailing out entire countries. To some that’s no big deal. But isn’t this the natural progression of a debt laden, global financial system? Just like a drug addict, the financial system needs bigger and bigger fixes. Initially, Greece’s bailout was slated to be around $60 billion, then increased to a $145 billion package. But that wasn’t enough; a $1 trillion dollar package for most of Europe was next. Even Germany’s chancellor Merkel admits that their only buying time. A wave of sovereign debt defaults was one of the seven predictions for 2010 by the ETF Profit Strategy Newsletter. In addition, the newsletter recommended buying the US dollar and dumping the euro back in fall of 2009. At that time, the euro was just bestowed the title of unofficial new reserve currency. Today the euro is on life support. The pattern set by government bailouts is the same as with corporations. The actual damage is larger than the estimates. Surely we’ll receive more sobering news soon and the stock market will react. Iceberg #4: Deflation The popular opinion on Wall Street, as well as Main Street, is that investors should brace themselves for inflation. But where is inflation? Even here in notoriously overpriced Southern California, everything from cars to dining out is getting cheaper. Businesses are competing for every consumer dollar. Wal-Mart just cut the price on over 10,000 items, discretionary (NYSEArca: XLY) and consumer staples items (NYSEArca: XLP). Money supply (M2) is down year-over-year for the first time since 1995 and the reconstituted M3 is down year-over year for the first time in 50 years. Why? Because corporate, consumer, and government debt – continues to implode. Most of the global debt is denominated in US dollars. As all the US dollars – even though it’s just fiat money – get destroyed, the dollars remaining become more valuable. This is the classic recipe for deflation. No wonder the iShares Barclays U.S. Treasury Inflation Protected Bond Fund (NYSEArca: TIP) is trading at the same price today as it did two years ago. Deflation is a rare economic disease; it’s therefore not surprising that its symptoms are often misdiagnosed. More importantly, the symptoms are actually the condition. Deflation shrinks revenue – just look at tax receipts. There is not enough revenue to service the debt corporations and governments have built up over decades. Therefore, defaults follow. Inconvenient flashback The last time we saw a deflationary environment was during the Great Depression. It was in fact a deflationary depression. In other words, prices across the board declined: real estate (NYSEArca: RWR), stocks (NYSEArca: TMW), bonds (NYSEArca: AGG) and commodities (NYSEArca: DBC). There was no safe haven. If this seems far-fetched, consider that the first leg down from the 2007 highs was stronger than the first leg in 1929. The 2009/2010 counter trend rally was also stronger than the 1929/1930. If the parallels persist, the next leg down should be hard to overlook. The Great Depression erased 29 years worth of growth. Interesting enough, if today’s market erases 29 years worth of growth, valuations (P/E ratios and dividend yields) would be right around where they were in the early 1930s. Did you know that the Titanic received an iceberg warning less than two hours before an iceberg brushed the ship's starboard side, buckling the hull in several places? An angry communications officer responded: “Shut up, shut up, I am busy; I am working.” Based on a detailed analysis of valuations, sentiment readings, technical indicators, parallels between the Great Depression and today and common sense, the ETF Profit Strategy Newsletteris sounding a similar warning today. The brand-new June issue includes a detailed short, mid and long-term forecast for the U.S. stock market along with corresponding profit strategies.
Sunday's (5-16-10) forecast for the week ahead said the following: "The weekly support at S&P 1,114 and 200-day simple moving average at 1,100 are the next logical targets for this week with much more bearish potential thereafter." We are there now, what's next? Will you heed the warning and avoid financial shipwreck? www.etfguide.com | 
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