Don't let anyone tell you this ugliness in the stock market was unforeseeable.
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On June 8, in a financial world otherwise frothing with happy talk, money manager Michael Gayed posted a piece on financial analysis blog, Seeking Alpha, headlined, "The Summer Crash of 2011, Or the Great Re-Adjustment."
Gayed wondered: If a bull market was truly on, why were defensive sectors--consumer staples, health care and utilities--outperforming the broader market? Typically, these stocks are where investors run to hide in a recession. Oh, and why were bonds beginning to outperform stocks--even as the Federal Reserve ended its QE2 bond buying program?
"The bond market is clearly afraid of something," Gayed wrote. "The stock market has not yet noticed what the bond market is screaming."
From there, Gayed authored a few other pieces and suffered the inevitable heckling that followed as the stock market roared higher.
"One reader wrote me an email saying, you should stop writing about a summer crash," Gayed said in a telephone interview. "All I did was send a response saying, the summer's not over yet."
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Gayed began his June 8 piece with a timeless quote from German philosopher Arthur Schopenhauer: "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."
Welcome to the self-evident phase of Gayed's truth.
Gayed is the chief investment strategist at a small firm called Pension Partners LLC in New York City, where he helps manage about $140 million. I talked with him for about an hour on Monday, even as the Dow Jones Industrial Average slid another 635 points. He had so much time on his hands, he even put the firm's founder, Edward Dempsey, on the call.
"We're having an easy day," Dempsey said. Clients weren't calling, all freaked out about the market melee because Gayed and Dempsey had jumped out of stocks before things turned nasty.
Gayed and Dempsey are quantitative analysts who study interrelationships in the market and come up with insights most everyone else should see, but somehow don't.
"If Wal-Mart is outperforming the S&P 500, what does that tell you?" Gayed said. "Wal-Mart only does well when the economy does poorly.
"And bonds are out-performing stocks in a way that has not been seen since the Lehman collapse," he said.
The two money managers view the world as suffering through a "rolling depression." Their strategy has been to invest where the depression isn't rolling at a given moment.
"Rather than buy and hold, it's buy and rotate," Dempsey said, moving money into the best-performing sectors and assets as fast as their algorithms can identify them.
A rolling depression has meant falling income levels and rising debt levels worldwide. Not long ago, consumers leveraged up their homes to maintain their lifestyles in an era of limited wage growth. More recently, the U.S. government took on debt to bail out the economy. Now, the government collects less tax revenue than in did in 2008, yet its debt is trillions higher.
"They know this," Dempsey said. "That's why they are desperately trying to create inflation&to pay that debt back with cheaper money."
Going forward, the guys who predicted the summer market plunge remain bearish on stocks but bullish on bonds, even as Standard & Poor's has dashed America's triple-A credit rating.
Loan demand, they argue, is so low interest rates won't go higher anytime soon. So S&P's downgrade simply means a shift in credit quality. "If the triple-A is no longer triple-A, then everything else has to get downgraded," Dempsey explained.
The U.S. will remain one of the safest borrowers, relatively, even if it is only rated AA-plus, Dempsey said.
Meantime, the risks of investing in stocks remain too great because too many things have yet to happen in a fragile global economy, said Gayed, who believes the stock market has further to fall on events that are out of anyone's control.
What if a large European bank fails? What if Germany decides it no longer wants to shoulder the debt load of the European Union? What if Congress and the President continue to frighten the world with ineptness? Or what if an earthquake shakes Los Angeles like Japan?
"We live in a world where extremes happen so frequently," Gayed said. "The unimaginable can become very real. & Our whole thing to is interpret the message of the markets. And the message of the markets is not good."
(Al's Emporium, written by Dow Jones Newswires columnist Al Lewis, offers commentary and analysis on a wide range of business subjects through an unconventional perspective. The column is published each Tuesday and Thursday at 9 a.m. ET. Contact Al at email@example.com or tellittoal.com)