The Coming Financial Collapse and How You Can Prepare for It

It is been our plaintive plea for some time that investors should begin looking for ways to exit their long positions in U.S. equities and begin transferring their money to safer financial instruments in anticipation of the coming stock market collapse.

It goes without saying that this bearish stance has brought with it much ridicule and scorn from the "go long" crowd on Wall Street and elsewhere. After all, they reason, the trend for U.S. stocks has been one of almost unmitigated upward progression for the last eight years. How can anyone go wrong investing in the stock market?

We have also endeavored to demonstrate through both technical and fundamental analysis the exceedingly precarious position the Dow Jones Industrial Average—and the stocks that compose it—are presently in. As we speak, it hovers on the very brink of collapse and could fall precipitously at any time.Being fully "invested" under these present conditions would be the height of folly.

The U.S. economy itself, while superficially looking good, is not nearly as healthy as it is being played up to be by the government and the mainstream media. Substructurally, we already see dire warning signs that all is not well with U.S. business. Hardly a day passes without a major layoff announcement from a newly merged company. We lost count of our ongoing tally of publicly announced layoffs at U.S. companies months ago when the number was well over a million.

And the trend toward mergers and acquisitions by U.S. businesses is a worrisome sign in itself. Bert Dohmen, in a recent issue of his highly acclaimed Wellington Letter, noted: "Mergers between large companies have a poor track record of being successful. There's a clash of philosophies and corporate identities. And where do you find the management talent to run such a behemoth? But strictly on a liquidity basis, there's a worrisome trend. Over the past 15 years, corporate mergers have actually injected hundreds of billions of dollars into the stock market…So far this year, cash has only been used in 19% of all mergers, compared to 36% in 1997 and 50%-60% in the 1980s. That means less new liquidity is being created for new stock purchases."

This same trend is also in evidence among major U.S. banks who have been merging at breakneck pace over the past few months. Mergers of monstrous proportions between financial institutions have been transacted and finalized in an incredibly short space of time recently. This phenomenon is nothing less than astonishing. Clearly, companies are going the merger route in an attempt to stave off financial collapse from what many of them perceive as a coming downturn in the stock market. Banks and businesses aren't the only ones preparing for a major financial collapse. Apparently, the U.S. government is also expecting a meltdown on Wall Street soon, the ramifications of which could spread to Main Street.

On 16 June 1998, the Navy and Marine Corps were conducting their annual strategy meeting entitled "Current Strategy Forum". This year's meeting was held at the U.S. Naval War College in Newport, Rhode Island. A source who was in attendance at the meeting reported that he was shocked by a sentence uttered by the Under Secretary of the Navy, if only for its remarkable candor.

Our source reports, "After speaking for about 30 minutes from his prepared notes, the U.S. Under Secretary of the Navy, the Honorable Jerry MacArthur, then began to answer questions. After answering several questions, Mr. MacArthur made this statement, apparently off the cuff: "Senior Military Pentagon officials have been working closely with senior officials at Wall Street to perfect severa scenarios that could quickly be put into action once Wall Street crashes."

Notice the Under Secretary did not say "could crash" or "may possible crash." He emphatically stated that the Pentagon is fully expecting it to crash. Food for thought for the still-bullish among us. With that in mind, we will proceed to lay out a financial blueprint, so to speak, that should enable the prudent investor to safely navigate the monetary minefield that lies ahead.

For our core position, we want to hold 15%-25% (depending upon the degree of the investor's conservatism) in precious metals. Most of this should be held in physical bullion form, especially non-numismatic gold and silver bullion coins. We do not especially recommend numismatic, or collector, gold and silver coins but neither do we deter investors from acquiring them. It has been our observation, however, that collectable coins tend to lose their collector value in a deflation or depression (both of which we are expecting) with only the inherent value remaining. It should be strongly noted that the market for any collectable item is cyclical and subject to the vagaries of the market just as any commodity. Stick mainly to U.S. Gold Eagles and British Sovereigns (for their metallic purity).

Also, we advise investors to avoid gold and silver stocks like the plague at the present time as they are tied to the overall stock market and could easily sink right along with the market itself during an equities meltdown. At the very least, one should consult with a reputable precious metals stock advisor before attempting a foray into this speculative sector. After we have established a firm anchor for our portfolio in the form of our precious metals holding, we should move onward to yet another reliable, low-risk investment, that of short-term "CDs" (certificates of deposit). We recommend 30-90 day maturity CDs, obtainable at your local bank. Recommended are only short-term CDs due to the utter necessity for liquidity in such a volatile market as we are now experiencing. And before making any significant financial transaction at a banking institution, make sure your money is safe and in an established bank by ordering a report from a bank rating service such as Veribanc (800/44-BANKS), Standard & Poor's (212/208-8000) or Moody's (212/553-0546).

Another relatively low-risk strategy can be found in short maturity paper. Conservative investors should consider placing up to 25% of liquid assets in a short-term U.S. Treasury Bill money market fund, utilizing T-Bill funds with maximum maturities of six months which do not use derivatives. Funds such as the American Century Benham 2005 Target Maturities Trust (800/345-2021) are an excellent place to start.

Finally, we should look at committing a certain portion of our assets in a safe, yet high-yielding, mutual fund. Two such funds we recommend once the equities bear market begins is the Rydex Ursa Fund ($25,000 minimum initial investment; 800/820-0888) and the Prudent Bear Fund ($2,000 minimum initial investment; 214/696-5474 or 888/778-2327). Rydex Ursa is inversely correlated to the S&P 500 Index and rises in value when the S&P falls; conversely, Ursa falls in value when the S&P rises. Prudent Bear engages in profitable short-selling of securities during a falling market. When possible, use protective "stops" in entering positions in hedge funds. The funds should return large dividends in the coming months as the bear market becomes established. For currency funds, we recommend the Benham Prime Money Market Fund (800/345-2021), which invests in the highest rated short-term paper and yields more than Treasury bills.

With careful planning and prudent investment strategies, capital can be preserved and profits can be made in even the worse bear markets.

Note: Leading Indicators is not being paid or compensated in any way by the investment funds named above. Nor do we presently hold positions in any of the above mentioned funds.

Clif Droke is editor of the weekly Leading Indicators newsletter covering U.S. and global equities markets and general socio-economic affairs from a technical perspective. For a free sample copy of Leading Indicators, or to subscribe, write to: 816 Easely St., #411, Silver Spring, MD 20910; e-mail:[email protected]