In combat, ambiguity and confusion about the enemy’s intentions, dispositions, capabilities and so forth is common. Every military force seeks to confuse the opposition as much as possible so that it obtain strategic and tactical advantage.

It is the same in investing and speculating. Participants seek to confuse others about prices, values, intentions, positions and so forth so that they can obtain profit from the unwary or less well informed.

One of the best-known myths in financial history is the story that Nathan Rothschild received early notice of Napoleon’s defeat at Waterloo, but then sold consols (British Government bonds), causing a panic in the market. Traders believed that he indeed had early warning, and that his selling indicated a British defeat. At which point he is supposed to have turned around and bought back his position, to make huge profits when Wellington’s dispatches arrived the following day. The story isn’t true, ironically. In fact, he did have early warning, but he passed the information to the British government and it was also published in a daily gazette. He wasn’t believed. There was a market panic as rumors of defeat went around, but Rothschild was a consistent buyer in the panic. He did make huge profits. The irony is that nobody believed that a trader like Nathan would tell the truth!

As the protagonist of my favorite television program, “House”, says - everyone lies. Some lie deliberately, but more commonly others are ignorant, misinformed or careless or simply cling to ideas and beliefs that aren’t true, despite overwhelming evidence to the contrary.

This has seldom been clearer than the present time. I see four distinct camps of belief or opinion.

1. The recession that hasn’t begun yet is over. The bottom is in after a brief and mild correction in the stock market. Swift and deft action by the Fed has stopped a credit problem from affecting the broad economy, and the fiscal stimulus programs soon to come into effect will put consumption and property prices back on a growth track. Supply will respond to demand, and the commodity inflation that has recently plagued the US will gradually disappear. The dollar’s decline will soon reverse itself, if it has not done so already, as growth accelerates once more. The recent pullback in the market has created a wealth of buying opportunities in “beaten-down” shares, notably in housing, financials and technology.
2. A recession has begun, which may be prolonged, due to falling consumer demand in the US. It may be just a growth recession, as although recovery will be slow, the recession will not be very deep. Unemployment may reach 6 or 7%, but the powerhouse Asian and European economies will keep global growth strong, and the US will be able to turn to exports for the resumption of growth, fortified by a falling dollar. Precious metals, commodities and overseas investments will be useful to protect wealth. The stock market probably has further to fall, likely to around 1100 on the S&P 500 to complete a cyclical bear market.
3. A recession has begun, which will be long and deep. Deep enough to be considered a depression, with US GDP falling 10-15% or possibly more and unemployment rates in the teens. Asian and European economies will not “decouple”, and will be pulled down along with the US. Deflationary pressures will be strong, and the major currencies will come back towards PPP. Demand for commodities and precious metals will fall as the world economy slows, and so will prices. Company earnings will fall, and shares fall even further, as years of bubble overvaluation come to an end, probably as low as the 400s on the S&P 500. Growth will only resume after the US has cleared the debt bubble and households have resumed saving.
4. A recession has begun, which will become a major depression, similar to, if not worse than, the 1930s. The financial system will crumble, and persistent attempts by the US Federal government to reflate the economy will cause hyperinflation, devaluing the US dollar to the point of worthlessness, along the lines of Weimar or Zimbabwe. Massive unemployment and shortages of food and energy will lead to civil unrest and wars. Commodities and the stock market will soar in nominal terms, but owners will not keep up with inflation. A gold-based currency will be seen as the only reasonable basis for renewed growth, and only holders of gold will be able to preserve their wealth as the price of gold soars to accommodate the need for hard currency.

Of course there are variations on the above. But these are the major themes that I see. Pick one you like and trade that way. I’m in #3. I’d be happy to hear other scenarios.