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Critical Economic and Market Commentary 12/03/09

Posted At : December 18, 2009 1:42 PM

Market Update – It feels like the 2004 election…on Viagra

Not since the 2004 presidential election has the country been so divided. I’m not talking about abortion, Iraq or the Yankees but rather about whether the economy is on the rebound or heading back into the abyss once the governments Viagra injections into the economy wear off. Both sides have a very strong argument which is why people on either side are so vehement about their convictions.

The Bears tout that the economy is on life support and/or still enjoying its healthy dose of Viagra and will most certainly collapse once the prescription runs out. This side is hard to disagree with. The U.S. has borrowed and burdened us, the taxpayers (and our kids…and kids kids etc) with enough debt to rival that of a banana republic.

The United States government is financing its more than trillion-dollar-a-year borrowing with i.o.u.’s on terms that seem too good to be true, but that happy situation of ultralow interest rates can’t last much longer. Treasury officials face a series of headaches: mountains of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed. Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent overstretched American homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher. In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan! Ouch!!

The Bulls on the other hand, continue to push the belief that the worst is behind us and the economy is on the mend. They point to the strong economic data released over the last several months as proof, and they’re right. Unemployment does seem to be leveling off (although severely high), industrial production is on the increase, the Leading Economic Indicators are looking astoundingly strong as well as a host of decent to good other reports.

The best support for the bullish cause comes from shear momentum. The market is rising and is usually a pretty good gauge of future economic activity. This bull market rally is hitting the ninth month mark, and looking at the past twelve market cycles of the past +4 decades, it is still young as the average bull market lasted almost twenty nine months.

With the Fed keeping rates artificially low, there is an enormous amount of liquidity available, which is critical. In very simple terms, the two most important things for investing is: “don’t fight the tape and don’t fight the fed”.

Is this another bubble in the making? Almost certainly. I discuss this bubble in my September 11th Market Update: Building another bubble…it’s a Hubba Bubba nightmare. Click the link to read


For the immediate term, the market looks strong and heading higher. However, the rally is beginning to show signs of aging. Over the last few months we have been seeing the shift from small caps to large caps, which is typical of the latter stages. More recently over the past few weeks, the DJI, S&P 500 and NY Comp. Index have been advancing to new highs on lower volume, while breadth and momentum indicators have shown signs of increasingly selective strength. This puts the rally into phase 2, a much more selective (and dangerous) environment for investors, but not one to avoid as long as you hold the proper investments. That said, every investor must have an exit strategy as there will definitely be a time to go to cash.

For the longer term, the demographic cycle of the aging baby boomer, which is turning from net spender to net saver, is the biggest obstacle. This is a natural demographic cycle that happens every 40 years or so, but the government seems to have a short memory while the people even shorter. I suppose if it’s not an election year problem, it’s not a problem. This is precisely what Japan experienced throughout the 1990s and 2000s. The Land of the Rising Sun has yet to recover from its credit bubble of the late 1980s, and the country’s aging demographics virtually insure that it will linger for some time. This is what a modern-day depression looks like. The economy does not tumble year after year; it stalls out. It contracts by, say, a percent or two one year, then returns to tepid growth for a year or two before falling into contraction again and again.

(I discuss the long term economic forecast and the current demographic situation in depth in my landmark special report: An Economic Tsunami Lies Ahead, which is as pertinent today’s as when it was first published. For a complimentary copy, click the link, (ET Link) reply back or give me a call. We now have it in pdf format, so it can be emailed to you.)

*The reality of the situation is that both sides are right! Just like Viagra, the stimulus can’t last forever….but it can make for a very fun and productive now.

So in conclusion and pertaining to the 2004 election, the Bears win the popular vote while the Bulls get the electoral vote.

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