Short term: I originally went bullish on March 11th, largely due to the tremendous bearishness and I will likely get out when the sentiment turns overly bullish. At that time I said the Dow would go to 10,300 and as high as 11,500. It seems like a lifetime ago! Well, we’re almost there. Although rising unemployment will be a strong headwind for stocks, I came across an interesting stat: The current unemployment rate in the US is 9.8%. The last time the nation’s unemployment rate was 9.8% or higher was the 1-year period from 7/82 to 6/83. The total return for the S&P 500 in 1982 was +21.6%, followed by a +22.6% gain in 1983 (source: Department of Labor, BTN Research). So there is precedent for a rising market in bad economic times, but it is by no means the norm. For now, I will still ride the trend, but with one finger on the sell button. When it turns, it will turn fast so stay alert. Pray for peace but prepare for war.
Long term: Severe dangers still exist and will not go away anytime soon. This market is still a bear market rally or as I discussed in last week’s newsletter and “Echo Boom”. Bear market rally’s are to be rented not owned! Not a new bull market. We are all between a rock and a hard place. If the feds don’t stop printing money, the dollar will crash and hyperinflation zooms in. If they do, the economy crashes. The Federal Reserve maintains its actions won’t lead to excessive inflation because it can “pull the right amount of money out of the market at the right time” as Fed Chairman Ben Bernanke recently said. Does anybody really believe they have the prowess? I won’t bet on it and I certainly won’t bet our clients money on it.
The federal government’s promise to extricate the U.S. economy from this recession involves more spending which increases public debt and creates more subsidies for consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt. You cannot cure a too much debt problem with more debt. We cannot borrow our way into prosperity. Every crisis of the past decades has been a result of too much debt and leverage and we seem to want to repeat the past mistakes, hoping that this time it will be different. It won’t!
Enemy #1 for any capitalist society is deflation. That is why the government is fighting deflation at all costs and trying to spend its way out of this mess. They are trying their hardest to create inflation, and they won’t stop until they do. Inflation will help the banks by raising the value of homes and the value of mortgage-back securities, thereby restoring the value of their “toxic” assets. However, inflation will force the government to borrow more money and at high interest rates, going deeper into debt while managing cash flow problems either by raising taxes or cutting services. Already GDP stands at $14.2 trillion, so there is approximately $3.73 in debt for every dollar of output in the United States, a level unprecedented in our history. The deficits for 2010 assume a rather robust recovery, but they will probably turn out to be much worse, especially if unemployment continues to rise as I expect and Congress decides to extend unemployment benefits.
According to the current Office of Management and Budget (OMB) projections, US federal expenditures are projected to be $3.653 trillion in FY 2009 and $3.766 trillion in FY 2010, with unified deficits of $1.580 trillion and $1.502 trillion, respectively. These projections imply that the US will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. To put it simply, roughly 40% of what our government is spending has to be borrowed. The tipping point for hyperinflation occurs when the government’s deficit exceed 40% of its expenditures. No, the long term incredibly dangerous, and you had better manage your finances accordingly.
Regards – Keith Springer