Current Thoughts on the Stock Market: Caveat Emptor!

Government surplus efforts are presently working.  Some are calling an end to the recession.  Green shoots are sprouting.  The stock market is breaking 2009 highs.   Life is back to normal.  All is well.  Or is it?

What is the real reason for all the happy faces of the folks on CNBC?

Answer:  Government spending.

I addressed the government spending effect on GDP  in June in an article called “What Really Backs the U.S. Dollar?”

The problem is that we’ve had our nice bounce in the market and a little in real estate, but there is nothing that has been put in place that is permanent in stimulating our economy except for more government spending.

When you build a house of cards on debt, and add more debt cards to the pyramid, eventually the weight of the cards will cause the pyramid to collapse (unless one has very special skills).  The Fed’s skills are indeed very special, but the solutions they have are not realistic.

There has been no time in our country’s history where adding more debt to debt has come out good (especially for the People’s purchasing power).  Heck, the government had to confiscate gold in 1933 when they last messed up our financial system and Bernanke thought this was good!

Deflation is only temporary.  Inflation is on the horizon.  The Fed’s policy of “stimulating” isn’t capable of getting GDP back to what it was.  It has helped out the Fed’s buddies over at Goldman and J.P. Morgan though.

“Let no man deceive you by any means…” 2 Thessalonians 2:3

The Stock Market Today

The Russell 2000, a better indicator of stocks than the DOW and S&P 500, is sitting at resistance.  P/E ratios are still nowhere near single digit “value” territory.  No one ever talks about this on CNBC or elsewhere.

Green shoots are short term effective, long term non-effective.  Same with spending on infrastructure which still needs much more attention and funds (aka taxpayer dollars).  California is a good example of what’s going wrong.  Governor Schwarzenegger is still not making the necessary cuts that need to be taken.

Unemployment in the U.S. is NOT subsiding.  Until it does, I wouldn’t expect a turnaround or an end of the recession like Newsweek and the Fed are claiming.  And I wouldn’t trust the government’s unemployment numbers as they don’t even count discouraged workers or those who work part-time just to survive any longer.

The one thing to keep an eye on, as I have said, is the U.S. dollar index.  The dollar bounced today off of the 78 area.  I had said that 72 on the index is the line in the sand.  All bets are off when we fall below that.  The Fed knows this.  How much more firepower do they have in interest rate manipulation?  Not much.

So when we do fall below that line of 72 in the sand, China and Japan will demand compensation for their vast U.S. treasury holdings and the Fed will have to oblige with higher interest rates to compensate for the weaker dollar.  This will be the beginning of the end.

When?  Don’t know.  But most portfolios have no hedge against a falling dollar (inflation) and financial advisors just don’t understand this is needed to insure portfolios against this coming fall in the dollar.  When gold breaks above $1,000 again, it will be because we are approaching that 72 mark in the dollar index.

Inflation, Interest Rates and Stock Market Predictability

According to Ed Easterling, author of the book, “Unexpected Returns;”

Prior to the 1960s, interest rates were relatively disconnected from inflation.  As the financial markets evolved, the relationship between inflation and interest rates–an accepted fact of modern finance–developed into a strong and relatively consistent relationship.

The average investor has tended to ride serenely through the turbulent volatility of interest rates and the bond market.  Why?  A generally declining trend in interest rates, and thus a generally rising trend in bond prices over the last twenty years, has obscured the volatility of interest rates and bond prices and led to the misperception of stability.  Also, media attention focuses far more on stock market action than on the bond market.

Since there is a connection between inflation and interest rates, Easterling goes on to say;

When inflation rises, the return that investors want from stocks increases because they wish to be compensated for the rise in inflation.  As a result, stock prices decline to a lower level where they can provide higher future returns.  When inflation falls into deflation, the result is a decline in future earnings.  If earnings are expected to decline in the future, the current price will decline as well.  You can see that from a level of very low inflation, a trend in either direction is not good for stock prices.

Since this post is getting long, I will expand on this analogy further with a future blog dedicated to P/E ratios, further signifying the continuance of this bear market.

Yes, I’m going out on a limb here, but I feel I have a better understanding of the economics of it all than most because I’ve spent the last four years researching in preparation for my forthcoming book: “Fed Up!”

Remember, all the Harvard and Wharton PhD boys got us into this mess to begin with.  Does anyone really expect these same folks to get us out of the mess? Same goes with your financial advisor.  Have they done anything to protect your portfolio from the coming inflation?

Lastly, October is just a few months away.  October is almost always a volatile month for stocks.  Caveat emptor!

Benchmarks as of this writing:

DOW 9096

S&P 500 at 976

Russell 2000 at 548