2009Mar22 Week in Review

WEEK IN REVIEW:

 

This week, the markets surged above resistance at 7,400 with the Fed's announcement to buy $750 billion of agency debt (like Freddie Mac and Fannie Mae) $100 billion in other agency debt, and $300 billion of long-term Treasuries. The intent is to provide liquidity to mortgage lenders and to keep mortgage rates down. That means over a trillion dollars to knock down rates 0.6% or a bit more. Silver prices rallied over 10% and gold 6% and the U.S. dollar plunged -- not a sign of approval. The government has responded to China's concern over its devaluation of Treasury bonds by printing more money to buy more of them -- in other words, it ignored the warning from China!

 

The devaluation of the U.S. dollar is virtually guaranteed at this point as the government continues to signal that it will pay any price to stimulate the economy and prevent deflation. When you add up all the guarantees and agency bond purchases and budget deficits, the price of this stimulus is off the charts. A run on the dollar later this year as well as a lack of substantial response in the economy could be the key trigger for stocks to start crashing again.

 

Japan already tried this in the 1990s under better circumstances when the rest of the global economy was expanding, and it didn't work. As a result, their national debt went from 60% of GDP to almost 190% today! That's where we are likely headed -- from 60% recently as well. There is no other trading partner with the economic strength to pick up our slack.

 

We do not believe the current rally marks the end of the bear market. However, there are a growing number who do. We believe the bear market will not end until our country has a resurgent consumer spending experience. Demographically, that will not happen until 2012 when the echo boom X-Gens of the 70s reach their household peak spending years. Even then, it will only be a few years of relief. Permanent recovery must wait for the Millennials to reach peak spending years in 2024.

 

Consumer confidence remains at an all time low as well as consumer and producer prices and the Federal Reserve funds rate remains nearly zero. While consumer confidence is not correlated to stock prices, it is correlated to the propensity to spend money. Without spending, corporate profits will remain hard to realize which is not good for stocks.

 

Low interest rates have meant easy financing over the past quarter century, but not in our present mess. Hedge funds, banks and insurance companies are no longer investing in Consumer Debt Obligations (CDOs) effectively drying up around 40% of the previously available consumer financing capital. Even if the money was available, the increasing unemployment news puts a psychological damper on household spending. Too many people asking “What if I lose my job?” creates fiscal conservatism.

 

This economic environment remains deflationary rather than inflationary. Deflation is the greatest fear that Chairman Bernanke has because there is no monetary policy to correct it. That explains his willingness to expand money supply risking inflation. If inflation rises again to unacceptable levels, the Fed can aggressively contract money supply to deal with it. For a brief cartoon explaining the pros and cons of deflation, click here.