Why We're Not Buying This Market

Two big dangers are manifesting themselves, the lack of consumer demand and rising interest rates.

We've already been warning for quite some time about rising interest rates. There are so many government bonds arriving at the markets, demand for them (especially from abroad as both the dollar and the US fiscal position are seen as vulnerable) might be somewhat problematic. To an extent, reduced foreign appetite will be made up by increased domestic buying as the American savings rate is increasing, but enthusiasm might be limited because of inflation fears, which are never good for bonds.

This is because the present economic situation which is characterized by highly indebted balance sheet has much to gain from mild inflation, so interest rates will rise to make up for increased inflationary expectations and this is already starting. We can only hope they don't rise to levels where they snuff out any recovery, however weak, but this is a serious risk.

Another risk has some relation to this: governments and central banks everywhere are spending and creating money to fill the large gaps in demand as consumption and investment have fallen because of the credit crisis and weak balance sheets. The idea is that at some point, this will create enough economic activity as to be self-sustaining, that is, more or less normal levels of private consumption and investment will take over from the public spending in generating economic activity further.

The only sign that this could happen is increased consumer confidence in America. But there are numerous problems here:

• The US dollar is weak, and is likely to get weaker still, giving that American consumer on which much of the rest of the world has relied upon to a considerable extent less and less bang for their buck. A tell-tale sign: American imports are falling at a heavy (20%+) pace.
• Unemployment is rising, which has a direct effect on consumption, but also an indirect effect, as many more working people fear getting laid off and cutback spending
• Much of the consumer boom in the US (but also in the UK and other countries) was credit induced and based on rising house prices. These mechanisms have gone in reverse, and it doesn't look like the overdrive of negative savings and mortgage induced spending will return any time soon (and in fact, in itself that is a good thing)
• Consumers in other countries are not likely to fill in the void left by the American consumer, at least not nearly to the same extent.
• Japan, Germany and the rest of Europe is in at least as big a funk as the US (if not bigger), and they have stagnant (or even shrinking) populations which are fast getting older
• There are a few places where economic growth still is in place, most notably China and India, but the first has a soft currency limiting imports and demand is increasingly dependent on the public sector while the latter, although surprising on the upside this week, is much less integrated in the world economy then China.

So where is the demand supposed to come from after the public stimulus programs have ran their courses? We think the most developed countries at least will experience a pretty prolonged period of lackluster economic growth at best, possibly even prolonged recession.

The latter is the real danger, because if the recession continues for some time, public spending will hit the limits of fiscal sustainability. This is already happening in countries like Iceland, Spain, Ireland and quite likely the UK and Italy, possibly Japan as well.

If that happened in America and continental Europe, well, then things would really turn ugly.

Comments

[dgfurr:]

You Might be right, but the markets don't don't thimk you are. I do beleive that you should not buy this market. In fact maybe you should not buy any market, that way you can proclaim to everyone, as the markets continue to rise, just how bad the economy really is and how wrong every investor must be. Good luck with that.

May 31 02:16 PM

[Old Trader:]

I think that India may end up suprising more than a few people. The outcome of the recent elections there is a HUGE positive for their economy. I'm not talking an overnight turnaround; they do have some major issues to deal with, notably really poor infrastructure, but if one looks 5 to 10 years down the road, some money invested there might show some really nice returns.

May 31 03:48 PM

[EUARTE:]

I should be on the Fed board. I have not a clue!

May 31 04:10 PM

[adan:]

the history of our country shows that immigration helped pull us through more often than most people realize

and that often the generally uneducated, but hungry industrious willing-to-assimilate immigrant was the best

balance that with some well-to-do's for immediate larger tax contributions, and no more so-called aging population!

but, i believe, if wasteful spending and dishonesty in goverment and big business, are not rectified, then it'll all just happen again -

actually, "again" again...that's in our history too....

May 31 04:50 PM

[Bjarne Jensen:]

Adan: I spent severasl years in the LA region of California. I have news for you, Mexican immigrants have no intention or desire to learn english. Their prespective is that they are reoccupying their country and anglos need to learn spanish. It is different this time!


On May 31 04:50 PM adan wrote:

> the history of our country shows that immigration helped pull us
> through more often than most people realize
>
> and that often the generally uneducated, but hungry industrious willing-to-assimilate
> immigrant was the best
>
> balance that with some well-to-do's for immediate larger tax contributions,
> and no more so-called aging population!
>
> but, i believe, if wasteful spending and dishonesty in goverment
> and big business, are not rectified, then it'll all just happen again
> -
>
> actually, "again" again...that's in our history too....

May 31 09:29 PM

[Chris Shenf...:]

It was John Keynes, the influential British economist, who once said "the market can stay irrational longer than you can stay solvent".
What this means is regardless of whether you characterize the present market as "irrational" based on a dire economic prediction (as this article seems to do) or as a strong rally based on real prospects of improving fundamentals (see www.minyanville.com/ar...), Mr. Market is the final arbiter of stock prices. I go with the latter and have been buying this rally aggressively based on my view that prices move first, then fundamentals.

May 31 10:18 PM

[Shareholder...:]

Squares, we agree to a certain extent. The rally so far was justified, at 6500, a severe depression was priced in (we're not THAT pessimistic), but much more upside is not justified. Unless we really see much more fundamental improvement, we can't really see the rally get past 1000 on the S&P anytime soon. We do not think it's likely that we'll see that much fundamental improvement, for the reasons stated in the article. But we have no crystal ball..

Jun 01 12:51 AM

[spadice:]

Keep your bear cap close on your head, don't lose it and sleep, sleep at your satisfaction, nothing wrong with it.
In the meantime I put on my bull cap and buy low, very low.
What shows the history? If you still don't know it....ask the most succesfull investors!

Jun 01 05:16 AM

[prairiedog555:]

I shall invest in producing economies such as EWA, EWC, EWZ

Jun 01 11:58 AM

[Chris Shenf...:]

Once we really see much more fundamental improvement in the US, the rally will be over. As for emerging markets, the fundamentals have already started improving. By the time you start buying, I'll start selling.

On Jun 01 12:51 AM Shareholders Unite wrote:

> Squares, we agree to a certain extent. The rally so far was justified,
> at 6500, a severe depression was priced in (we're not THAT pessimistic),
> but much more upside is not justified. Unless we really see much
> more fundamental improvement, we can't really see the rally get past
> 1000 on the S&P anytime soon. We do not think it's likely that
> we'll see that much fundamental improvement, for the reasons stated
> in the article. But we have no crystal ball..

Jun 01 12:27 PM

[Shareholder...:]

We did advise to buy earlier on and still have a buy on InterOil (which really is a no-brainer) :)

Jun 01 02:29 PM