So let’s get this straight right from the beginning. The real world that we all live in has a lot of problems. Many economists say we are slipping back into a recession - a double dip. Others point out that the economy has never gained enough traction to come out of the original recession that started back in December of 2007. The most optimistic of economists state that the economy is actually growing, albeit at a very slow pace and that we are currently experiencing a “soft patch.”
Then there is another economy, one that my friend and writer Ron Coby refers to as the casino economy. That economy is comprised of the stock and bond markets. That economy is also heavily influenced by the Federal Reserve and their money printing machines. That economy is analogous to a professional athlete on steroids. How good would these markets really be if it weren’t under the constant injection of freshly printed money?
The S& P is down 4.6% year to date, not exactly setting the world on fire. There is talk of a bond bubble. The housing market looks to be imploding again. The job market is stagnant and maybe vulnerable. Congress is already getting into reelected mode. I understand the need to be optimistic, but it is essential to recognize the type economic backdrop we are in. After a period of unprecedented government bailouts and stimulus programs, existing home sales collapsed a record 27%, month over month, to an all time low of 3.83 million annualized units. New home sales fell 12% last month, to a rate of 276,000 units annually, which marked the lowest number since economists started tracking home sales back in 1963. Are you kidding me? In addition, the average price for a home dipped again and is now back to levels last seen in 2003.
This Housing data is telling us something valuable about the real world economy where mortgage rates have tumbled nearly 100 basis points in the last year to a record low of 4.36% for 30-year loans, and the government has implemented a plethora of programs to put a floor under the housing market, yet housing continues to decline in both prices and sales. Some will argue that things would be much worse without all this manipulation, but when is enough going to be enough?
In the casino stock market, droves of individual investors are pulling the cord and bailing out of any further participation as the real world data does not seem congruent with the stock markets action. The market is being supported in a very big way by the Federal Reserve’s commitment to keep the money printing presses on overdrive for an extended period of time. What does it mean when the US Federal Reserve is the second largest owner of US Treasury debt globally? How good would it be if you could go down to your tool shed and print your own money to buy back your own debt?
There is money out there. But try to get a loan if you’re an average American or a small struggling business – that money is hardly available to you. It is estimated that corporate America has over $1 trillion in excess reserves. We are witnessing a pickup in mergers and acquisitions, and many of these deals are for cash – not debt (like the 80’s) or equities (like the 90’s). Let the stock and housing markets find their own equilibrium. Stop wasting taxpayers’ money on trying to influence those markets. After more than ten trillion dollars of global government intervention, how much better off are we in the real world economy?
If the government stopped intervening on behalf of the business community, there would most likely be a sharp and painful reconciliation, but the economy and markets would bottom quicker and allow the healing process to begin sooner. They should focus on job creation, or the lack thereof. So far we have had the government expend huge resources to keep many failing industries afloat, but that has generated very little in the way of positive long lasting results as the economy is teetering back towards a recession. Hopefully the real world starts to recover soon but band aides only treat the symptoms, they don’t provide a cure.
As far as the casino economy is concerned, the stock market has become extremely oversold on a technical basis. Markets tend to back and fill in those instances. In addition sentiment has become overwhelmingly bearish. The recent AAII (American Association of Individual Investors – sometimes referred to by professionals in the industry as dumb money) numbers show only 20.7% bullish. There have been only 48 times in the history of this association that bullishness has dropped below 21% and in 47 of those 48 instances the market was higher three months later. Finally we had Fed Chair Ben Bernanke’s promise on Friday that he was ready, willing, and able to employ all his resources (read keep the money printing presses going 24 / 7) to keep the economy from falling off a cliff.
So we covered our short positions in anticipation of support holding at around 1040 on the S&P 500; 2100 holding on the NASDAQ; and 580 holding on the Russell 2000 small company index. The markets will most likely rally enough to work off the oversold conditions and lift the spirits of individual investors just enough to get crushed at a later date. Resistance for the above mentioned indices are probably in the ranges of 1100- 1130; 2220 – 2280; and 630 – 645 respectively before the market again pursues a lower path.
There is a tremendous amount of speculation in the bond market. Is it a bubble or not? Can bonds even have a bubble – or not? Are heavily debated topics of conversation. Let me clarify this right here – ALL INVESTMENTS CARRY RISK! If you put your money under a mattress you have inflation risk and risk of theft. If you buy treasuries, rates can go up and you can lose principal if you sell prior to maturity. If you hold individual treasury bonds for the full term, sure you get the full amount back, but inflation could decrease the purchasing power of your matured value.
Ten year treasury rates have dropped from over 4% in April to 2.5% Friday morning. That’s a 37.5% move in four months. That kind of move happened most recently at the end of 2008. Within seven months the entire move was retraced and many people lost a lot of money. Currently bonds carry a lot of risk! To lock in a rate of 3.7% for ten years, one would really have to believe that we are and will be in dire straits economically for a long, long time.
I believe patience will pay dividends. For those traders out there – money can be made buying stock and shorting bonds for an ultra short time frame. For more conservative long term investors sit this rally out, wait for better yields on the bonds and hopefully by the time the elections are over, the markets will start to normalize again. There are two worlds right now – the one we all live in and the stock and bond market world that is under the control of the Fed. Ensure you can separate the two before they separate you from your money.
Disclosure: Pacific Financial Planners holds positions in GLD, JJC, SINA, SLV, & TBT
Pacific Financial Planners is not recommending any investments in this article as we do not know your timeframe and risk tolerance. Before investing in any ideas or taking any action you should first consult with your own financial advisor.