The economy would have to be weak for us to start speculating on whether the Federal Reserve will start buying corporate bonds to prop things up. But that's where we find ourselves in the wake of last Friday's dismal employment figures.
True, hours and wages increased a bit in May. But that means little in light of the fact that the economy only created 41,000 private sector jobs. We need to do much better than that if we hope to achieve a self-sustaining economy.
Assuming (and this is an easy assumption) that our leaders are not willing to simply let America plummet into a second Great Depression, there are only two possible actions.
First, Congress could put together a huge spending package to stimulate the economy. However, it barely managed to pass a rotten package a year ago. With an election coming up and more voters dead against higher deficits, we doubt a new stimulus package could be passed before winter, if at all.
The second alternative would be for the Fed to reinstate quantitative easing (for instance, buying corporate bonds to pump new money into the economy or for that matter just selling the dollar hand over fist). Our guess is that we are one or, at most, two bad economic statistics away from such a program.
This brings us to the stock market, which (as Wall Street frequently forgets) is more than just the world's largest casino operation. The market has a huge impact on the real economy and the net worth of individuals.
We don't like to pay too much attention to precise technical levels, but if the S&P 500 were to break below 1040, many investors would be drawing comparisons with the recession/bear market of 2001-2002. It could be a self-fulfilling prophesy as the selling got underway with chilling consequences such as the possibility of the S&P even taking out its 2009 lows.
Fortunately, we still have a bullish divergence in which small cap stocks have been outperforming large caps. That suggests a serious recession is unlikely. However, in both the late 1970s and in 2001-2, small cap stocks similarly held up quite well, while large caps (and hence the major indices) fell 20%.
It may be, in fact, that the small caps are showing strength because they anticipate the Fed will take measures, such as quantitative easing, to support the overall economy and the broad market – even if large caps stocks suffer a sell-off.
Our bet for some time has been that the government and the Fed would prefer to have inflation rather than recession/depression. Admittedly, one could put together a case for either option at the moment. But it's exactly today's rampant fear of deflation that should prompt our leaders to make sure inflation is the more likely outcome.
Meanwhile, the weakening U.S. economic picture gives rise to another key question for investors...
WHICH IS WORSE: THE DOLLAR OR THE EURO?
Tuesday morning, we had a report from Germany that factory orders have increased significantly. No doubt this is the result of the recent decline in the euro. Germany, whose currency would be much higher if it was not mixed in with the euro, gets a boost to its exports as the common currency falls.
We can't say at the moment which currency has the worse outlook going forwards: the euro or the U.S. dollar. Both suffer from hideous fundamentals. Right now, sentiment seems to be against the euro and we may see the euro fall close to parity with the dollar in the next few months. However, if the Fed is forced to engage in more quantitative easing, the relative strength the dollar has at the moment would dissolve.
For investors, rather than try to guess which currency will be the worst loser in this troubled period, the key is to preserving wealth will be to focus on the one clear winner. By that, we mean gold. Gold is the one currency that cannot be undermined by any nation's profligate spending or weak economy. Therefore, it's the one currency that retains value when all others fall.
Incidentally, we don't mean just gold here. Other precious metals such as silver and the platinum group will do well as the world's major currencies decline.
So for the time being, if we had to pick two top investment categories, the first would be gold and gold-related stocks such as ASA Ltd. (NYSE:ASA) and Newcrest (OTCPK:NCMGY).
Turning to other commodities, we don't see the recent downturn in prices as anything but temporary - baring a serious recession. And even in that case, the resulting stimulation efforts around the world would reignite the commodity bull in short order.
With investors focusing on the recent Greek debt crisis and weakness in the world markets, several events bullish for commodities have escaped their due attention. One of these is Australia's recent decision to impose a 40% tax on mining, which signals the growth of economic nationalism in resource-rich nations. This movement will surely increase the scarcity of industrial metals and lead to higher prices.
The on-going oil spill in the Gulf may be getting a lot of attention, but only as an environmental catastrophe. What is being underplayed is the effect it will have on oil prices. At the very least, the spill will lead to heavier regulations and higher costs for offshore drilling, a slowdown in the development of these deposits, and higher oil prices over the next few years. The worst case scenario would be if offshore drilling is deemed too dangerous to continue at all, in which case oil prices will climb at an even steeper rate.
Rising oil costs raise the likelihood of a sharp advance in natural gas prices. Natural gas is a less expensive alternative to oil that is seriously undervalued at the moment. But because it is not immediately substitutable for oil will need a catalyst. A political cry for natural gas cars would do the trick. So our second top investment category is companies involved in natural gas production. Two excellent choices we mentioned last week are ConocoPhillips (NYSE:COP) and Nabors (NYSE:NBR).