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REAL BULL OR NEXT ASSET BUBBLE?

|Includes: GS, JPM, SPDR S&P 500 Trust ETF (SPY), UUP, XOM
Often most bull markets are due to a decline in the fed funds rate; the interest rate that the Federal Reserve Bank charges other large institutions for overnight lending.  Obviously this has a major influence on the money supply.   The lower the rate, the easier credit should be, and the more money is in the system.  In 1980 and 1981 these rates fluctuated from 10%-19% respectively.   This  a major crimp on the economy.   When the so-called bull market began in 1982 many gave most of the credit to the then President Ronald Reagan and his so-called trickle down economics policy.  While tax cuts are always a stimulus for the market it is really the low Fed Funds rate set by the Federal Reserve Bank that gives the huge rise in asset prices.   Throughout the Reagan era the feds funds rate went from around 19.00% at one point down below 6.00% in 1986.  Yes, the bull was running as the easy credit flowed and the DJIA had advanced from 817 in April 1980 to 2596 in September 1987.  This was a run for the ages; however, there was a major crash and panic in 1987.


Now lets fast forward to the roaring 1990's. The markets again faced a declining housing market in the late 1988 throughout the early 1990's.  There was a recession taking place and a new President was elected.  It's always about the economy when it comes to Presidents and this time a second birth of the bull began.   The fed funds rate was steadily kept around 5.00-5.50 % and the market continued to climb.   In 1999 the rate was decreased to less than 5.00% and the bull market advance was a run for the ages as the DJIA crossed over the 11,000 level.   Then as we all know in 2000 the great bear awoke as the stock market began a 2.5 year decline as the Dow lost 4700 points from peak to trough.


In 2003, the Fed funds rate was lowered to 1.00 %, this was really uncharted waters from the Federal Reserve Bank.  Again a new President was elected, taxes were cut and this gave birth to one of the greatest bubbles in American history.  It has been called the great housing and credit bubble of the new millennium.   Even as the former Fed Chairman Alan Greenspan increased rates by a quarter point at every FOMC meeting beginning in 2004 and continued to do this until 2006 when the fed funds rate was as high as 5.25%.  As we all know in October 2007 the great collapse began as the DJIA peaked at 14,200.  Since that top the fed funds rate has steadily been lowered to the current 0 - 0.25% rate.


As of now the low rate and massive global stimulus has rallied the markets over 50% from the March 2009 low.  However, this has come with a cost as the U.S. Dollar is near its 2008 lows and commodity prices have soared recently.  The last time the dollar was this low oil was at $147 a barrel and that certainly was a factor to the major break in the market.  The big question now is going to be what does the Federal Reserve Bank do for an encore?  The fed funds rate obviously cannot go any lower.  Therefore, the plan they have must be simply to inflate this market back to health.  One can only ask why would they want to do that?  Wouldn't this just be doing exactly what was done to create the original problem?  There can only be one answer, and that is to attempt to fight deflation.  The recent breakout of gold is telling us that they will inflate at all costs.  The only real currency that the world has ever known (gold) does not lie.  When you really think about it the market has had a huge rally off it's March lows and so has gold.   The only problem with this rally is that since the U.S. Dollar has fallen so much what have you really made in the market?  Gold right now is the better trade over the DJIA.


Can the Fed really bail us out of the possible deflationary spiral that has plagued Japan since the late 1980's?  Only time will tell.  The one thing we all know is that the fed funds rates can't stay at zero forever.   What are they to do for an encore?   Perhaps they may buy gold to protect their own accounts.  This is surely going to be a volatile decade ahead of us.


Nicholas Santiago,
Chief Market Strategist
www.InTheMoneyStocks.com