Inflection Point Decisions

Let’s start with what we know. The stock market has been going up. Some of us call it a rally in a bear market, and others say it’s the “start of the new bull market.” (Abby Cohen – Goldman Sachs.) Regardless of who is right; the market has come a long way since the March low. (Notice, I didn’t say bottom.) At this moment in time, the question becomes, “what is the right move going forward?” I say “this moment in time,” because it would appear the rally is showing some fatigue, and could be in the beginning throws of rolling over. However, it could be just catching its breath for an assault on 10,000, 11,000, or even 12,000. How about the old high of 14,000, and beyond? Anything is possible.

But, I said let’s start with what we know. Consumption (the consumer) is 70% of the economy, and the government is the other 30%. During recessions, consumer credit growth rarely goes negative. The exceptions are just after World War II, 1991 through 1992, and right now. This is significant because the consumer always leads the economy out of the recession. It’s the consumer getting jobs, earning money, and buying goods that ultimately creates a cycle that reinvigorates an economy. Government stimulus can help for just so long, but no economy can be resurrected without the consumer consuming. Every recession has been similar in that the consumer has had a large pot of savings, equity in their home, and a revolving line of credit cards to draw from. The key component stimulating the consumer to consume is confidence. Confidence that the consumer has a job, confidence that inflation will be under control, confidence they have a roof over their head, and confidence that tomorrow will be better than today.

As the government cranked up the printing presses in the Spring, people’s confidence level rose, as exhibited by the Consumer Confidence Index. However, real unemployment continued to decline, foreclosures continued to escalate, and confidence came down like a lead balloon. The consumer effectively stopped consuming. Yes, cash for clunkers was a large success, if you consider drawing demand from future auto sales successful, and if you consider adding several billions of dollars onto the balance sheets of people who can’t afford their next credit card payment. But this has been the government’s strategy, to get consumers spending again. Unfortunately, the consumer has, other than what the government doles out, nothing left. They are maxed on their credit cards, upside down on their house, out of a job, and scared to death. Thus, the government’s gambit of lowering interest rates, encouraging lending, and promoting giveaways all in the name of consumer stimulus has failed. Not because of a lack of credit, as politicians would have you believe, but because there is no demand from credit worthy borrowers. The American public has decided to close their wallets, and not take on any more debt.

However, the stock market continues to rise, and continues to ignore manipulated unemployment figures, rising deficits, accelerating foreclosures, P/E ratios not seen since early 2000, and insider selling at all-time highs. “Thus viewed, the stock market is but a mirror, which perhaps as in this instance, somewhat belatedly, provides an image of the underlying or fundamental economic situation. Cause and effect run from the economy to the stock market, never the reverse. In 1929, the economy was headed for trouble. Eventually, that trouble was violently reflected on Wall Street.” (– John Kenneth Galbraith) The real substance of economic life rests in production, employment, sales and personal income. In 2009, as in 1929, all four continue to decline. However, knowing all this, the inflection point says “It doesn’t matter.” The stock market could go dramatically higher; we should be long the market. It also says “It matters a great deal,” the stock market could go dramatically lower; we should be out of the market. Thus were developed hedges to take the guesswork out of a manipulative, frothy, and bizarre marketplace. The end point is known, it’s how to get there is the question.

Till next time,

Bill


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