Short-Term Rally; Long-Term Worry Still the Name of the Game

I often get asked the question: “Why are you so gloomy?” Or “Why can’t you look at the BRIGHT side of things?”

And you know what my answer is? In regular life, I am an optimist. Optimistic to a fault actually! Just ask my family or friends.

But when it comes to the markets, it’s a different story. I’m neither an optimist NOR a pessimist. I’m a realist. I call things like I see ‘em.

That’s what I did back in 2005, when I predicted a massive housing crash … only to be ridiculed by some for being too glum. And that’s what I did back in 2007, when I called for a massive credit market crack up … only to earn more heaps of scorn.

So what about now, in light of the recent rally? I wish I could be more positive about the economic outlook. But the evidence just isn’t pointing in that direction …

• We have ongoing weakness in housing,
• We have continuing problems in the banking sector,
• And American consumers are tapped out — more interested in paying OFF debt rather than taking more ON.

Meanwhile, governments are out of fiscal policy bullets — and central bankers don’t have any more rabbits up their sleeve. That doesn’t mean the stock market is going to go straight down. And it doesn’t mean the economy has to collapse tomorrow.

But it DOES mean the risk of a Double-Dip Recession is extremely high … and the need for portfolio protection is greater than ever.

“Less Bad” Doesn’t Mean “Good”

If it seems to you like the markets are all over the map right now, trust me. You’re not alone.

One day, the world looks like it’s coming to an end and stocks are falling off a cliff. The next day, some piece of news comes in slightly better than expected and the markets take off like a Polaris missile.

That’s precisely what we’ve seen happen over the past couple of weeks. It’s not like the news is great. It’s just been slightly “less bad.” And that has helped light a fire under stocks.

But, folks, this is all short-term stuff …

Take a step back from the day-to-day market gyrations, and the big picture becomes clear. Stocks are still more than 6 percent off their high, and the recent rally has done absolutely nothing more than push the market into a zone of key technical resistance.

As for the fundamental news, I don’t see anything that suggests a robust recovery is underway. Far from it.

Take retail sales. They rose just 0.4 percent in August, roughly in line with forecasts. And it took deep discounts and tax-free back-to-school holidays in 17 states to generate even that paltry gain.

Americans are focused on paying down debts, not spending.

Or how about Best Buy, the electronics giant that reported earnings this week. The company managed to beat earnings expectations. But it wasn’t because of a healthy increase in sales.

In fact, sales at stores open at least one year, called “same store sales,” actually FELL 1 percent from a year ago. Only things like share repurchases and cost cuts helped bolster the bottom line.

At the same time, industrial production growth decelerated to just 0.2 percent in August from 0.6 percent in July.

And the New York Federal Reserve’s economic index slumped to a 14-month low of 4.1 in September. That was down from 7.1 in August and well below the average economist forecast of 8.

Meanwhile, the economic news continues to weaken overseas. Investor confidence in Germany plunged to the lowest level in 19 months in September, while European industrial production flatlined in July compared with forecasts for a small gain.

Warnings Coming in from
All Over the Globe

I’m not the only one who’s concerned by the way things are shaping up. The warnings are flooding in from around the globe …

• Ethan Harris, a Bank of America Merrill Lynch economist says of the recovery: “We were waiting for the second stage of the rocket, and it just fizzled out” …
• Dominique Strauss-Kahn, a managing director at the International Monetary Fund says “the labor market is in dire straits” with economies reflecting a “wasteland of joblessness” …
• Mohamed El-Erian, chief executive officer of the massive fixed income investment firm Pacific Investment Management Co., just told Bloomberg: “Already, there are too many examples of policy outcomes that have fallen well short of expectations.”

El Erian also warned of “the high unemployment rate that persists in the face of unprecedented fiscal stimulus and the extended use of unconventional monetary policy” … and noted that “Normally, cash burns a hole in the pockets of Americans, especially when the Federal Reserve is aggressively using low interest rates to push us all to assume more risk. Not today.”

• The European Union, in a brand new report, further warned that the continent’s economy is going to slow down dramatically — coming to a virtual standstill in the fourth quarter, with growth of just 0.3 percent.
• And The Wall Street Journal pulled no punches a few days ago. It said: “Hopes of a U.S.-led recovery have faded as American consumers retrench. Bursts of growth in Japan and Germany are waning or expected to do so. China and other big developing nations are still growing strongly, but at a slower rate than they were not long ago.”

Again, this doesn’t guarantee that the stock market is going to tank day in and day out. But the accumulation of all these lousy fundamentals and dire warnings should have you paying attention and looking to reduce risk in your stock portfolios.

Policymakers Running Out of Options —
But You Sure Aren’t!

The E/U foresees a stagnant economy ahead for Europe.

A year or two ago, if the economy ran off the rails like this, governments worldwide would respond with massive stimulus spending. Central bankers would cut interest rates to the bone.

But they’ve already tried that once … and it clearly didn’t work! Now there aren’t any policy bullets left in the gun. Even countries that theoretically could boost stimulus spending are finding it politically impossible to do so.

All told, I remain unimpressed with the recent rally. Similar rallies in mid-June and mid-July fizzled out once the fundamentals reasserted themselves, and I’m looking for a three-peat.

Until next time,

Mike

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