The markets are at the top of their range, where do we go from here?

March 21, 2012

Simple question but difficult to answer. Here is the long answer.

I still think that we are getting near a tipping point with both the economy and the markets. The “economy continues to improve” groups are basing their argument on headline numbers. For example,

1. Auto sales are up slightly but inventories are even higher;

2. or an average 200,000 jobs have been created over x months but that is not enough and half the jobs are part-time and for lower wages;

3. Or manufacturing and service indexes are over 50 and therefore show “modest growth,” but are higher inventories good for the economy or just GDP index.

4. Corporate profits are high (decades high levels) and going higher (implies margins will continue to expand), but many indications that margins will contract (rising costs, gasoline hurting consumers, increasing housing foreclosures mean people have to move and pay rent rather than spending their mortgage payment on restaurants and cars, etc.)

5. The warm whether is also a factor being ignored by the Fed’s models.

At the same time, the money the Federal Reserve and deficit spending have pumped into the economy is going into the markets as Bernanke wants to get them animal spirits going; and he is being helped by the media: consumer sentiment is improving and the VIX (volatility or risk measure) is now extremely low (what risk can there be?)

“Darth Vader” on the other hand is looking at the fact that the pace of money supply(the key driver of GDP) has started to contract and that means decline for the GDP by June/July unless there is a new stimulus program or QE3+.

I think the Fed is looking for an “excuse” to print more money but it can’t look like a political move so he needs some economic data to point to in order to pull the trigger. This could be some bad economic numbers or a market correction along with a correction in gold and silver. Or it could be done through stimulus as we prepare for to engage in another war.

Net/Net: The economy remains in recession and looks to stay there for some time because we have not addressed any of the issues that brought us into this recession or are keeping us there (spending, debt, central planning, printing money, government interference in the economy and markets, etc. etc.

But, the $8 trillion dollars pumped into the economy has helped GDP’s and increased assets. This is what politicians (including Fed Reserve politicians) do. It seems to be the only thing they know how to do. Therefore, I expect another round of stimulus or money printing in time to help the elections and before the new debate on the debt limit ceiling which will likely be reached by October.

Investments must be flexible (risk on, risk off) because the exact shape and timing of the markets are unknown; and tradable (for protection and opportunities) until the longer trend becomes known.

Net/Net: The short answer is that the market is at the top of its range and can only be held there by more action from the government.