Wednesday, March 17, 2010

Being Bullish

Last March the markets were crashing. There was a mild panic. No one knew how low it could go because it had already sank further than most predicted.

What a difference a year makes.

Today we had a
Dow Theory Confirmation. The Dow closed at a new high for the rally and above the 10,725 level, above the 50% Principle. Plus the Transports also closed at a new high for this most recent rally. First "commandment" of Dow Theory is that there is no clearer indication of future market trends than when the Dow and the Transports both close at new highs (or new lows) on the same day. This is a strongly positive signal.

The consensus is that the promise of
continued low interest rates fueled the rally today. This part of a continuing strategy by the Federal Reserve to promote historic levels of liquidity as a means of fighting off recession. Investor money is now coming back into the markets with more confidence.

So, is the Great Recession now over? Well, there are still
issues with employment and the federal debt. There is legitimate concern (in my opinion) about the long-term policy of the Fed. But, for the near-term consumer spending somehow remains strong even as the consumer paradoxically pays down their debt.

Despite the Confirmation, however, it is difficult to see how consumer spending is going to continue to hold up when there are no new jobs being created. The interesting thing in this situation is that, under ordinary circumstances, this much liquidity in a radically low interest-rate environment would produce at least a moderate level of inflation. That has not been the case. Because it hasn't been the case we are in some kind of strange limbo between deflation and inflation.

Deflation is a killer because of the high levels of public debt. In a deflationary world, the cost of most things goes down but the level of debt stays the same. Therefore, the debt feels larger in relation to everything else. On the other hand, in an inflationary world - with no job growth - the stress on cash flow can become overwhelming. In either case, stocks are subject to bearish retractions. Gold, however, is a more stable investment either way.

Overall, this appears to be the strongest economic trend since I started this blog. I could be second-guessing my sell-off of stocks back in December. But, I still put my faith in gold more so than in stocks. Clearly, however, the market is outperforming gold in recent weeks. Will that continue? No one knows but, according to Dow Theory, the near-term picture looks bright.

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