Friday, October 30, 2009

The Long and the Short of It

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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In the short term the market can trade on fantasy, it the long term it always trades on reality. So we can state that at some point in the future, the current U.S. stock rally based on economic 'recovery' will eventually fade. It probably will not happen all at once, but in succession with small cap stocks turning down first and big caps last. The Russell 2000 chart looks awful, while the Dow Jones chart looks OK. There seems to be little if anything left to push stock prices higher. Short-term interest rates are already around zero and have been at that level since last December. The Feds only option to push stocks higher after a drop is to buy government bills, notes and bonds in the market with newly printed money. The Fed is supposed to stop its quantitative easing program for treasuries today however (this decision can be reversed in a heartbeat). The employment report next Friday is the next big test for stocks.

The stock market rally yesterday didn't evenly undo the damage from Wednesday. The Russell 2000 was up 2.5%, less than its 3.5% drop the day before, while the Dow was up 2.1%, more than its previous 1.2% drop. Nasdaq was the laggard, rising only 1.8%, also less than its 2.7% drop on Wednesday. The S&P did better, going up 2.3% after falling 2.0%. Spot gold rose as high as $1049.10 (there is resistance at $1050) after bouncing off support at $1025 the day before. Silver rose to $16.69. The dollar fell and closed at 75.94, below the key 76.00 level. Bonds had a significant sell off, with the 10-year treasury interest rate rising to 3.50% and the 30-year rising to 4.35%. For people who want to short long-term treasuries (the same as going long on interest rates), there is a leveraged 200% ETF, TBT and a leveraged 300% ETF, TMV. These are very aggressive trades.

News was out overnight on inflation and employment in the Eurozone. Year over year CPI is down 0.1%. While there is much hand wringing about deflation and this being caused by a weak economy, this is not what is actually keeping prices flat. Just as falling currencies are inflationary, rising currencies are deflationary. The euro has rallied from the 1.25 to the U.S. dollar range in early March to a high of 1.5020 on Oct 23rd. Since all commodities are priced in U.S. dollars, this has kept their costs from rising as much in Eurozone countries as they have in the U.S. This factor was even mentioned in news coverage in relationship to oil prices. When inflation is defined as a currency losing its value, everything else falls into falls into place. Mainstream economists rarely use this definition however - and their economic predictions are almost always wrong.

The current party line in the mainstream media on inflation is that it is going to happen, but not for three or four years, basically at some distant time in the future (so no one should be worrying about it). Admitting that inflation is going to be a problem at any point is actually a big switch in the tone of coverage. Deflation was the key theme in the news for most of the last two years. Inflation is going to start picking up by the CPI report for December. Why? Because oil prices are the key swing factor. Oil fell as low as $33 last December and gasoline was below $2 a gallon in the U.S. Oil closed yesterday at $79.87 and gasoline prices are closer to $3 a gallon. Oil's price this December is going to a lot higher than last year's and that is going raise the CPI number. While this is totally predictable, the mainstream financial media seems incapable of seeing what is coming. Even though they can't see the obvious that will take place 3-months ahead, they will quote predictions for 3-years from now. My impression is that most financial reporters haven't the slightest idea what is going on in the markets, but then again I don't like getting my investing advice from English majors. Anyone who gets their financial information from the mainstream media is doing just that.

NEXT: Bank Banruptcy Bonanza

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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