Signs of a Bottom - Don't Count on It

I'm amazed at how many people come on TV and make statements like “Now is a good time to buy stocks for the long term” or “Stocks are trading at a 20% discount, they are cheap buy now.” I believe these people are clueless of what is really going on with the U.S. economy. The truth is that the Dow Jones Industrial Average will be trading below 11,000 before the third quarter in my judgment. What prompts me to write such bold statement are several reasons that I find fundamentally wrong with the U.S. economy.

My main reason for my bearish view on the markets is the monetary system. Currently the Federal Reserve is printing money and will probably continue to lower interest rates with the goal of stimulating economic growth. I find this to be a temporary band-aid on the economy. Lowering interest rates is not going to solve the countries debt problem, on the contrary is going to worsen the issue. Allen Greenspan, former Fed Chairman in 2001 lowered the Fed Funds Rate from 6% to 1.75%, than to 1% in 2003. This action created the availability of cheap credit, where anyone could borrow money at very low rates. This was the beginning of the housing market buddle. People began to buy homes at very low interest rates, not to mention the amount of dollars circulating in the economy was increasing. This combination creates two things bad investments and price inflation. We see this scenario with the rapid increase in housing price from 2001 to 2005. This also includes a 60% percent increase in the Dow Jones Industrial Average.

Price appreciation ended after Greenspan increased the Funds rate17 straight times to 5.25%. This makes borrowing money more expense on current and new debt. The outcome of higher interest rates with respect to housing is higher mortgage rates. With millions of American’s not being able to afford new “higher” mortgage rates they will default on their loans which leads to foreclosure. This is how the beginning of the housing crisis began.

Today, new Fed chairman Benny boy has stated that FOMC will lower interest rates to maintain stable economic and job growth. To me it seems that people already in debt will have access to more credit, and they will use this credit to pay for their living expenses which is increasing. This includes business as well. The main goal here according to the Fed is to create stimulus for consumers and incentives for business. The idea that the Fed has to lower rates to create incentives for companies to borrow money cheaply to expand and grow their business is absurd and unsustainable. The U.S. economy grows on borrowing money and printing money which lowers the value of the dollar and creates inflation. This model does not work in the long term if abuse and that is exactly what is going on. The model is being abuse.

To focus on the financial markets one interesting observation is if housing prices collapsed because of low interest rates and increase in the money supply, would the stock market suffer the same outcome? The answer to that question is YES. The stock market has been inflated with the creation of new dollars and lower interest rates. This buddle will burst at some point with a market correction of over 25%.