Market Healthier Than the Public Realizes

With all the lurking potential problems out there, why is the market holding up so well? And where’s the market headed the next few years? Perhaps the market knows something we aren’t aware of, such as:

1.	Of the United States 150 largest metropolitan areas, home prices last year increased in 73 of those markets;
2.	The second half of 2008 is expected to produce a spike in consumer spending from $107 billion of tax rebates;
3.	M-3, the broad (real) money supply, is increasing at the rate of 15-16% this year – a record for M-3 increases over the last 47 years;
4.	Since January of 2002, the dollar index (U. S. purchasing power measured against other leading world currencies) has decreased 36.5% making goods more affordable to foreigners;
5.	Foreign tourists are flooding the U. S. and shopping until they drop. Everything here is “cheap” and on sale from clothes to real estate;
6.	U. S. trade imbalances have created a pool of capital equal to $3.2 trillion dollars that is called the “sovereign funds” of other nations. These funds are finding their way back into the U. S. from the purchase of U. S. assets at what managers of these funds consider to be bargain prices;
7.	The Dow Industrials and the S & P 500 are selling at price-earnings ratios far below those in the rest of the world’s stock markets, and U. S. dividend yields far exceed dividend yields in the rest of the world’s markets;
8.	When key banks recently reported a loss of capital from sub-prime loans, Citibank, Merrill-Lynch and Bank of America were re-liquefied from foreign funds in less than thirty days;
9.	Money moves markets, and in addition to the current U. S. increase in money supply of 15%, Russia, India, China, the U. K., and Canada are increasing their money supplies at rates of 42%, 21%, 18%, 12% and 8% respectively;
10.	Globalization will continue to change the structure of ownership of the world’s assets. The modern period of globalization started in the fifties as a result of the dollar becoming the world’s reserve currency. Dollars “trapped” overseas from the Truman and the Marshall plans were used to invest in U. S. companies and U. S. assets setting off a boom in U. S. stocks in the 1950s. A super boom in stocks is being predicted by several economists from investments of the worlds Sovereign Wealth Funds now being used to purchase U. S. real estate, stocks and bonds;
11.	While we’ve been asleep, Russia has made the same moves to consolidate Putin’s power that Hitler made in the 1930s. The media has been nationalized, cooperation with NATO has been suspended and entire industries have been taken over by the central government. This insures a profitable and booming U. S. defense industry;
12.	Economic expansions are always associated with a build up in debt. Credit excesses used to be rectified with economic contractions, but our politicians today do anything to avoid recessions. Hence the high and continuing increases in M-3 over the last several years and the record increase in the money supply that is now occurring.

Now for the second question: Where is the market headed the next few years? Let’s apply some “Dow Theory” technical analysis in the form of the 50% principal.

The “50% Principal” states that a bear market does not exist until more than 50% of the markets gain from its bear market low has been lost. For example, this market’s bear market low was 7,286 points, occurring October 9th, 2002, and the high of 14,164 points occurred in October of 2007. The difference of 6,878 points between the high and the low, divided by 2 (50%) is 3,439 points, which added to the 7,286 point low, equals 10,725 points. According to Dow Theory, for the market to be declared a bear market, the Dow Jones Industrials would have to move below 10,725 points. The low of January 22, 2008 halted at 11,971 points, 1,250 points above the “50% level”. Currently the market is about 2000 points above the 50% level.

There are only two possibilities of where this market is headed:

1.	A bear market is in force, and it’s only a matter of time before the 50% mark is breached; or
2.	The current market downturn is simply a correction in an on-going, and renewed, bull market.

It would appear, based upon all of the above facts, we are in an extended bull market that has the potential to turn into a super boom due to the trillions of dollars in the world’s system available for equity investments.

Furthermore, the U. S. Federal Reserve System is charged by charter with two duties: to protect the purchasing power of the dollar, and to ensure that the economy is prosperous. It can appear sometimes that the two responsibilities are mutually exclusive. But here is how the Fed copes with their responsibilities when they appear to be in conflict with each other—it’s called moral suasion (convincing, persuasive talk). Recently, the moral suasion is introduced to us by Fed Vice Chairman Don Kohn, a long-time, veteran central banker. Kohn in several recent speeches has stated “The Fed is more worried about the U. S. economy than it is about the potential for inflation”. Translation: “the Fed will act to stimulate the economy by helping to re-liquefy the banks, and by reducing interest rates dramatically. But when it comes to fighting inflation with the economy mired in so many potential problems, the Fed will simply resort to talk about inflation while ignoring the rapidly decreasing purchasing power of the dollar”.
The Fed has closely watched the effects of deflation in Japan in the 1990s and wants nothing to do with a deflating economy. Clearly, more inflation is in our future. And when inflation becomes a “problem” as it did in the 1980s, the Fed will then face, and try to contain, that problem.

Money, money, money! There’s lots of it out there – there is not a shortage of capital. Selective investments in “A” rated stocks with high dividend yields and low price earnings ratios are likely to return very good results over the next several years. And with good dividend yields, the downside on these stocks should be minimal.

Carpe Diem.
George Rauch
February 29, 2008

....