How I See the Picture Unfolding Now

For the benefit of new readers, and to up-date all PROFIT CONFIDENTIAL readers, here’s my current interpretation of the stock market and economic action:

The bull market in stocks which started in 1982 (some will argue, 1974), ended in the spring of 2000. The euphoria surrounding the internet and hi-tech resulted in a rapid speculation I had not seen in years.

Once the tech bubble burst, the bear came in. From a high of 11,722 in early 2000, the Dow Jones Industrial Average (DJIA), the world’s most popular stock index that mirrors the stock price action of the 30 biggest companies on earth, fell to 7,286 by late 2002. Today, the DJIA sits at 9,825.

Basically, investors who sat with their big-cap mutual funds and practiced the buy-and-hold theory for stocks, which I detest, have averaged a simple annual loss of 3.3% over the past five years. Even if you take into consideration dividends, big-cap investors have been losers over the past five years. And if you take into account mutual fund management fees, they have actually faired worse than the popular average.

Some will argue the bear market ended at 7,286 in 2002 since stocks rallied upward from there. I tend to disagree as the DJIA never broke its all-time high after hitting the 2002 low. A bull market, by definition, starts when all-time highs are broken. In my humble opinion, I see 7,286 on the DJIA as being the first down leg of the bear market.

Right now, the DJIA could be on its way down to test, and ultimately break, its 2002 low, before finding a new low from which to rebound. That would result in leg two of the bear market being completed.

The excess of the tech rally on the economy was never really washed out as would be expected in a traditional growth and contraction economy. An all-out war by the Fed against the bear market (easy money, 46-low in interest rates) fought the bear like never before. This resulted in other bubbles being created, specifically debt and property bubbles.

Earlier this year, the Fed witnessed strong job growth. Hence, the Fed decided to start a policy of rising interest rates. The Fed has announced two quarter-point increases in the Federal Funds Rate so far, taking the rate to 1.5% from a 46-year low of 1%.

As I discussed when the first Fed hike was announced, I believe that Greenspan will be restricted on how far he can raise rates because the economy is not doing as well as expected. In fact, aside from real estate and construction, the economy, in correlation to a 46-year low in interest rates, is actually pathetic. Greenspan may only be raising rates now to lower them later.

The best leading indicator of the economy is the stock market. And the market tells us it sees trouble ahead. Maybe the market sees deflation. Or maybe the market believes consumers are financially tapped out. After all, consumer spending in the U.S. accounts for two-thirds of the U.S. Gross Domestic Product. If consumers reduce spending, we’ll be in big trouble.

Bottom line: Throughout history, the stock market has been the best leading indicator of the economy. And today, that indicator tells us trouble lies ahead. If interest rates were not so low, I would not take the implication as seriously as I do because the Fed would have the ultimate tool of lowering rates to stimulate the economy. But the Fed tried that and it didn’t work. I can’t see what economic stimulus ammunition the Fed has left to help the economy, thus cementing my bearish outlook.