The Only Thing the Stock Market Cares About for Direction

by Michael Lombardi, CFP, MBA

During the period from 1982 to 2008, interest rates went only one way: down. Investors and consumers enjoyed a 26-year period of falling interest rates. Those 26 years also coincided with the greatest bull market investors have ever seen.

Getting right to the point, in my study of interest rate cycles, I find that interest rates trend in multi-year cycles either going up or down. We all know that interest rates cannot go any lower than they are today, which means that they have only one direction to go in the future: up.

While the Administration in Washington continues its all-out war against the economy, spending trillions to turn the economy around, interest rates cannot stay at zero for ever. In fact, at one point, the surging money supply and ever-rising debt of the U.S. will force interest rates higher. It is only a matter of time.

China is demanding more guarantees that its trillions of dollars in U.S. bonds are safe. To me, that means higher interest rates to keep the dollar strong and China happy. Federal Reserve Chairman Ben Bernanke is urging government spending restraint. The Chancellor of Germany, Angelina Merkel, is publicly asking world central banks to show money supply restraint.

When you add it all up, the future to me looks like inflation and higher interest rates. And that is something the stock market does not like. In fact, if there is one thing that determines the direction of the stock market more than anything else, it is the direction of interest rates. Hence, if we enter a multi-year period of higher interest rates, which is where I believe we are headed, we are in for a much lower stock market.

Paul Volcker was the Chairman of the Federal Reserve under Presidents Carter and Reagan from the period 1979 to 1987. Volcker is widely credited with raising the Federal Funds Rate to 20% in 1981. Interestingly, Paul Volcker is the current chairman of President Obama’s newly created Economic Recovery Advisory Board.

Can history repeat itself? You bet it can.

Michael’s Personal Notes:

I believe that the great majority of individual investors have missed the current market rally. Since its 12-year low on March 9, 2009, the S&P 500 has risen 40%. Of course, the investing public’s portfolios have not increased in value by 40% since March. Retail investors always miss major market moves; they also enter the stock market at the worst possible times. This is what I see happening now: As all major American stock markets are up now for 2009, stocks will continue to advance, finally luring the individual investor back into the market. And that’s exactly when the big, bad bear will turn south again and take investors’ hard-earned money once more. What a game!

Where the Market Stands:

The Dow Jones Industrial Average has finally followed other major stock market indices and turned positive for 2009. I have been saying this would happen since March…and finally the Dow Jones delivered my wish. From here, I believe that the stock market will continue to climb higher on “the wall of worry.” A bear market rally? You bet. But why not enjoy it and make some money while it lasts?

What He Said:

“Prepare for the worst economic period ahead that we have seen in years, my dear reader, as that is what I see coming. I’ve written over the past three years how, in the late 1920s, real estate prices fell first before the stock market and how I felt that the same would happen this time. Home prices in the U.S. peaked in 2005 and started falling in 2006. The stock market is following suit here in 2008. Is a depression coming? No. How about a severe deflationary recession? Yes!” Michael Lombardi in PROFIT CONFIDENTIAL, January 21, 2008. Michael started talking about and predicting the economic catastrophe we started experiencing in 2008 long before anyone else.