We are seeing some hesitation in the upward movement of stocks despite what has been a fairly decent earnings season early on. The problem I see is the influx of uncertainties in Europe that is making traders think hard about going long.

While there are problems with jobs and housing in the United States, you must not forget about the massive debt and deficit problems plaguing Europe. Without renewal in Europe and other foreign markets, we cannot expect a sustainable recovery.

In Europe, Spain recently said it would need to raise more capital; this country remains in a risky position.

Britain reported that its fourth-quarter GDP contracted 0.5%, not something you want to hear.

Take a look at the comparative growth rates. In Europe, there are concerns with the slow growth there. In Germany, the GDP growth in 2011 is estimated to fall to 1.4%. In comparison, the U.S. economy is predicted to grow about 2.4% in 2011.

The Organization for Economic Cooperation and Development (OECD) expects growth in the U.S. and Japan to exceed that in Europe.

I feel that Europe may continue to underperform the global markets in 2010 and 2011.

In Europe, the 27-member European Union (EU) is critical to the global economic recovery. There are over 500 million people in the EU, accounting for about 28% of the world’s gross world product in 2009, according to data from the International Monetary Fund.

The problem is that the big countries such as Germany and France are supporting the weaker members who cannot survive on their own at this time without capital infusion. This is not good and will hamper growth in Europe. The trillion-dollar austerity measures will take away from investing in the country’s growth and economic renewal.

Weak members such as Greece, Ireland, and Portugal may need to be cut off from the EU until such a time that they can rebuild their financial infrastructure, but I doubt this would happen.

The last thing the EU wants is weak members dragging the member group down, especially at a time when the countries are trying to rebound from the global recession.

The reality is that the global economies are interlinked and problems in one region of the world will have a domino effect on countries and regions thousands of miles away. You cannot escape this relationship and, unless there is global economic renewal, I feel there will continue to be high risk.

The bottom line is that sustained growth in America cannot be achieved without renewal in the major world economies, which is why Europe should not be ignored.

Economic issues have a concrete impact on any country’s domestic policy. The problem is that world economies are so intertwined that their relationships and any issues arising from these relationships sometimes have an adverse impact on how governments formulate and implement policy. The U.S. policy has had its share of such adverse consequences, the most prominent being the country’s dependence on foreign oil and, more recently — and more importantly — its dependence on foreign debt financing.

According to the latest data posted on the U.S. National Debt Clock, foreigners own about $3.98 million of U.S. Treasuries. China and Japan own most of them, holding $900 billion and $795 billion, respectively. Year-over-year, foreign ownership of U.S. Treasuries rose almost 20%, faster than the U.S. government could issue them at a rate of 15.6%.

Why is the U.S. selling its debt faster than it can print it? The short answer is that domestic savings are so low they are almost non-existent. Relying on the statistics posted on the Debt Clock, average savings per every man, woman and child in America is a measly $1,058!

Expressed as a percentage of GDP, some 30 to 40 years ago Americans were saving between five percent and seven percent. In the past 20 years, that rate has dropped to somewhere between one percent and three percent; although, in the wake of the Great Recession, the savings rate has improved slightly. Still, unless interest rates start rising, Americans have no real reason to start saving more aggressively. And, given the Fed’s policy on interest rates, it is unlikely that we will see them going up anytime soon.

The picture of the U.S. overall savings is just as bad as that of Americans’ personal savings. Total savings of any country are comprised of consumer and corporate savings, plus government surpluses. In early 2009, just as the Great Recession came for its proverbial pound of flesh, U.S. total savings expressed as a percentage of GDP entered negative territory for the first time since 1952.

Why so much difficulty saving money? Why the accumulation of so much debt? Well, saving money in the U.S. is not a simple matter of having the will to save. It is primarily the consequence of the country’s overall inability to finance itself via domestic means. The U.S. government is currently operating with a monster of a budget deficit, the size of which has grown to $1.44 trillion at the latest count, or more than 10% of GDP. This also means that the government does not have enough money to finance itself, which is why it has to rely on foreigners to buy the Treasuries and pay for them with actual money.

There is no other way of putting it: dependence on foreign debt financing represents a serious economic and strategic risk for the U.S. According to the Congressional Budget Office, the U.S. will need to run the deficit until at least 2035, because the government savings rate is negative and foreign debt financing might be the only thing keeping it from bankruptcy.

What can make a dent in the U.S. reliance on foreign financing through debt? There are several ways, such as increasing the savings rate on all levels: consumer; corporate; and government. The government would also need to increase taxes and use that revenue to pay down the deficit. The U.S. government should also introduce aggressive austerity measures.

The alternative is grim. Being a long-term debt nation will start — and possibly already is — shaping U.S. policy. It could mean that our largest creditors could be in a position to tell us what to do and dictate what role we play on the international stage and how we conduct ourselves on that stage. That risk of being indebted as a nation to other nations was not lost on the Founding Fathers. It was Thomas Jefferson who said it that, “To preserve our independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude. Our properties within our own territories should not be taxed or regulated by any power on earth but our own.”

— “Calling the Trend” Column, by George Leong, B.Comm.

Okay, are you sitting down? Get ready, but President Obama announced that the U.S. budget deficit would come in at a record $1.56 trillion, or 10.6% of GDP this year. The deficit in 2009 was about $1.41 trillion. That is a massive amount and well above the previous estimate of $1.35 trillion. The mounting deficit is even more concerning in light of the mounting debt of $12.32 trillion, or $40,000 per citizen. As I alluded to in a previous editorial, the national debt has increased at about $3.89 billion per day since September 2007.

The fear is that the weak financial position of the U.S. will put pressure on the demand for U.S. investable assets such as debt, stocks, and real estate. China, the largest buyer and holder of U.S. debt has been expressing concern towards the mounting debt and size of the deficits. If China decides to buy less U.S. debt, it could place pressure on the U.S. treasury to increase the interest rate offered. The reality is that China has increased clout in the U.S. due to its holding nearly $2.0 trillion in U.S. debt. Could you imagine if China decided to start selling off the debt? That could negatively impact the bond market. What I feel China will do is add less U.S. debt and look to diversify to other countries in Europe where the financial situation is not as bad.

President Obama has suggested that the deficit will begin to fall in 2011 to around $1.27 trillion, but, even so, it is a significant amount — and don’t forget the mounting national debt and related interest payments. Luckily, interest rates are low at this time, but once they reverse — and they eventually will — the associated interest will be massive.

The President will be looking at slashing some costs to cut down the deficit, but, given the continued fragile state of the economy, it could backfire. The reality is that the country faces financial hurdles going forward. Jobs creation will be a key going forward in trying to drive up consumer spending and the GDP. Only in this way can the economy hope to recover faster and help President Obama in his plans to reduce the deficit and increase government revenues. The problem is that if the global and U.S. economies struggle with minor growth, it will impact the hopes of President Obama. And we have yet to discuss the financial impact of the proposed healthcare plan that is under debate.

Make no mistake about it, the U.S. economy will continue to face some hurt going forward. President Obama can only do so much, but, as I said, he will need a lot of help from the global economies and domestic recovery.

— “Profit Confidential” Column, by Michael Lombard, CFP, MBA

Here are some outlandish, almost frightening numbers I want my readers to be aware of:

• The government deficit for the current fiscal year (what it spends as opposed to what it takes in) is expected to be a record $1.6 trillion.
• This year’s deficit will represent 10.6% of the total U.S. gross domestic product (GDP), the biggest percentage since World War II.
• By the year 2020, the public debt will be $18.5 billion.
• Interest on the debt will hit $800 billion annually by 2020.

Where is all the money going?

Blame wars, Medicare, social security programs, “boost-the-economy” programs and lack of tax revenue mixed with rising interest payments for our increasing debt.

The best news I saw in the 2011 budget plan announced by the President yesterday was a freeze on discretionary spending outside of defense and security.

The worst part of the 2011 budget plan?

Higher taxes, of course. The proposal is to raise taxes on Americans making more than $200,000 a year by almost $970 billion…just part of a broad $1.9-billion tax increase proposal.

I’ve never been a big fan of raising taxes to pay the deficits governments have created. Not because I’m greedy and want to keep more of what I make (the later which is natural), but because raising taxes stifles consumer spending and job creation.

As a businessman, why would I want to go out, take the risk of starting or expanding a business (which will hopefully create more jobs), work so many longer hours, just to pay more tax in the end?

My personal opinion be known, taxes should be lowered and government spending slashed. That’s how I believe we will create jobs in the long term. But my feelings aside, from an economic standpoint, I can tell my readers this.

If we look at history, and we specifically look at countries that through time raised taxes sharply because of fast rising national debt, in all those cases, the currency of those countries eventually fell sharply in value against other world currencies. 

My questions: Can the U.S. dollar sustain a $1.6-trillion deficit this year without falling in value? Can the U.S. dollar sustain national debt of $18.5 trillion 10 years from now? The answer to both questions is NO. I pity those foreigners buying the debt we issue to sustain our bad spending habits. Unfortunately, one day, we will be the ones to be pitied.

Michael’s Personal Notes:

Thank you to the 10,094 people who signed up in January to receive PROFIT CONFIDENTIAL — a new monthly record for us. We truly enjoy writing to you each day. Hopefully, we are making adifference…helping you with today’s difficult investment decisions.

Thursday of last week, gold bullion prices fell to a three-month low and, this past Friday in PROFIT CONFIDENTIAL, I wrote about the fire-sale going in the junior gold market. The junior mining companies may have hit bottom here in terms of price. I see great bargains among the junior gold companies.

Where the Market Stands:

Dow Jones Industrial Average starts this morning down 2.3% so far for 2010. An important article appeared yesterday in PROFIT CONFIDENTIAL about the relationship between the stock market and the U.S. dollar. If the dollar is up, the market is down. If the dollar is down, the market is up.

There is no doubt the stock market loves a weak U.S. dollar. This morning, with the U.S. dollar coming under pressure again, stocks are moving higher.

I continue with my view that there is more life left to the bear market rally that started on March 9, 2009.

What He Said:

“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour waits…people are spending in America today at an unbelievable clip. 1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.

— “Calling the Trend” Column, by George Leong, B.Comm.

Markets are currently in a funk and unable to fight the downward bias that has taken hold of stocks despite some decent quarterly results. Last Thursday saw another triple-digit loss for the DOW, the fifth in the last nine sessions. Markets have declined in six of nine sessions on a trend of weak market breadth, as there is little interest in buying at this time. The S&P 500 is testing key support at 1,080, while the DOW is eyeing 10,000. The charts do not look good, especially given the weak Relative Strength. Support will be from the oversold condition.

January will end up in the red, with the DOW and NASDAQ down over two percent. In mid January, markets were up over two percent and things were looking pretty good, but stocks then began to slide and have done so in five of the last eight sessions to January 27. As we have said in previous commentary, what happens in January could help influence how stocks behave going forward. A positive January can point to gains and given the current situation; a negative January may point to a negative year, yet there is no concrete relationship.

The S&P 500 option volatility reading (VIX) has been rising after being flat for weeks. The VIX is holding at 24 after recently trading as high as 28, its highest reading in months, an indication of increased fear in the market. Be careful as market risk has increased and this could result in more volatility.

At this moment, traders and investors are cautious on wanting to bid stocks up given the uncertainty regarding the strength of the economic renewal in both the U.S. and globally. The gains in 2009 were excellent and have been largely discounted.

The fourth-quarter GDP grew at a sizzling 5.7% annualized rise, the biggest reading since the third quarter of 2003, largely due to stimulus. Watch what happens when the stimulus moderates going forward and the economy will have to rely on organic growth.

President Obama delivered his second annual State of the Union address last Wednesday at a time when there has been much debate on how effective he has been in his first year in the Oval Office. The President took office at a very difficult time, when the U.S. and global economies were slowing and entering a recession. Over seven million jobs have been lost in 2008 and 2009, and homeowners continue to see their home values fall.

The President did what was expected in trying to rally his troops to advance America. He acknowledged the difficulties, but also called for bipartisan efforts to advance key areas such as healthcare reform, while taking aim at Wall Street. Again, he talked about the importance of small businesses and the creation of jobs, but there was really nothing new here. It was more or less a rallying cry by a President operating in a hostile environment. The next year will prove crucial. The significant growth in the debt and deficit will become more of a sore point over the next five to 10 years.

The estimates set the deficit at a whopping $1.35 trillion this year. Add in the mounting debt of $12.32 trillion or $40,000 per citizen and you’ll understand the immensity. The national debt has increased at about $3.89 billion per day since September 2007. President Obama is looking at cutting some costs, but given the still fragile state of the economy, this could backfire. The reality is that the country faces financial hurdles going forward.

— “The Financial World According to Inya” Column by Inya Ivkovic, MA

I know, I don’t need to beat this “we-are-not-out-of-the-woods-yet” dead horse. Yet, what makes me pick up that bat repeatedly is irrational optimism, too much of it and too often. Don’t get me wrong, I’m basically more of an optimist than a pessimist, but irrational optimism really ups my “worry factor.”

Now, I’m not saying there is no reason for optimism. In the midterm, the U.S. outlook should be fairly optimistic. We went through a financial crisis, we survived credit drying up and we experienced investor exodus towards safety and quality.

However, this rudimentary “cash parking” ended about six months ago. It seems that, these days, the market has found its new equilibrium and its pendulum has stopped swinging violently. Toxic assets seem to have been flushed out and, typically, after such panics as the one we lived through in 2008/2009, the economy tends to make up lost ground relatively quickly. The only wrench thrown into worldwide economies’ wheels — and it is quite a wrench — would be trillions of dollars in budget deficits left in the wake of unprecedented and concerted worldwide economic stimuli that had essentially flooded the global financial systems.

There are other wrenches, too, such as stagflation. With so much debt on the table, there may come a moment when the U.S. Federal Reserve, for example, won’t be able to keep inflation under control. The only way for any central bank to impact inflation is to have a financially healthy government to back it up. But when a government is technically insolvent, inflation is going to happen and there is nothing its central bank can do about it. The worst case scenario would be getting stuck at high price levels with no recourse against them. Unfortunately, that is also quite a plausible scenario.

Making matters worse are potential new defaults happening elsewhere in our globally interconnected economies. Like Iceland before it, Greece appears to be de facto bankrupt, if not de jure. Most governments around the world are suffocating under monstrous amounts of debt, which cannot be easily herded and is likely to lead towards high and distorted taxes, potentially causing unbearable deadweight on the society.

Then there are government tendencies to micromanage and hide behind aggressive policy-making. Proponents of the free market believe that the economy should be left to its own devices. Perhaps there are arguments to be made supporting this thesis, but I cannot shake the possibility that the market being free of any reins is what got us into this mess in the first place. I also don’t have an answer for this one, other than to acknowledge that the U.S. government and the Fed are really stuck between the proverbial rock and a hard place.

If there was any advice to be given to Obama Administration, it would be to stop making reactionary decisions in a panic. Every single thing that has gone wrong with our world most likely cannot be fixed and certainly not within a year. Sometimes being patient and giving time for the dust to settle and raw wounds to heal is the right way to go. Policymakers should also become better listeners, focusing on what economy is trying to “say,” and devising policy that is evidence-based, not panic-based.

— “The Financial World According to Inya” Column by Inya Ivkovic, MA

I know, I don’t need to beat this “we-are-not-out-of-the-woods-yet” dead horse. Yet, what makes me pick up that bat repeatedly is irrational optimism, too much of it and too often. Don’t get me wrong, I’m basically more of an optimist than a pessimist, but irrational optimism really ups my “worry factor.”

Now, I’m not saying there is no reason for optimism. In the midterm, the U.S. outlook should be fairly optimistic. We went through a financial crisis, we survived credit drying up and we experienced investor exodus towards safety and quality.

However, this rudimentary “cash parking” ended about six months ago. It seems that, these days, the market has found its new equilibrium and its pendulum has stopped swinging violently. Toxic assets seem to have been flushed out and, typically, after such panics as the one we lived through in 2008/2009, the economy tends to make up lost ground relatively quickly. The only wrench thrown into worldwide economies’ wheels — and it is quite a wrench — would be trillions of dollars in budget deficits left in the wake of unprecedented and concerted worldwide economic stimuli that had essentially flooded the global financial systems.

There are other wrenches, too, such as stagflation. With so much debt on the table, there may come a moment when the U.S. Federal Reserve, for example, won’t be able to keep inflation under control. The only way for any central bank to impact inflation is to have a financially healthy government to back it up. But when a government is technically insolvent, inflation is going to happen and there is nothing its central bank can do about it. The worst case scenario would be getting stuck at high price levels with no recourse against them. Unfortunately, that is also quite a plausible scenario.

Making matters worse are potential new defaults happening elsewhere in our globally interconnected economies. Like Iceland before it, Greece appears to be de facto bankrupt, if not de jure. Most governments around the world are suffocating under monstrous amounts of debt, which cannot be easily herded and is likely to lead towards high and distorted taxes, potentially causing unbearable deadweight on the society.

Then there are government tendencies to micromanage and hide behind aggressive policy-making. Proponents of the free market believe that the economy should be left to its own devices. Perhaps there are arguments to be made supporting this thesis, but I cannot shake the possibility that the market being free of any reins is what got us into this mess in the first place. I also don’t have an answer for this one, other than to acknowledge that the U.S. government and the Fed are really stuck between the proverbial rock and a hard place.

If there was any advice to be given to Obama Administration, it would be to stop making reactionary decisions in a panic. Every single thing that has gone wrong with our world most likely cannot be fixed and certainly not within a year. Sometimes being patient and giving time for the dust to settle and raw wounds to heal is the right way to go. Policymakers should also become better listeners, focusing on what economy is trying to “say,” and devising policy that is evidence-based, not panic-based.

— “Calling the Trend” Column, by George Leong, B.Comm.

By the time you read this, President Obama would have delivered his second annual State of the Union address on Wednesday at a time when there has been much debate of how effective he has been as commander and leader in his first year in the oval office. The President took office at a very difficult time, when the U.S. and global economies were slowing and entering a recession. Over seven million jobs were lost in 2009, and the homeowners continue to see their home values fall. In fact, it will be a difficult speech to make as he tries to express to Americans the challenges he is facing and how he will continue to try to fix things.

Yet there has been no job creation yet, although the government’s massive economic stimulus spending has saved jobs from being axed. The question is: how effective has the spending been to actually generate real and sustainable employment? CNN has been doing its own research into the cost-benefit of the many economic stimulus projects and, quite frankly, some have been questionable as far as the success. Some actually appear to be more of a waste of funds, yet you would expect wastage when spending nearly a trillion dollars. President Obama has hoped the economy would improve and lessen the need for further spending, but so far it has been a difficult road.

The reality is that the country has grown its debt and deficit levels and this is a growing risk, but it’s required to jumpstart the economy out of the recession. Fiscal spending will slow, as many incentive programs have come to an end or are about to, so the economy must produce. I sense that more incentives may be required to avoid a relapse. The Federal Reserve will likely hold interest rates at record lows for at least the first half of 2010 and then take a close look at the economy. Inflation remains a non-issue, which plays well for rates.

Adding to the concern is an estimate setting the deficit at a whopping $1.35 trillion this year. Add in the mounting debt of $12.32 trillion or $40,000 per citizen and you’d understand the immensity of it. The national debt has increased at about $3.89 billion per day since September 2007. President Obama is looking at cutting some costs, but given the still fragile state of the economy, it could backfire. The reality is that the country faces financial hurdles going forward and the President will likely indicate this.

Jobs and housing and their impact on consumer spending and confidence will be the key variables to monitor this year. Given the lagging jobs, there will be pressure for the Obama administration to reverse the losses and generate jobs in 2010. Only through job gains will consumers become more confident when deciding to make that next non-essential purchase. The reality is that corporate America is likely hesitant when thinking about adding jobs until the economy begins to show more life, which is not good. 

Let’s hope that the economy picks up, or there could be more hurt going forward for both the government and Americans.

— by Inya Ivkovic, MA

Honestly, nothing could have prepared me for what the White House forecasted on Tuesday concerning the federal deficit. I congratulate them on their honesty, but if there ever was a time I would have preferred being lied to, it was on Tuesday, when the budget deficit forecast for the next decade was announced.

The final tally was a 10-year cumulative deficit of $9.0 trillion. And some tally that was! Even if we were to sum up all previous deficits since the Boston Tea Party, it still wouldn’t top the current $9.0-trillion figure over a 10-year period. Or, for those who like to think in proportions, for the next decade, America’s debt will represent three-quarters of its total economy. Adding insult to injury, before anything can be done about it, the U.S. still has to survive the recession and unemployment aftershocks in the vicinity of 10%.

What else are President Obama’s number-crunchers saying? Not as if they haven’t said enough, but the new estimate is for a U.S. 2009 GDP contraction from 2.5% to 2.8%, even as the economy is crawling its way up out of the deepest slump in decades. This latest estimate on economic growth is also the grimmest so far this year. Considering we are four months from the year-end, this estimate unfortunately has the most chance of coming to fruition.

To say that the challenges ahead of Obama are huge would be the understatement of the year. The economy is still far too vulnerable to afford traditional deficit-reducing methods, such as spending cuts and tax increases. Then there are at this point some “psychotic” U.S. debt holders, particularly foreign bondholders, who could — maybe and only maybe — be convinced to hold on just a bit longer if interest rates are increased. But increasing interest rates might once and for all silence the famed American consumer.

How did Wall Street react? Well, you’d think those rascals would all up in arms about the prospect of the leanest decade in history, but they got their pacifier in the form of President Obama’s decision to nominate Republican Ben Bernanke for a second term as the Fed’s chairman. I suppose that, for a moment’s peace to digest the news, it is a small price to pay. But I shudder thinking what will happen once the Titanic and that iceberg of federal deficit make contact.

Joking aside, of course I don’t really like to be lied to, so I have to say “kudos” one more time to Obama for having the guts to be honest with America and tell it like it is. It couldn’t have come at a worse time for him, yet he didn’t falter. The man promised he would cut the deficit in half by 2013. I suppose that’s not going to happen. Had the economy held as forecasters expected it to at the end of 2008 and early this year, this goal would have been easily achieved. Alas! And Obama’s swan song was supposed be his healthcare bill. I have a feeling that’s not going to happen either. Adding another trillion dollars to the proverbial iceberg of a deficit is not likely to fly with lawmakers, with the public or with Obama himself.

Having said all that, I refuse to join the Republicans’ pouncing. That’s just demoralizing and the last thing we can afford at the moment. Yes, we know that borrowing, spending and debt are out of control. And, yes, you don’t have to have a degree in math to realize that a deficit of $9.0 trillion in aggregate over the next decade is essentially unsustainable. But that’s just describing the water to a drowning nation.

I’m short on ideas on where the exit is, although, like many others, I know which doors lead nowhere. The only idea I have is for ordinary people, which may not even be an idea, but merely common sense. That idea is to dig down, work harder than ever, save more than ever, eliminate debt aggressively and ruthlessly, and, most importantly, unlearn the behavior of senseless consumerism. Republicans, Democrats, Independents or “Uninteresteds,” we have all been enslaved by a mountain of debt of our own creation. If we want to be free again, the decade ahead will have to be the decade of the fiscally responsible, humble and frugal Americans.

— by Michael Lombardi, CFP, MBA

Here are three important concerns about the economy I want to share with my readers this morning:

For the fiscal year that will end this September 30, 2009, the U.S. budget deficit will reach $1.8 billion. (I remember when the Bush Administration reached its first $500-billion annual deficit and I thought that was a lot). Government debt is increasing so rapidly that the U.S. Treasury has asked Congress to increase the government statutory debt limit past the current $12.1-trillion maximum.

Interest rates rise and decline in long-term trends. Since the early 1980s, interest rates have fallen. In fact, we have just come off a 27-year cycle of declining interest rates. There is only one way for interest rates to go, and that is up. While most analysts expect the Fed to keep interest rates down right into 2010, it is a safe assumption that any spike in the inflation rate will send interest rates higher.

The U.S. is very dependent on foreign countries buying our bonds, the proceeds of which are used to finance our deficit. With our total debt increasing so rapidly, how long will it take before foreigners start having real concern over our bonds? More specifically, at some point, foreigners may demand higher interest rates on our bonds as an incentive to keep buying them.

Have you ever heard the saying “paying the piper?” In this case, it means that there is a severe price we will have to eventually pay for this massive monetary stimulus program. Every action in the economy has an eventual reaction. The risks to the U.S. are very clear: too much debt; the viability of the U.S. dollar as a world reserve currency; and higher interest rates.

These are real concerns all my readers should know about and be prepared for. Unless the gas peddle is soon eased on the monetary stimulus, we could be headed for another economic crash.

Michael’s Personal Notes:

In a commentary in “The New York Times” yesterday, Warren Buffett had words of caution for the Administration. Buffett warns that the mass of monetary stimulus pumped into the economy to save it could have severe side effects. This is exactly what I have been writing about in PROFIT CONFIDENTIAL over the past few weeks. I’ve never seen a monetary action not have side effects. After months and months of reduced interest rates, an expanding money supply, and increasing debt, all these monetary incentives will have a widespread effect on the economy if they are not reined in soon. We could be going from one financial crisis to another.

Where the Market Stands:

The Dow Jones Industrial Average sits five percent higher than it did when it started the year and 43% higher than its March 9, 2009, low. Yes, from the depths of the March bear market low, the Dow Jones has regained 43% of its losses. While most retail investors have missed the boat on this rally, we have seen many stocks double in price.

But the stock market these days is confusing the heck out of short-term analysts and day traders. Monday, the market fell sharply when Companies, Inc. (NYSE/LOW) missed earnings expectation. On Tuesday, the market rallied when The Home Depot, Inc. (NYSE/HD) reported better-than-expected earnings. And this morning, futures are pointing to a weak day, as news spreads that China’s Shanghai Composite Index has entered a bear market.

I tend to see the news as an excuse as to why something has happened — not the reason something is going to happen. The bottom-line question: Is the bear market rally over? My answer is no. We still have a very good chance of the Dow Jones breaking through the psychologically important 10,000 level.

What He Said:

“I see the coming recession as being deep and difficult, because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that, when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2006. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.

— by Michael Lombardi, CFP

If a company takes on too much debt, and then needs to borrow money to pay back loans, or worse, borrows money just to make interest payments on its old loans, what eventually happens to that company? Yes, it goes broke, because at a certain point, lenders will not lend to the company. Add falling revenue to the mix and the company is surely headed for bankruptcy.

Is the overall state of America’s finances really any different from the above example? We know revenue for the government has fallen off quickly, as corporations and individuals pay less tax because they are making less money. While money coming in (tax revenue) is decreasing, costs of the economic bailout and two ongoing wars have risen.

For the first time in history, the U.S. deficit has surpassed $1.0 trillion. The government’s fiscal year ends October 31, 2009, and the deficit is expected to hit $1.8 trillion by then. Think about it: we are taking in $1.8 trillion a year less than we pay out. That’s $5.0 billion more a day that our government spends than it takes in. How long can this go on for? When will the proverbial “house of cards” start to come apart?

Going back to my example of a company following the same path, at a certain point, losses will be unsustainable. The best-case scenario (and what we all hope for) is that the economy turns around, the costs of the economic bailouts decline, and tax revenue picks up. My concern is the cost of other major projects being considered, such as a revamping of our medical system and the “going green” initiative. Where is the money going to come from for these new costs?

As I have written many times, there are several risks we are running with this high-deficit policy. We are risking the status of the U.S. being the world’s reserve currency, we are risking foreigners not wanting to buy our bonds and, ultimately, we could be setting ourselves up for higher interest rates. The stock market loves a lower U.S. dollar, but it hates higher interest rates.

I’m doing my best to monitor the house of cards for my loyal readers, as there will be risk and opportunities in the months ahead for investors who are prepared for higher interest rates. My readers will not be caught off guard. 

Michael’s Personal Notes:

Last week was the best week for stocks since March. Many of the major market indices like the Dow Jones Industrial Average and the S&P 500 were up 7.0% for the week. Better than expected earnings reports from companies like IBM, Google, General Electric Co., and the banks caught many investors off guard. Second-quarter earnings reports are 16% better than analysts had expected (according to Bloomberg).

The stock market is rallying again and the positive economic forecasts are also starting to roll out again. Not so fast, I say. The economy is still on very shaky ground. The government itself expects the unemployment rate to hit 10%, banks are not lending to business like they use to, and home foreclosure rates continue to rise. We are far from being out of the woods.

Where the Market Stands:

The Dow Jones Industrial Average, which was up 7.0% last week, is now close to the breakeven point for 2009. The media was quick to credit last week’s stock rally to better than anticipated earnings reports form large U.S. companies. Yes, earnings reports for the second quarter are coming in at an average of 16% better than analyst expectations, but please remember that the market always does the opposite of what is expected of it. Two weeks ago, most analysts had been calling the bear market rally that started March 9, 2009, as over. The stock market is delivering the opposite.

What He Said:

“When property prices start coming down in North America, it won’t be a pretty sight, because consumers are too leveraged. When consumers have over-borrowed so much that they have no more room in their credit lines to borrow more, when institutions start to get tight on lending, demand for housing will decline and so will prices. It’s only a matter of logic, reality and time.” Michael Lombardi, in PROFIT CONFIDENTIAL, June 23, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.

— by George Leong, B. Comm.

There are rumblings regarding why President Obama decided to fire General Motors Corporation’s (NYSE/GM) CEO Richard Wagoner Jr. after allowing the CEO of American International Group, Inc. (BYSE/AIG), Edward M. Liddy, to keep his job.

These are difficult times and sometimes things don’t make much sense. The lack of consistency from President Obama is worrisome, as is the government’s role in interfering with the free market system. GM has received about $15.0 billion in aid, compared to a whopping $180 billion by AIG. There appears to be a different approach to Wall Street and GM. This is not healthy for the market’s confidence. Whether the GM firing was right or wrong, the point is that there must be a consistent and fair approach. In a free market, it is up to the board of directors to decide on the fate of its CEO and not the government.

In the case of GM, maybe the company, which is now coined “Government Motors,” should be allowed to seek bankruptcy protection and then restructure thereafter, instead of receiving more funding. It appears this could happen unless the government can somehow come up with a solution to the grave problem at GM. And don’t forget there are over 240,000 jobs at GM at stake, along with the thousands of jobs from companies linked to GM. The company will need to be saved, but not by simply giving it taxpayers’ money. A workable solution must be developed.

The sad reality is that the government cannot help every sector that is in trouble. Next we could see the retail sector seeking help. The auto parts sector has already requested billions in aid. The government does not have an endless supply of money.

The deficit will run in the trillions and could swell even more. As a government, you simply cannot just hand out money. The recent weak auction of U.S. debt is a concern, as the money loaned has to come from somewhere, since you cannot simply go out and print money. Mind you, in Europe, the idea of printing extra money has been put out there. China may begin to reduce its investment in U.S. debt due to its concerns regarding the U.S. economy and desire to diversify its foreign reserves outside U.S. assets. This will impact the debt market.

Anyways, there is a sense that markets could eventually trade lower again. As I have been saying, the global economic and investment climate is not right, and will continue to require tons of work. The upcoming G20 meeting will try to look at solutions, but we are hearing resistance to more spending from some countries, such as Germany. The leader of the European Union called the U.S. spending a “way to hell.”

It may not be a way to hell, but clearly the growing size of the deficit is a concern, especially if the recession is longer and deeper than expected. President Obama is betting on an economic recovery to cut the deficit, but the deficit at that point may be massive.