A Roaring Start to the New Year

A warm New Year’s hello to all my beloved Profit Confidential readers! I say warm because the temperature this year has been uncharacteristically high. This holiday season, I enjoyed the best weather ever in Southern Florida with warm sun every day. In Toronto, there’s no snow on the ground (today, anyhow). And in New York, a raincoat will do.

But it’s not just the weather that’s warming up. So are many investment markets. Because of the recent “heated” activity in the markets, I thought I’d offer my two cents on what I see going on in the stock market so far in the first few days of 2006.

All the news in the business sections of the newspapers (I read four papers a day) of late is about the Dow Jones Industrial Average having hit the 11,000 level for the first time in four years. To this, I say, “So what?”

The facts are there for us all to see: stock P/E ratios continue near record highs, while dividend yields are at record lows; earnings growth has slowed substantially; the Federal Funds rate has risen from 1% just two years ago to over 4% today. With the average American household having close to $10,000 in credit card debt alone, where are consumers going to get the money to keep the American economy moving?

What I’ve written above are my logical reasons why the rally in the Dow Jones Industrial Average will be short-lived. But here’s a seemingly illogical scenario my readers should not take for granted.

The futures market points to the Fed raising interest rates one more time on January 31, 2006, the same day Greenspan retires. The Fed has admitted to watching the action in the housing market, fearing a bubble effect. If the Fed’s actions over the past 18 months to raise interest rates to cool the housing market have been successful, do you think the Fed would resist lowering interest rates aggressively if the U.S. economy starts to cool too fast? Of course it will. And the stock market today is celebrating the near end to the Fed’s interest rate hikes.

This is what the bond market has been telling us all along: Interest rate hikes would be short-lived. As the years have gone by, the Fed has been more aggressive at raising and lowering interest rates to respectively cool and warm the economy.

Sounds like a good plan. The Fed has cooled the housing market with its interest rate hikes. And now, if the economy starts to cool or consumers start cutting down on their purchases, the Fed will lower interest rates again. How could the stock market not love that? But I am suspect. And that’s because I don’t believe external forces, even the Fed, can sway the natural forces of a bear market.

Here’s a caveat all my readers should be aware of: The theory the stock market is currently following (about the Fed soon lowering interest rates) could be very short-lived if the U.S. dollar continues under pressure. I’m reading all kinds of reports about the projected U.S. deficit for the next three years, and it’s downright frightening. Maybe that’s what the recent strong rise in gold prices is telling us: The debt ridden U.S. dollar may soon become a big problem. If it does, interest rates will rise aggressively to support the U.S. dollar. And all bets on the big-cap stocks will be off. An interesting year 2006 will be. Let’s see how she unfolds.