The Event That Will Cause Stocks to Break Their March Lows

by Michael Lombardi, CFP, MBA

What’s this…

In one corner is President Obama, pulling all the stops out to get the economy going by promising billions in economic bailouts, delivering a record $1.85-trillion budget deficit, and having tax payers own the majority of General Motors Co.

Fed Chairman Greenspan is in the other corner, keeping interest rates low, expanding the money supply, and even applying quantitative easing by buying U.S. Treasuries and mortgage bonds.

How could we go wrong? Well, we were going in the right direction up until now, because, all of a sudden, interest rates are going up, up and up.

One of the core goals of government is to get consumers spending again in the housing market, so that the market stabilizes. But the unexpected is happening. Long-term interest rates are moving higher. The most popular mortgage for Americans is the 30-year FRM (mortgage with a fixed rate). Today, this mortgage stands at 5.45%, which is the highest in six months.

For months now, I’ve been warning in this column of higher interest rates. And that’s what we are getting. The Fed may call it a “conundrum,” but I see it very simply: the more debt the government takes on, the greater the threat of inflation and the higher long-term interest rates go.

So, what are the repercussions of higher long-term interest rates?

Generally, when long-term interest rates go up, investment real estate will go down in value. I’m not a big fan of getting into investment real estate right now, because, long-term, I see rates only rising, and investment real estate will suffer as interest rates rise.

Eventually, higher long-term interest rates will result in short-term interest rates rising, too. After all, where can interest rates go but up? We know they can’t get any lower than they are.

So, will higher long-term interest rates be the catalyst that sends stocks lower, so low they test their March 9, 2009, multi-year lows? I’m afraid so.

Michael’s Personal Notes:

The job loss numbers for May were encouraging. This past Friday, the U.S. Department of Labor reported that 345,000 Americans lost their jobs in May, the lowest number since September 2008. There is no doubt that all the monetary and economic stimulus being created by the Federal Reserve and the Obama Administration is having its wanted positive effect on the economy. The unemployment rate in the U.S. stands at 9.4%, and I would expect it to be over 10% before this recession is over.

Where the Market Stands:

The Dow Jones Industrial Average is flat for the year. While other major stock market indices like the NASDAQ and S&P 500 are well into the black for 2009, the momentum for the Dow Jones has not been as great. The biggest dividend cuts by large corporations in 71 years is not helping the case for big company indices like the Dow Jones. If it were not for long-term interest rates starting to move up, the Dow Jones would already be well ahead for 2009. I’m sticking with my prediction that the Dow Jones will turn positive for 2009, as the rally within the confines of the secular bear market continues.

What He Said:

“When I look around today, I see falling stock prices…I see falling house prices…and prices falling for retail goods stores declining. The media has it all wrong blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively, as deflation starts to rear its ugly head.” Michael Lombardi in PROFIT CONFIDENTIAL, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.