Why I’m So Worried About the Second Half of This Year

— by Michael Lombardi, CFP, MBA

We all know that interest rates are so low because the Fed and the Administration in Washington are trying their best to jump-start our crippled economy. But we must face the facts. The jobless rate in the U.S. is now at 9.5% — a 26-year high. Six and a half million jobs have been lost in the U.S. since December 2007. Ten percent unemployment soon is almost a given.

June was the 18th consecutive month of job losses in the United States. Most startling: all the jobs created by the economic boom that followed the dot-com bust have now been lost. Hence, this is the only recession on record, except for the Great Depression, where all jobs created during the growth cycle before the recession have been eliminated. Scary stuff.

The reality is that all the stimulus programs, the increasing money supply and low-interest-rate policy have yet to have the desired positive effect on the economy. Hopefully, we’ll see some green patches, too, but I’m very concerned about the second half of 2009.

My study of interest-rate cycles has one basic conclusion: Interest rates rise or fall in 20 to 30 cycles. From 1981 to 2008, a period of 27 years, interest rates fell. My fear today is that interest rates will now move up for an extended period of time. And when interest rates move up, the stock market goes down.

Let’s face it. interest rates cannot go any lower when the Federal Funds Rate is between 25 basis points and zero. But here are the reasons that interest rates can, and will, go up: Too much borrowing by our government will place pressure on the U.S. dollar, thus pushing interest rates higher; The increasing money supply will eventually cause inflation to rise and interest rates will need to move up to curb rapid inflation; The foreign buyers of our bonds (that we use to finance our deficit) will demand higher interest rates for their money.

Higher interest rates: that’s why I’m so worried about the second half of 2009. And just maybe that’s why the bear market rally in stocks that started in March of this year is starting to unravel.

Michael’s Personal Notes:

Saturday, I saw the greatest fireworks display of my life. In celebration of July 4 and the anniversary of Henry Hudson’s exploration of the Hudson River America 400 years ago, Macy’s put on a spectacular fireworks display on the Hudson River between Manhattan and New Jersey. The fireworks display was preceded by a show on the U.S. Intrepid, which is now parked on the Hudson River: 40,000 shells went off every 1.5 minutes. It was truly spectacular. Millions watched the display either live or on NBC. My thanks to our friend in New Jersey for inviting us over to watch the greatest fireworks display ever put on.

Where the Market Stands:

The stock market rally that started on March 9, 2009, is faltering. We’ve had three soft weeks for the stock market now. As you know, I was expecting the bear market rally to turn the Dow Jones Industrial Average positive for 2009. That did happen, but it only lasted a couple of days. With the Dow Jones not retracing 50% of the bear market loss, it is not a good sign. The Dow Jones Industrial Average is down 5.6% for 2009.

What He Said:

“Interest rates at a 40-year low: The Fed has made borrowing as easy as possible, resulting in a huge appetite for loans and mortgages. We are nearing a debt crisis.” Michael Lombardi, PROFIT CONFIDENTIAL, April 8, 2004. “We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi, PROFIT CONFIDENTIAL, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low-interest-rate policy when the Fed first dropped interest rates to one percent in 2004.