You Can’t Have Your Cake and Eat It, Too

07/12/10 — In the coming weeks, the news is all going to be about large-cap stocks and what these businesses say about their operations will be critical to stock market sentiment. The market is somewhat looking beyond second-quarter numbers to third-quarter visibility. Currently, investors expect large-cap technology to be relatively strong. Institutions will certainly be looking to see if companies have been able to maintain price increases for their products. This trend began in the first quarter

If we get mediocrity from corporate earnings, then we’ll most likely continue to have mediocrity in the broader market. Investors are looking for a catalyst to take action, either long or short. Without a strong catalyst, prices will just drift.

I still view investment risk in the equity market as very high. There remain a lot of fundamental problems both in the domestic economy and on the global front. The flip side is that no other economy on the planet is better able to right itself than the U.S. economy. The entrepreneurial spirit still reigns supreme, and no other economy rewards innovation and hard work better.

There’s no way to predict which way the economy is going to go over the coming quarters. Economists around the world are sounding the alarm bells on the new era of fiscal austerity that’s being talked about. It’s true that, if government budgets do get tightened, then stimulus spending will suffer. This will slow economic growth and restrict new employment. But, as we all know, you can’t have your cake and eat it, too. Fiscal austerity is exactly what the global economy needs, particularly in Europe. The financial risk of sovereign debt default is just too great.

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It’s entirely possible that we’re in for a long period of economic malaise, similar to the period from the mid-60s to early 80s. If history repeats itself, we’ll likely have to deal with inflation, higher interest rates and stagnant employment. For equity investors, your best assets will be high-dividend-paying large-caps, hedged with exposure to precious metals.

A new era of fiscal austerity, both individually and at the country level, is the right direction in my view. We can’t rely on government spending to stimulate the economy. It isn’t affordable and it isn’t sustainable.