We continue to believe that commodities as well as stocks will continue declining throughout the rest of this year and into 2009. We also expect the leaders of this country to do whatever they can to bring a halt to the deflationary bear market we anticipate. They have already lowered interest rates to levels well below our trading partners.
They came up with "liquidity auctions" which, in essence, were nothing more than substituting our Treasury securities for toxic paper. These auctions were expanded, extended, and were opened up to institutions that were, in the past, not even regulated by the Fed. Furthermore, they bailed out one of the most prestigious investment banks on Wall Street when Bear Stearns was "on the ropes". The bail out of Fannie Mae and Freddie Mac was the latest in the lengthy process of dealing with the "deflation" we have been predicting for some time. This will not stop! We will see "competitive devaluations" and "beggar-thy-neighbor" policies next. There will be a race to lower interest rates by central bankers all over the world. New Zealand lowered their rates .5% to 7.5% today and Australia will be next followed by the ECB and then the U.S. before the year is out. This subject will be discussed in more detail in next week's comment.
Wouldn't you think that after all the past failures of government intervention that the market would actually decline right after the announcements rather than rally for a few days or weeks thinking that the intervention will "save the day". We had a 10% rally on January 23rd of this year that lasted one week. This rally occurred on speculation of a government plan to bail out bond insurers and a surprise 0.75 percentage point Fed rate cut. Another rally of 14.5% that started on March 17th and lasted two months (Bear Stearns bail out), and another that started on July 15th lasted about one month and rose 9.5% (rumors of FNM & FRE bail out). All of these rallies were in response to rate reductions and rumors of potential bail outs and/or actual bail outs by the government (one also coincided with Jim Cramer calling for a market bottom). This week the market bottomed at 1217 before rising to 1275 after the Fannie Mae and Freddie Mac bailout by the government. This time the rally lasted just one day and only rose 4.5%. At least we are learning, slowly but surely, that government interventions are not the elixir that many investors thought they were.
This bailout could actually backfire on the Treasury Department. The total government debt was about $9.5 trillion before this bailout if you don't count the promises made on Medicare, Medicaid, and Social Security (these promises unless they are reneged upon will skyrocket the debt). But now, by taking on the debt of FNM and FRE the total government debt rises by about 50% and if that causes interest rates to rise on government debt, what happens to the other debt instruments in this country. There is over $50 trillion of total debt in this county and if our leaders try to lower rates as we expect on Fed Funds and Treasuries the interest rate spreads will widen considerably. Immediately after the latest bail out this week the credit spreads soared. This is indicative of real trouble in the near future.
Alan Greenspan was interviewed on CNBC this week promoting his book that just went into paperback form. We happen to believe that Greenspan was probably more instrumental in the mess we find ourselves immersed in presently than even George W. We have two special reports on the left side of our website that deal with this subject. The first is titled "How We Got Into This Mess" and the second "How We Can Get Out of This Mess". You will find Greenspan prominently displayed in the first report. Mr. Greenspan stated this week, "that the only thing that can turn this economy around is for housing prices to stabilize and then rise". He happens to be correct in that assessment, but we suspect he believes this will occur a lot sooner than we do. He should have thought about that before dropping Fed Funds down to 1% from 5.25% at the beginning of this century (and keeping them there for a year). And as he lowered rates he encouraged inappropriate prospective homeowners to buy homes with complicated debt instruments such as adjustable rate mortgages.
The bottom line is that government bailouts will not work in the long run and we are convinced the S&P 500 will not rise above their 200 day moving average. When it breaks down below the low of 1200 reached in July we believe the third stage of the bear market "fear and capitulation" will commence.