U.S. economy is fizzling whilst Stock Markets are sizzling !
Economics / Analysis & Strategy Jan 05, 2007 - 06:49 PM
You know what I think of when I look at the U.S. markets right now? The Charles Dickens' masterpiece, A Tale of Two Cities . Here's why ... For many parts of the “real” U.S. economy — America's factories, employers, shopping malls, and homeowners — it's looking like the worst of times.
Signs of an economic slowdown are everywhere:
- The Institute for Supply Management's manufacturing index sank to a 43-month low of 49.5 in November. It managed a minor bounce in December, but several index components remained below the crucial 50 level, including order backlogs, inventories, and employment.
- On Wednesday, ADP Employer Services said U.S. companies eliminated 40,000 jobs in December. This is the first employment drop since April 2003. Wall Street expected a gain of 120,000 jobs.
- Construction spending slumped again in November. It's been weak for four out of the last five months.
- New home sales dropped more than 15% year-over-year, while existing home sales sank almost 11%.
- And U.S. retail sales gained just 3.1% in December, the worst holiday performance in two years.
Meanwhile, for the “finance” side of the U.S. economy, it's the best of times. Takeovers ... mergers ... and rampant speculation are all off the charts. In fact, Wall Street's rainmakers are partying like it's 1999! Just look at the numbers:
- Worldwide merger and acquisition volume surged 38% last year to $3.79 trillion. That topped the previous record from 2000.
- Riskier “alternative investments” like hedge funds and private equity funds are swimming in investor money — $3 trillion worth.
- Companies have so much cash that they spent more money in the first nine months of 2006 buying back their own shares ($327 billion) than they spent investing in equipment for their businesses!
On the surface, it's hard to understand why Wall Streeters are celebrating in the penthouse as the foundation of the building is rotting away. But I have an answer ...
This Startling Disconnect Exists Because Money Is Still Too Easy
As I told you back in November , we've seen a gigantic surge in global liquidity. That's been fueling a gigantic wave of merger activity. It's been driving up commercial real estate values. And it's been helping hold long-term interest rates down.
Now you're seeing this same message in the mainstream media. Just three days ago, the Wall Street Journal ran a story called, “Investors Riding the ‘Cash' Rapids.” According to the article, “A world awash in cash helped drive share prices higher and fueled frenetic merger activity in 2006 ... Riskier assets, such as emerging-market debt, are priced at only a small margin above much safer Treasurys ... Market volatility is exceedingly low.”
The fact is that central banks the world over may be raising short-term interest rates and talking tough on inflation. But they're also flooding their economies with lots of money and liquidity. U.K. money supply is exploding higher, up 13% in November. European broad money is rising at a 9.3% year-over-year rate, something we haven't seen in more than 16 years! And it's the same story all around the world.
End result: Companies can borrow billions of dollars at a whim. Investors can leverage themselves to the hilt without a problem. Everyone's out there chasing returns with a fistful of dollars. The mantra of the markets is, “Party on, dude!”
What's a prudent investor to do?
Enjoy the Good Times, But Watch Your Step!
There's nothing better than a good party, especially one that makes you richer. But remember, no amount of easy money can cure every one of the market's ills.
For example, it isn't helping companies in the housing and mortgage sectors. A major subprime lender just filed for bankruptcy. Another shut down its wholesale operations and laid off 80% of its workers.
And one of the biggest home builders in the country, Lennar, said it would have to write-down the value of some of its land and land options. The size of the financial hit: Up to $500 million!
Plus, you never know how long the party is going to last. So enjoy the music, but don't ignore the risks:
First, stick with the stocks and investments that have the best fundamentals. I'm talking about foreign shares ... top-performing exchange-traded funds ... and U.S. stocks with specific, bullish catalysts.
Second, if you're a more frequent trader, use protective measures like stop loss orders. They instruct your broker to immediately sell a stock if it falls to a predetermined level.
You might even want to consider “trailing” stops for your high-flyers. These stop loss orders adjust their trigger prices higher as the underlying stock rises. They allow you to keep riding favorable moves, but get you out of a position if it reverses course.
Third, always maintain a hefty chunk of your assets in cash equivalents or short-term Treasury investments. As I've said before, there's no telling when a sharp market shift will cause traders to re-evaluate all the risk they've taken on. By keeping some money on the sidelines, you'll be positioned to turn a panicky pullback into a great buying opportunity.
Until next time,
Mike Larson
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