Will stocks wilt in May?

Back in July, 2008 I wrote in “Myths of the Market”:

“Sell in May and Go Away,” is one often quoted saying that implies that stock market returns are higher in the November-April period than in the May-October months. After 27 years experience in global markets, I tend to agree. My belief is backed up by multiple studies that indicate that in 36 out of 37 developed and emerging markets this indicator works the majority of the time. Although no one can provide one single cause for this, I believe it has something to do with summer vacations, especially in Europe, where the effect has been noticeable since 1694.”

As a contrarian, when everyone is expecting the same thing, (in this case, a sell-off in the markets lasting into the fall), I tend to lean the other way. There certainly are plenty of good reasons to be concerned that this third year will be the charm. Questions over QE3, the on-going Euro crisis, a slowdown in China, an incredible first quarter rally in stocks—all of these would indicate we need a correction or at least a healthy pull back.

The most convenient thing for all of us would be to cash in our chips, get to the sidelines and enjoy our summer. If you had done so in 2010, you would have missed a meager 1% gain in the markets between April 30 and October 31. In 2011, you would have dodged a 6.7% slump in the averages. But markets usually do what is most inconvenient for the greatest number of investors.

A recent report from Ned Davis Research pointed out that the Selling May strategy doesn’t work nearly as well when it occurs in a presidential election year. They looked at every presidential election since 1900. Investors on average would have missed a hefty 4.4% gain as measured by the Dow Jones Industrial Average in those years by selling in May. If an incumbent wins, the gains are even higher (7.6%).

Now, before you reverse course and buy everything in sight, a word of caution is appropriate. The same study did show that, on average, a correction did occur during the second quarter of presidential election years. The duration of the pull back is what differs.

Usually, a summer rally occurs after the second quarter sell off in an election year. When the incumbent party has lost the election, the summer rally fizzled out and the Dow made a new low in late October, followed by a weak year-end rally. When the incumbent won, the summer rally was stronger and the pull back in the fall was mild, followed by a strong gain into the end of the year.

The explanation for the differences in these presidential election year markets comes down to uncertainty. That uncertainty is compounded when the economy has been weak, as it is now. Leadership in times like these is extremely important to market investors. Some would argue that the incumbent (the devil you know) is preferable to one you don’t know, who may or may not, usher in successful policy changes. The presidential candidate’s party affiliation did not appear to have any bearing on the results.

So the moral of this tale is that there may still be a sell-off between now and the end of June, but politics will have an inordinate influence on what happens this summer and fall.

Obesity-related illnesses cost us $179 billion annually, with obese Americans spending 42% more per year for medical care than the non-obese to treat everything from type 2 diabetes to heart disease. Breaking that down into individual dollars and cents, it costs $4,879 for women and $2,646 for men every year in various costs associated with being overweight or obese.

It means that obese women pay nine times more and obese men pay six times more in associated costs than do individuals at a healthy wright. Besides the obvious individual health costs associated with this American epidemic, there are also work-related costs that you may not realize.

A study by Duke University concluded that it is costing business $73.1 billion/annually in absenteeism, work productivity and other costs for obese, full-time employees. Lost productivity alone is costing us $12.1 billion/year, which is twice as much as the medical costs. It works out that it is costing business $16,900 per capita for females and $15,500 for men in the 100 pounds overweight category of worker.

Other non-medical costs include wage loss, higher premiums for life insurance, short-term disability and disability pension insurance, sick leave (obese men miss two more days of work than healthy men) and early mortality.

 Much of the statistical data on how many of us are overweight or worse is derived from measuring the Body Mass Index, a cheap and simple formula to determine a rough estimate of body fat. You use your weight and height to compute a score. Those over a certain score are considered overweight and as your score increases so does the obesity factor.

Let’s take me for example, for most of my adult life my weight fluctuated between 185-190 pounds. At six-foot, two, I smoked and worked out like a fiend (love those contradictions). Seven years ago, I quit smoking, stopped exercising, and subsequently ballooned in weight to 255 pounds. My BMI soared from 24 to 33. I avoided standing on the scale and hated getting my yearly physical for obvious reasons. What I didn’t know, won’t kill me (yep, another contradiction).

In the meantime, my brother, who is three years younger than I and about the same height and weight, came down with Type II diabetes because of his weight. It was only a question of time before my added pounds was going to show up as serous health issues.  I started back to the gym but continued to eat what I wanted. I gained even more.  It was at that point, I realized that I had been kidding myself. I wasn’t overweight, I was officially obese.

Almost 55 pounds later (and lighter), the years seem to have have fled and I feel better than I have in a decade. The point to this “true confessions” is that although I knew all the obesity statistics, I never considered myself anything but overweight. I suspect we are all the same until something happens that allows us to take a bite out of reality.

There is good news and bad news about the obesity epidemic in this country. The Centers for Disease Control and Prevention announced that after two decades of steady increases, obesity rates in adults and children in the U.S. have remained unchanged during the last 12 years. Either we have reached the saturation level in the population where everyone that is prone to gaining weight has done so, or that the constant drum beat of public education on the dangers of obesity has made an impact That’s the good news.

The bad news is that a recent study by the New York University School of Medicine indicates that obesity in America might be far worse than we think. The culprit is the same BMI that we all use to determine obesity. Although the BMI is cheap and the starting point for measuring a weight problem is also one of the least accurate medical tests in existence. The study concluded that the number of obese Americans may actually be much higher than we think.

The researchers believe the problem with the BMI is that it estimates rather than measures body fat. The study used two other measures along with BMI —the amount of Leptin, a protein which regulates the body’s metabolism and Dual Energy X-Ray Absorptiometry that tests body fat, muscle mass and bone density. Thirty-nine percent of those patients in the study who were classified as overweight were actually obese.

The bottom line is that we are killing ourselves. Our children are entering adulthood heavier than they’ve ever been at any time in human history. The way our food is processed, American’s addiction to fast food, our increasingly sedentary life style, an aversion to pain or discipline—all have been offered as reasons for this state of the nation.  It doesn’t matter who or what is to blame, in my opinion. Fat is fat and until each of us understands and takes responsibility for his or her own part in this epidemic there is little anyone can do outside of food rationing. My advice is get on the scale. And take it from there.

Their forecasts are being extrapolated from the present price of gasoline which averages $3.52 per gallon. That is high for this time of year, since February is usually a period of low gasoline demand. You might think that this year is a bit different since the mild winter and absence of snow throughout much of the country might bolster driving. But demand nationwide is down to 15-year lows.

What has propped up oil prices so far this year is continued instability worldwide. The financial crisis and subsequent recession in Europe, which should have reduced energy demand has been counterbalanced by events in the Middle East. The real culprit in the oil patch appears to be Iran.

The world wants Iran to cease and desist developing nuclear weapons or else. In response, Iran has been threatening to close a key oil avenue through the Strait of Hormuz, if the U.S. and the EU deliver on their intent to apply economic sanctions to their country. As a result, the price of oil has been flirting with $100/BBL level over the last few months and is presently trading above $102/BBL for West Texas crude. The threat of higher oil prices if Iran were to embargo Europe or the U.S. is real. Iran boasts the world’s fourth-largest proven oil reserves and the world’s second largest natural gas reserves.

Middle East tensions are nothing new. The oil market periodically moves up and down with unfolding events in that region. Spikes tend to be short-lived but everyone from the Fed on down pays attention to trends. What makes this situation a little different than usual is that the tensions are occurring just at the moment when the U.S. economy appears to be picking up some speed.

The last thing this country needs right now is for oil/gasoline prices to trend higher. I have written at length on how energy prices are another form of tax on American consumers. Although energy prices account for only 5% of our overall spending, it is spending that cannot easily be cut back. If the experts are right and gasoline prices move higher as a result of a stronger demand and the continuation of political tensions, then consumers might be paying a few hundred dollars more this summer for gasoline.

That is a lot of money when multiplied by the number of Americans driving cars, trucks, buses and motorcycles. If past behavior is any guide, consumers will fork over the extra money for gas but at the same time cut spending on other things like restaurants, vacations, and shopping at the mall. Higher energy prices will also take a bite out of profits in Corporate America. It will also mean higher prices from everything from diapers to tires as companies attempt to pass on the higher energy costs to consumers.

Unfortunately, higher energy prices are here to stay as long as this country fails to develop a comprehensive energy plan that will reduce our dependency on oil. Until then, we will remain hostage to every two-bit, oil-rich dictator or wanna-be nation that takes a swipe at us.

Volatility ahead

This year a lot can happen. So much depends on forces outside our control that predicting the markets will be up (or down) X percent by year end would be criminal at best. Instead, I would like to broadly outline the possibilities and risks we face in the months ahead and how best to play them.

As I predicted, we are currently in a rally that began before Christmas and should extend for the next few weeks if not months. I don’t think we will hit any new highs during this period or if we do it won’t be until April. Europe will most likely continue to dominate the news, so we should continue to experience quite a bit of volatility. Be prepared for the 1-3% up days followed by the same or more on the down days.

 I believe that ultimately Europe will get its house in order but between here and there the markets will be quite choppy. A foot in both the equity and bond markets should play best in that environment. Stick with dividend and large cap stocks and defensive sectors in this period along with corporate and high yield bonds and short-term paper.

Although the U.S. economy continues to improve, it is nothing to write home about. Without additional help from the do-nothings in Washington or an end-run by the president around Congress, unemployment will remain high and growth between 1.5-2.5%.That is an optimistic scenario, which assumes that a European recession is inevitable but at the same time contained to their side of the ocean.

If, on the other hand, it appears that Europe’s recession is spreading globally then all bets are off. Remember too that stock markets sell first and collect the facts later in this day and age. Just a hint that something like that is in the cards would be enough for  a major sell-off in world markets Therefore it wouldn’t surprise me if we have a classic “sell in May (or April) and go away” scenario this year.

Granted that would be a worse case scenario but one we must all be prepared for. Further hiccups in Europe, fear of renewed recession here at home without further monetary or fiscal stimulus from the Fed or White House could spook sending the S&P 500 Index back towards its 2011 lows at 1,100. Granted, that would be a worse case scenario but one we must all be prepared for. A switch to all bonds would be best in that case.

But remember, we are also in an election year and markets usually begin to anticipate that in the second half of the year. This could give investors an opportunity once again to buy the dip. If history is any guide, the Obama Administration will want to do anything and everything they can to boost the economy going into the November election. This year that argument should carry additional weight since both parties are campaigning on the economy and unemployment.

In that case, we could see a major move higher in the averages off the bottom this summer that could move the U.S. market to substantial gains by the end of the year and into 2014.  Now, wouldn’t that be nice?

If some or most of my forecasts come true for this year, it is quite obvious that a buy and hold strategy will be a recipe for disaster as will all cash, all bonds or all stocks. There will be times during the year investors will want to be both aggressive and defensive and it will be a lot of work, just like last year. There is an old saying that “if you can’t stand the heat, get out of the kitchen” or in this case, hire a money manager that can make those decisions for you, but be sure you pick the right one.

Before the markets opened, central banks of the U.S., Canada, England, Switzerland, Japan and Europe announced a plan to provide cheap dollar loans to European banks and other institutions, reminiscent of the actions they took after the Lehman Brothers bankruptcy in 2008. This action, like that of 2008, puts all investors on notice that the world’s central bankers have no intention of letting Europe go down in flames anytime soon. It is a lesson we should have learned by now after three years of government intervention in capital markets.

 Clearly, the week was shaping up to be another dismal episode in the European crisis, despite Monday’s 3% rally. The S&P credit agency had lowered the credit ratings on a slew of banks. European sovereign bond prices continued to plummet and rumors abounded of a possible bank failure somewhere in Europe as early as December.  The news came in the nick of time.

And time is the one commodity that is most in demand among Europe’s leaders. Make no mistake; this latest action by the central banks is a stopgap measure. It is intended to give European nations the time to come up with a solution to their crisis. It is not a panacea that will fix the PIGS, Italy or Spain’s faltering economies and enormous debtload.

Think back to our own Federal Reserves’ actions over the last few years.  The bank has continuously injected liquidity into our market through a variety of tools including lower interesting rates, buying bonds, and delving into the credit and mortgage markets directly. Its efforts continue today and are designed to keep the financial markets from collapsing, giving the government and private sector vital breathing room to dig the economy out of a recession.

How has that worked for us?

 In my opinion, their actions avoided a total collapse of financial markets, averted another Great Depression, kept unemployment from climbing even higher than it could have been, and restored confidence among investors. Where the ball has been fumbled is among our private and public sectors.

Our government’s inability to respond to slow growth, high debt and high unemployment is a failure of our politicians. Private companies have also failed by hoarding cash, refusing to lend and bolstering profits by avoiding new hiring while working existing employees to death.  Bottom line, our leaders have frittered away a lot of the time the Fed has given us.

The question: will Europe repeat the mistakes of our leaders or will they use this time to actually come up with solutions to their economic problems?

The challenges are great and in many ways even deeper and more difficult to solve. Their debt issues are with countries as well as banks. Unlike the U.S. dollar, their currency is in jeopardy. Governments are in far worse shape than they were two years ago and there are serious political and economic contradictions within the European Community.

One might dismiss their chances, given the embarrassing and inept handling of the crisis that has already dragged on for two years. I believe that the central bank actions have granted Europe and world markets a temporary reprieve and I fully expect Europe to respond positively to this gift.

Does the little guy stand a chance?

It is not too difficult to understand why investors have abandoned stocks en masse. The declines and losses most investors experienced in 2008-2009 were traumatic. Many investors never returned to the equity markets, but preferred, instead, to keep their money in bonds or money markets. Those who did participate in the subsequent stock market rally from March, 2009 to the beginning of 2011 made quite a bit of their money back.

This year, however, the individual investor experienced a level of volatility that was beyond comprehension. It didn’t matter whether you were invested in stocks, mutual funds or exchange traded funds, or in defensive areas such as dividend stocks or preferred shares. Nothing was immune and the volatility was insane.

Consider the movement in the S&P 500 Index for one thirty day period in September through October of this year: Up 8.31%, Down 7.34%, Up 5.34%, Down 5.68%, Up 7.38%, Down 8.70%, Up 7.34%, Down 10.14%, Up 6.65%.

By the end of the third quarter the Dow, S&P and NASDAQ all lost more than 12%, the worst decline since the fourth quarter of 2008. If you were invested in Europe, the results were even worse with Germany, Italy and France all down over 30%. Between the volatility and losses, no wonder the few hardy souls who had stuck with the market since 2009 have decided to abandon ship.

Their desertion has drained a great deal of liquidity from the markets over the past few years. Liquidity is a term used to describe the ease in which you can purchase or sell a security without moving the price higher or lower by an appreciable amount. In a recent story in the Wall Street Journal “Traders Warn of Market Cracks”, several Wall Street traders argue that it is increasingly difficult to trade large amounts of stock without moving the market (price level) substantially.

We have all heard of high frequency trading (HFT) by now. These HFT firms represent about 2% of the 20,000 trading firms that operate in the markets today but account for over 73% or more of trading volume. Directed by computerized algorithms, hi-speed computers buy and sell in mini-seconds capturing tiny profits (less than one cent per share in many cases) over and over again 24 hours a day around the world.

In calmer market environments, HFT does provide additional liquidity in the markets and actually drives down costs. Where the system breaks down is in volatile markets like we have today. These traders are geared to make small amounts of money on large volumes. When good (or bad ) news hits and markets begin react “in size” the HFT firms back away from trading, which instantly causes a 73% drop in liquidity at the very time it is needed most. It is what happened during the “Flash Crash” in May of last year.

In addition, some critics are blaming certain leveraged exchange traded funds for contributing to the volatility in the markets. ETFs have experienced explosive growth in the last five years and now accounts for 40% of the daily trading volume. The use of ETFs that provide 2 and 3 times the amount of exposure to an underlying index, they say, causes excess buying and selling that would not occur otherwise. ETF defenders argue that leveraged ETFs only account for 4-5% of volume and are simply reflecting market sentiment not causing it.  A subcommittee of the U.S. Senate has opened hearings on the issue this week.   

The bottom line, in my opinion, is that today’s stock market environment is no place for the retail investor unless you have help from a professional. Rampant insider information between government and Wall Street, both here and abroad, overnight trading by professionals that effectively prevents the individual investor from participating in the market’s big moves, and the above volatility factors make the markets an unfair arena for most of us.

New versus used cars?

My wife, Barbara, and I have been shopping for either a used or new car. We own matching 2004 Subaru’s that we purchased used back in 2005-2006. We would much prefer a vehicle with even better gas mileage, but we live in the Northeast where snow and ice demand a four, or all-wheel drive vehicle and that limits our choice of fuel efficient transportation.

The good news for us is that although all used cars are priced higher these days, smaller, fuel efficient models and hybrids are commanding especially good prices. As a rule of thumb, every $1 increase in the price per gallon of gas, the value of used compact cars rises 8% to 12%. So if the trade-in value of your car was worth $10,000 last year, it could bring $11,000 this year.

However, this shortfall in supply won’t last long. Dealers estimate by late fall or winter the pipeline will begin to fill once again.

Much of this used car price windfall is a by-product of the 2008 recession. The consumer was hit by the double blow– less income and, thanks to the financial crisis, increased difficulty in qualifying for either a lease or auto loan.  As a result, today, three years later, there are a lot less used autos for sale. The average car on the highway today is 10.6 years old, according to Polk, the auto research firm.  That’s up from 9.8 years in 2007.

 Another large source of used cars for dealerships has traditionally been the leased cars market. Companies sell leased cars as used when leases expire. But a lot less leases were written during the financial crisis, leaving a large hole in supply at the wholesale level.

“Wholesale prices are quite high,” says Mike Coggins, General Manager of Haddad Dealerships in Berkshire County, MA. “We haven’t passed those prices on to the consumer so our margins are smaller.”

Still, Coggins isn’t complaining since his used car sales are up 25% this year, leading all of his other divisions.

The effect of Japan’s earthquake has also contributed to an overall shortage of new autos this year. The disaster in Japan disrupted the world’s supply chain of auto parts as well as the export of many Japanese made vehicles to the United States. This is a far cry from three years ago when all three U.S. automakers were on the ropes and dealerships around the country were closing every day.

It may actually make more sense for us to look at replacing our autos with a new car this time around. I am going to do my research, something you should do as well, if you are planning to buy a car.  Figure out the price differences between a used model and a brand new vehicle before making a decision. I tend to drive my auto for many years (as opposed to trading it in every three years) so the new car avenue may make economic sense for me.  Find out a ballpark asking price for your vehicles from “Kelly Blue Book” on the internet and find out what similar cars are selling for in your area.

I know that we would probably get a higher price for our vehicles by selling them to a private party. Something I suggest you try if you really want to get the best price for your car. We will probably take a 10% haircut on the price by trading it in to a dealer.

Yet, neither of us is willing to put the effort into listing it on the internet and haggling with potential buyers. I would much rather devote that time to writing columns for you, my readers.

Investors on the chopping block

            The good news is that September is over. Does that mean we can look forward to better times ahead? Well not quite; we still have to deal with October, which like March, is usually a month that begins like a lion and ends like a lamb as far as selloffs are concerned.

So what makes investors so fearful of October? It might be because October has ushered in some auspicious dates of calamity beginning with a 12.8% plunge in the Dow on October 29, 1929. In today’s markets, a 12 % plunge doesn’t feel like a big deal but back then it was substantial and it didn’t stop there. The market went on to lose 90% of its value and usher in the Great Depression.

Then there was the stock market crash of October 19, 1987. That was my first of many encounters with stock market meltdowns throughout the world.  Fortunately, it was a short, sharp decline and the U.S. markets recovered quickly.

And how could we forget October, 2008? It was the worst month for the S&P 500 Index, NASDAQ and the Dow in 21 years. Global equities lost $9.5 trillion that month and it was the most volatile 30 days in the S&P 500’s eighty year history. We registered the most down days in a single month since 1973.

Actually, despite these gruesome statistics, October historically turns out to be the seventh-best month to own stocks, tied with April, putting it in the middle of the pack.

September, on the other hand, is the bad boy of the calendar year. It holds the record for most miserable month as far back as 1929. If we look even further back in history we discover the root cause of September’s stock market underperformance.

Back in the day, much of 19^th Century American commerce consisted of East Coast purchases of newly harvested crops from the South and Midwest regions for sale to the rest of the country. September was harvest month so bankers and other investors would borrow large sums of money from Wall Street, temporarily pushing up interest rates while redirecting money flows away from stocks and into the bond market.  This would also coincidentally push down prices in the stock market that month.

Although money flows have long since been regulated by the Federal Reserve for events like the planting season, the tradition of down Septembers persist. Since 1959, the S&P 500 Index has declined an average of 0.9% in September. In the first two years of a presidential term the performance is a bit worse. Overall, investors have suffered the most double digit losses in that month as well.

In today’s world. other concerns might explain September’s continued poor performances. There is the ‘back to work’ phenomenon, which occurs just after the Labor Day holiday. Many investors typically take the summer off and when they come back are disappointed to find that their portfolios gained little during the summer months. They lose patience and sell.

One reason for that disappointment may be that a company’s earnings for the year have not met the expectations of the market. The normal end of June, early July, quarterly earnings announcements often time disappoint. What may have seemed a reasonable expectation by company management at the end of the prior year may not be a reasonable estimate by mid-year for a variety of reasons. The company’s stock price may decline or simply mark time temporarily. Many investors won’t want to hang around for yet another earnings disappointment at the end of September, so they sell ahead of earnings season.

This year, September has certainly lived up to its reputation with the averages declining almost 5% overall while volatility has skyrocketed. The bottom line is that if September is usually the month when crashes occur, then October is the month that ends them. Since September is over, the good news is that we have weathered the worst and if history is any guide, the future should be a bit better.

Is the White House and Fed planning a big REFI?

For the longest time, I have been convinced that the housing market holds the key to economic growth (or lack of it) in the U.S. As such, I have been hoping against hope that one or more of a long line of presidential candidates would actually have the courage and intellect to recognize and address our main problem.

Instead, I hear how “we need to get America back to work” or “we need to roll back all these regulations that are preventing businesses from investing.” While all of those jingoistic slogans sound good, none of them address the main issue: how to deal with the trillions of dollars in underwater mortgages and the people who hold them.

The Fed, through QE II, attempted to push interest rates low enough so that borrowers could stave off foreclosure by refinancing their mortgages. The problem is that lenders insist that the market value of homes to be refinanced must be no lower than 25% of the mortgage they carry. That’s a real “Catch-22” for most borrowers, thanks to the decline in housing values over the last three years.

 Their houses are now worth a lot less than that. So mortgage holders are in a bind.   They can’t sell their property because they won’t get back enough to pay off the loan. They can’t refinance because the house is worth less than the mortgage and they can’t afford the monthly mortgage payments. As the situation drags on, more and more Americans slip into bankruptcy or walk away from their home/mortgage leaving and already weakened financial system to pick up the pieces.

Right now this is just my guess of what the Obama administration may be planning.  Over the past week a number of governmental trial balloons have been floated in the media concerning refinancing of up to $1 trillion of mortgage loans on easier terms. It won’t be a giveaway, if it occurs, in the sense that to qualify for re-financing, you must be current on your mortgage payments and the loans must have been guaranteed by Fannie Mae, Freddie Mac or the FHA. How would it work?

Homeowners who qualify would get a new 30-year loan at say 4% and payoff 100% of the old mortgage (presumably carrying a much higher rate of interest). This is called prepaying your loan in the mortgage business. Your bank receives the proceeds and pays off the old loan to Fannie and Freddie. These two government mortgage entities would receive these billions in prepaid mortgages and dispense them to the ultimate mortgage holders in the mortgage-backed securities market.

Now, guess who holds the lion’s share of mortgage backed securities in this country? You guessed it, the Fed.

That still leaves Fannie and Freddie with a problem. They need to refinance all these new 30-year, 4% mortgages. They are also assuming a lot of risk since lending now, when interest rates are at historical lows, is a dicey business.  Who will buy them and how can they protect these new mortgage loans from future losses when interest rates begin to rise? The answer was revealed in yesterday’s Fed announcement.

The Federal Reserve announced that it intends to drive long-term interest rates lower by purchasing long term U.S. Treasury bonds. The Fed said it will also juggle its $2.65 trillion securities holdings by using its enormous cash flow to buy more mortgage debt. In other words, since it will be on the receiving end of all these billions in prepaid mortgage money, it will just turn around and use that cash to buy up billions in these new refinanced mortgages. At the same time, by driving long rates lower through their purchase of long dated treasury bonds, they effectively remove the risk of rates rising anytime in the near future. The Fed becomes both buyer and seller of this entire refinancing operation.

The beauty of this move, in my opinion, is that the White House will be able to launch a new refinancing program/stimulus plan without going through congress for approval.  Nor will it add to the deficit, since all of these transactions will be run through the Federal Reserve. The Republicans may have gotten wind of this, thus the letter to the Federal Reserve Board just prior to their meeting, warning the Fed members not to do anything further to stimulate the economy.

Well, boys, the Fed just blew you off and you can’t do a thing about it.

Is this all a hair-brained scheme of mine born of too much work and too little vacation? Time will tell. But if I’m right, I would expect an announcement fairly soon. I have to hand it to the Obama Administration if it is true and they can pull this off. The scope of refinancing they are planning will put $2,000 or more a year into borrower’s pockets, which will amount to a huge stimulus program that bypasses congress and goes straight to the people. I hope I’m right.

All eyes on the Fed

The stock market has been climbing over the last week in anticipation that the Federal Reserve will, like last year, announce another monetary stimulus program similar to QE II. There are several problems in betting on that outcome in my opinion.

Number one is investor’s knee-jerk expectation that the government will save the stock market every time we have a selloff of 10% or better. We have become conditioned to expect some sort of governmental intervention ever since the 2008-2009 financial crises. That’s when the TARP Plan was passed, followed by the stimulus plan, the extension of the Bush tax cuts and the cut in payroll taxes, not to mention last year’s QE II announcement almost exactly a year ago today.

The second problem is that the Fed has already done quite a bit to stimulate the economy with mixed results. Their announcement of just a few weeks ago that they will keep interest rates low until mid-2013 is actually an extension of QE II, (call it QE 2 ½). I doubt that they will be willing to move much beyond their present efforts until the economic data clearly indicates further weakening.

There has been some talk that the Fed might change its focus from buying short-term U.S. Treasury bonds to buying long -term U.S. Treasury bonds. I am at a loss to understand why they would want to do that. Lowering long-term rates would theoretically make borrowing cheaper. An implicit assumption is that lower rates would encourage long-term investment in plant and equipment. The problem with that theory is that large corporations already have record amounts of cash to invest but are still not investing in long–term projects. They believe there is simply too much uncertainty within our political system, our regulatory environment and in the economy to warrant additional investment right now.

As for smaller corporations, those that represent the majority of America’s work force, only those businesses that don’t really need to borrow are eligible for loans. It is not the level of interest rates that prevent banks from lending. It is the uncertainty that loans to small businesses will be paid back that has created an almost complete cessation of new lending in that arena. It has already been shown (via QEII) that banks are not willing to lend no matter how low rates fall.

            In any case, it is not our economy that has been driving markets lower. The financial problems in Europe are what have most investors spooked. Make no mistake, Europe’s problems are serious and their leaders have yet to come up with a decisive, comprehensive plan to deal with their financial problems.  The Fed’s actions here won’t resolve the problems on the other side of the Atlantic.

            In summary, unless the Fed pulls a bull-sized rabbit out of their hat tomorrow, the markets will swoon. Let’s see what happens.

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Bill Schmick is registered as an investment advisor representative with Berkshire Money Management.  Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM.  Direct inquires to Bill at 1-888-232-6072 (toll free) or e-mail him at Bill@afewdollarsmore.com