6 Stumbling Blocks for the Market

 

“Stagnation” may describe the broad stock market this summer, unless Mister Market can overcome six stumbling blocks in his way.

And I’m not even including Standard & Poor’s downgrade of the U.S. credit outlook. As you probably heard, on Monday, S&P came to the astonishing conclusion that the United States has a debt problem, and revised its long-term outlook on the United States to negative from stable.

The astonishing thing is that it took S&P this long to figure out that the United States is drowning in debt. But, as they say, denial ain’t just a river in Egypt. Take a look at this chart of U.S. debt:

Source: Der Spiegel

Maybe S&P finally threw up its hands in disgust when Congress and the White House went into a major kerfuffle in an attempt to cut $38.5 billion from the Federal budget. That’s a “whopping” 1% of the entire budget.

And the Congressional Budget Office came out later and said the cuts actually amounted to just $358 million. Hell, the Federal Government probably wasted that much preparing for the potential government shut-down that the budget deal “saved” us from at the last minute.

The federal debt stands at more than $14 trillion and climbing. Since 2009, annual budget deficits have topped $1 trillion, and estimates indicate trillion-dollar deficits will continue at least through 2012. And now — NOW — Standard & Poor’s notices that the U.S. has a debt problem? Sheesh!

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Anyway, the stock market hasn’t minded the super-sized U.S. debt before, so I’m not including that in one of the six stumbling blocks that could stagnate the stock market.

Here they are:

1. The second round of quantitative easing, or QE2, ends on June 30. By that time, the program will have pumped $600 billion into the economy, meeting Chairman Bernanke’s stated goal of jump-starting the stock market. The end of the program means a tightening of monetary policy unless there is QE3. I think there will be QE3, but the market disagrees with me … for now.
2. More budget battles to come. The soap opera in Washington isn’t over. Democrats and Republicans are bracing for the next round of confrontations over federal spending, which will include issues involving the future of entitlement programs as well as the debt ceiling. This could delay or change important funding for government programs.
3. Commodity prices are rising, and so is inflation. Take a look at this chart of the CRB Index, a basket of leading commodities:

This squeezes corporate profits at a time when it is hard to pass rising costs along to consumers because consumers are strapped for income and are paying down debt.

What do you get when you combine stagnation (in the economy) with inflation (of commodities and other prices)? Stagflation. Hoo boy, is that ugly. We saw it in the 1970s. It was a great time to be in precious metals, but stocks sucked wind.

4. Oil prices are too damned high. While oil prices have pulled back from the recent peak, they’re still too high. Fear is seeping into the market, and oil prices are floating higher on it. The conflict in Libya is dragging on and threatens to spread to other Middle Eastern nations. Also, elections in Nigeria — an important U.S. supplier of imported oil — turned violent. Roughly 17,000 people fled their homes in eight northern Nigerian states as violence erupted after opposition leaders charged the election had been rigged.
5. China’s inflation scares investors. Consumer prices in China rose at a red-hot 5.4% rate in March. As a result, China raised interest rates for the fourth time in an apparently futile bid to cool down the economy. China’s economy is growing at 9.7%, according to the National Bureau of Statistics.

   Why does this scare investors? Because investors worry that China will overcompensate for inflation, and cool off its economy too much, raising the risk of a global recession.

6. U.S. GDP forecasts will likely be lowered. We’re seeing a wave of first quarter GDP downward revisions, and those will probably continue as we go forward. Last week, the International Monetary Fund lowered its forecast for U.S. economic growth to 2.8%, down from 3%. We’ll probably see more revisions coming because of higher oil prices. This saps the enthusiasm of stock investors.

   To be sure, lower economic growth doesn’t mean a recession. And I think growth will remain hot in countries such as China, India, Vietnam, the Philippines and other emerging markets. That will be enough to keep the global economy chugging along. But it could make the U.S. economy look less attractive to investors by comparison. That could be ANOTHER hurdle.

However, not all is bad for the markets. For one thing, the recent Beige Book report (a report on economic conditions published by the Federal Reserve eight times a year) showed business is good at U.S. manufacturing plants. But weakness in employment, the squeeze on consumers and other factors could drag on a manufacturing recovery.

Also, the U.S. dollar is in serious trouble. I examined this in the latest issue of Crisis Profit Hunter. This is important because assets — including stocks — are priced in dollars. As the dollar goes lower, dollar-priced assets tend to go higher. So asset inflation could counter some of the negative forces in stock prices.

But unless the market can pull it together and overcome these hurdles, this hot summer could be more of a swamp.

How You Can Invest

I think I’ve told you plenty about gold being a good investment. And sure enough, gold hit another new high this week, and silver hit a 31-year high. Physical gold and silver should be very good places to be this summer.

All the best,

Sean

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