Sunday, April 24, 2011

News Letter 4/24/2011

Note: Highlighted words provide links to sources to support my views below.

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The Economy

The economy is recovering nicely with the latest unemployment rate dropping to 9.2% and less weekly unemployment claims filed in recent weeks. However, there are head winds ahead of us. Food and energy prices are rising as are commodity prices. Oil prices are back up to $112 per barrel and gas prices are at $4 per gallon. Gold is at an all time high of $1,504 per ounce, silver is at an all time high of $46 per ounce, and the US Dollar is at all time lows against foreign currencies. The Inflation and the low US Dollar are a direct result of the negative side effect of the Fed’s monetary policy of providing liquidity in the market through Quantitative Easing (QE2). The Fed’s objective is to stimulate the economy and to increase employment, but achieving this objective is causing inflation and a devaluation of the US Dollar. The Fed funds rate is at an all time low near zero and the money supply is increasing which is what causes high inflation. The fed will inevitably reverse direction and stop the Quantitative Easing and even increase interest rates in the near future in order to stave off inflation and to strengthen the US Dollar. The stock market indexes are at 2011 highs per the chart below.


The Republican controlled house lead by John Boehner is gaining control over the legislative process and dictating fiscal policy. The House passed a budget that reduced government spending. The House has also vowed that it will seek to reduce corporate business taxes and personal income tax rates. President Obama is compromising with the Republicans and acquiescing to their demands. Lower taxes are good for the economy and for the stock markets. This will bode well for future stock prices.


Although investors enjoyed high stock prices last week, the stock market has been rather volatile lately with 1-2% reversals from one day to the next. Volatile markets are good for traders and are indicative of a lack of conviction on the part of investors. If the Fed reverses its Quantitative Easing policy and increases interest rates which is an inevitable conclusion, Stocks will retreat and correct in the short term. Commodity prices will also start to go lower and inflation will ease. Also, the US dollar will strengthen. It is advisable to reduce exposure to commodities and to move some cash to the sidelines at this time. The stock for this Newsletter is GM. Since the IPO in November, 2010, GM stock rose from $33 to $39 and then went down to $29.5 and traded at $31 at the close last Friday. High oil prices caused by supply disruptions in the Middle East and the low US Dollar seem to influence GM stock price in the negative direction. Also, the US government unloading its shares of GM stock will increase the share supply and cause pressure on the stock price. In addition, GM will issue new shares to the old bondholders per the bankruptcy terms which will dilute the number of outstanding shares and will reduce the stock price. GM stock is a “hold” in my opinion. There may be some volatility ahead of it in the short term. In the long term GM price should go higher to its 12 month price target of $42 as predicted by an average of 16 analysts.

Disclosure: I am a GM employee and do not own GM stock at this time.

Mike Katto
Registered Investment Advisor
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