Wednesday, September 21, 2011

Newsletter 9/21/2011

Note: Highlighted words provide links to sources to support my views below. Click on graphs to enlarge for easier reading.

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The Economy

The economy has slowed down in Q3 of 2011 with projected GDP growth numbers being revised downwards. Q2 GDP growth numbers have been revised from 1.8% to 1% per the chart below.

Economists agree that there is a 1 in 3 (33%) chance that there will be a double dip recession in the near future which also means that there is a 2 in 3 (67%) chance that there will not be a recession and normal growth will resume. The unemployment rate has stayed at a stubborn 9.1 percent despite the quantitative easing policies of the Fed and low interest rates. The Fed today added additional accommodation with operation “Twist” by selling short term bonds and buying long term bonds bringing long term interest rates down further. The Fed will also buy mortgage securities to lower mortgage rates. Inflation is running higher than expected at a 3.8% annual CPI index. Inflation is the negative side effect of low interest rates and excess money liquidity in the market. Housing starts are lower than expected and unemployment claims are higher than expected. The European sovereign debt crisis in Greece and Italy are still an unresolved problem that threatens European and US banks if Greece were to default on its loans and other troubled countries were to follows suit. Economists state that there is a 95% chance that Greece will default on its loans. Some economists are predicting that the Euro currency will not survive too long into the future. On the other hand, corporate profits were higher than analysts’ expectations and corporate balance sheets are flush with cash. Corporations have cut down costs and have not hired in mass yet. CEO’s are not certain about the future of the US and the world economies and are not willing to make large investments in hiring at this time. Forecasts for GDP growth for 2012 have been cut in half to 1.5% by some invetment bankers.

The Stock Markets

Systematic risk has scared investors in Q3. The debt ceiling debate took a toll on the stock market in July and August by delaying the decision to raise it to the last hour and by making the possibility that the government would not be able to make its payments a very real possibility. In addition, the S&P downgrade of the US debt took another toll on confidence in financial markets. That combined with the European sovereign debt crisis have taken the markets down from a high of a positive 10% YTD return in May to a negative 10% in August. See chart below. Stocks are cheaper now and valuations are being ignored by technical traders. High frequency programmed electronic trading has taken markets through day gyrations of 5% daily movements downwards and upwards. The uncertainty about the direction of the markets remains high and the markets are waiting for the resolution of the many components of that uncertainty before investors will feel secure about moving their money back into the markets.


The republican controlled Congress has opposed president Obama and the democratically dominated Senate in their plans to stimulate jobs and to raise taxes on wealthy Americans. Republicans believe in small government and that low taxes are the best way to improve the economy while the democrats believe in spending on bridges and highways to stimulate the economy. The democrats wish to fund their spending and reduce the budget deficit with tax increases on wealthy Americans while lowering taxes on the middle class and poor Americas. The democrats also wish to cut spending on subsidies for farming and oil companies. The republicans want to cut spending on entitlement programs while reducing taxes. The debate continues and there is deep division and partisanship about how to resolve the slowdown in the economy.

Future Outlook and Strategy

As outlined and predicted in the last newsletter, the markets came down and corrected in the summer of 2011. Going forward, uncertainty remains and markets will go through more gyrations. It would be prudent to start buying stocks when markets dip down in the coming weeks. The uncertainties outlined above will be resolved and the world economies will eventually repair themselves. The time to buy stocks will be when everyone is panicking and selling. There will be a large drop when Greece defaults on its loans. Banks and financial stocks will take deep cuts. However, just as in the Lehman Brothers crisis in the USA, markets will eventually stabilize and there will be a return to normalcy in the after math of the European debt crisis resolution. Europe will have to come up with a way to fix the financial crisis and there will be a resolution. The USA will stabilize and a compromise between the Republicans and Democrats will be reached to start the economy moving up again. Buying on the dips and getting back into the market is the strategy of this newsletter..

Mike Katto
Registered Investment Advisory Representative
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