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Today's Commentary: 04.25.05
Slightly more than Ominous

Don't wait until May pack it in for the summer. Last week's 2% rally on Thursday will repeat itself at various intervals over the next four to five months but with the negative reports beginning to stack up against the spillway of optimism, packing up early and moving to higher ground - or any ground not near equities will be not only wise, but profitable.

The idea of selling in May, a barometer developed some years back by the Hirsch Organization has resulted in several reasons why moving your money out of equities during the months from May to November is a good idea. Top of the list is the enviable higher overall return of this strategy versus full year investing. Seems the diminished volume during the summer months adds to volatility and with an expected disappointment in earnings during the period, the both quarters in question could put such a drag on the full year as to make 2005 downright dismal. With a forgettable first quarter and the predicted clouds ahead, the last quarter of the year might just be the only hope. There is more, however, to consider.

Those negative reports continue to just keep piling up, many of which we have dutifully dissected. With so much near-term bleakness in the outlooks, we will focus instead on just three of the major reasons - for the sake of time and space - why the sideline seems so safe.

The bond market may be the best indicator of where this market is headed. Alan Greenspan aside, the tightening in measured pace will continue largely because the Fed may be flummoxed by the continued credit party everyone seems to be having and simply can't think of another way to tighten the tap. The bond market is seeing those actions and grimacing.

Corporate yields have started to rise which means prices for said offerings have begun to fall. Add in the slow down of issues being offered and some distance is now being placed on the curve that compares corporate bonds to Treasury offerings with similar maturities. Tight yield curves tend to exist when the money supply is flowing freely because of cheap rates. Greenspan's conundrum several months back, his open worry over this very curve, is now in full correction. As the yields begin to spread away from each other, an effect of credit tightening, the economy slows down for a breather. On a side note, the risk of those offerings has increased with the yield pushing some otherwise solid companies well toward junk status.

Popular wisdom suggests that equities cannot hold up if the bond market goes into a funk. With the days of easy money quickly becoming a diminishing speck in the rear view mirror, equities will feel the hot breath of a short term bear.

Second on the list of problems for the stock market - and the economy in general - is wages and spending. While they do amount to two distinct items, they are inextricably tied together by virtue of the bad news they both portend. Our spending spree might be close to an end. Excluding those growing mortgage obligations, which have become quite huge unto themselves, we borrowed our economy to health forking over $675 billion more than what we took home.

Those mortgage obligations made possible by stubbornly low advertised mortgage rates and the creativity of the home lending industry is now, as a whole, guilty of aiding and abetting this debt expansion. Equity is still being tapped at an alarming rate as home prices continue to rise in a growing number of select areas.

For the risk averse, this will play itself out in dramatic fashion as the sluggish economic expansion bogs down under its own weight. Retail sales will slow, and there are indications that this has begun, even if you exclude the impact of fuel on the prices. This will have a ripple effect that will take away what little solid footing equities currently have. We're not talking a long term dip in economic strength. Growth this year will still be better than 2%, but only barely.

Mr. G. added to the mix and probably fueled the Thursday rally as well with comments such as: "Indeed, under existing tax rates and reasonable assumptions about other spending, these projections make clear that the federal budget is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years." His reversal of American fortune was relatively blunt. It was almost a veiled suggestion that raising taxes might be the only thing available to an administration whose promises to reduce the deficit by half in 2009 are now beginning to seem unlikely under the current spending plans.

The baby boomers have been promised too much the Fed chief warned as well. With entitlement programs projected at 8% of gross domestic product, 9.5% by 2015, and 13% by 2030, unless Congress faces one of two choices head-on - either raise taxes to bring the deficit in line or cut the constituency off - major economic problems are much easier to predict for the near future.

And lastly, we deserve the economic vise we are in and the equity markets see little wiggle room now that we are in it. How it plays out, the market should believe, will not be pretty.

Inflation will force interest rates higher whether it comes from fuel or food or lack of pricing power. Blaming the deficit, which includes the borrowed $155 billion from Social Security trust et al, was up a cool $374 billion over the previous year. And because of this, dollars have been in cheap circulation around the world in such abundance that the only place they can be spent is back on our home turf. Foreign banks are going to continue buying U.S. Treasuries because they have no other option. Not because they are the best value or they believe in the full faith and credit of the U.S. government but because of the lack of other choices.

If China keeps its currency pegged to the dollar, and I suspect that it will even if European and Japanese imports cost more, China will need to keep buying Treasuries. Should they dump their investment in our debt, another improbable occurrence that would result in giving them more dollars that they don't need, or revalue their currency, the United States would not be out of the woods economically speaking. The dollar would still be weak. The world markets have grown over the last three years of dollar decline but in doing so, have become even more imperfect than ever.

Our cries for protection are being echoed at various levels globally and are not expected to help our goal of increasing foreign investment. Remember, for investors overseas to find us attractive, our deficits, both federally and trade-wise need to come down, our dollar needs to remain attractively low to make imports more expensive which would magically make America a great place for foreign investment.

If anything, taking the summer months off might provide some prospective. There is an increasing feeling that we may not be able to "see the forest for the trees" now. Couple that with the gains one might get from avoiding the upcoming spat of market losses, and waiting in the wings until fall seems downright intriguing. I'll still be here but your money should be on vacation.

The Blue Money Report
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