Tuesday, August 11, 2009

The U.S. Economy is in a Dangerous Catch-22

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August 11, 2009  

The consumer-based U.S. economy is trapped in a dangerous catch-22…

Two thirds of the U.S. economy is based on consumer spending. So, if we want to boost the economy, consumers must spend money. But spending is not a solution. The long-term solution is to save and invest.

Caught up in the excitement of the rally, few commentators are looking at the realities of consumer debt. Our own Steve McDonald breaks it down:

"While consumer debt is down from the insane 2007 levels of 132% of disposable income to 124%, it will be a dead weight on the market and economy for many years. Congress will not bail out the consumer."

"Second, saving rates are up from a scary low of less than zero in 2005 to 6.9% today. They are expected to settle in the area of 7% to 10%. This is usually good news."

"Finally, consumer borrowing is down for the fifth straight month which is an indication that consumers are being more realistic. This is also usually good news."

The problem is that 66% of our economy is driven by consumer spending. And you can't save money, reduce your debt, borrow less and spend more all at the same time.

The absence of the big spending we're used to has to affect the stock market at some point. This will be the stopper to any real growth.

This rally to the mid 9,000s has been a welcome relief for investors. But for the run to continue much longer, there will need to be some real revenue growth -- not just the cost-cutting that has gotten us to this point.

And revenue growth will have to come from spending. But with the savings rate going up and consumers clutching their cash more tightly, where will it come from?

If you plan to make money long-term, it pays to diversify out of the stock market. Corporate bonds are a logical choice. They allow you to sidestep the market's crazy volatility, and still collect super-safe returns that rival those of stocks.

Steve McDonald's research service, called The Bond Trader has delivered subscribers an average of 13% per year in investment grade bonds, with more than 50 profitable recommendations in the last year. Learn more here.

Yesterday, we pointed out that a correction is imminent after such a strong run. But we don't expect the market to challenge the March lows anytime soon.

Now is the time to be cautious in stocks. The markets have run up 50% in a matter of months. And the sentiment among individual and institutional investors is decidedly bullish – circumstances that are begging for a correction.

We are not prepared to call an end to this bear just yet, but neither are we oblivious to the trillions of dollars that the Fed and the Treasury have pumped into the system. There is really no debate between inflation and deflation. Inflation will always win when the political will is great enough to break deflation. With no fiscal restraint, there is a potentially infinite supply of dollars, compared to a finite supply of goods and services.

Has the Great Re-Inflation arrived? It is too soon to say. But we suspect it is close at hand. And the beneficiaries will be stocks and commodities.

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Market Window

The gleam of gold lures the "Masters of the Universe"

Gold used to serve as little more than a trading vehicle for hedge funds and institutional investors. But as our natural resources expert, Russell McDougal, points out in this report, gold is moving toward the mainstream.

He notes that John Paulson, reigning king of the hedge fund honchos, has made huge investments in gold on behalf of his funds. David Einhorn of Greenlight Capital is also betting big on the yellow metal. Along with many others.

Now, Reuters reports that inflation-wary hedge fund chiefs are adding physical bullion to their private investment portfolios. In a survey of U.S. hedge fund managers, 20 out of 22 interviewed claim to have purchased physical gold for personal investment.

The "mania phase" of the gold bull market is still ahead…

We are a little wary of all the attention gold is getting. But keep in mind, this is still the smart money taking a position. Mom & Pop America are still woefully ignorant of the dangers posed to their currency. Most people still hold no investment position in precious metals. Make sure you are not one of them.

But remember this: when the day comes that you hear about gold at every cocktail party, and you see a golden bull crashing through Wall Street on the cover of Time Magazine, take your profits.

Good Investing,

Bob Irish
Investment Director
Investor's Daily Edge

Bob Irish - Investment Director
Andy Gordon - Editorial Contributor
Jon Herring - Editorial Director
Ted Peroulakis - Editorial Contributor
Christian Hill - Editor Emeritus
Dr. Russell McDougal - Editorial Contributor
Steve McDonald - Editorial Contributor
Michael Masterson - Editor Emeritus


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