As the post holiday numbers roll in, it’s becoming clearer that we are an economy in retreat. Only WalMart, among the major retailers produced positive figures. All the rest, including Target, Macy’s and Penny’s showed significant declines. With core inflation on the rise,
driven chiefly by record oil prices and the specter of crippling credit card debt, consumer and investor confidence in the economy has begun to slip. The burning query is not if the housing market will continue to plummet, but how far.Most economists are reluctant to utter the “R” word, for fear that it becomes a self-fulfilling prophecy. But, of late, the most dreaded letter among economic prognosticators is “D” for deflation.
To this point, the Fed’s seeming pre-occupation with inflation is akin to rearranging deck chairs on the Titanic. The greatest hazard to this economy is not the soaring price of ethanol, but the probable cascade in home prices, durable goods and ultimately, the stock market.
Throughout the tenure of former Chairman Alan Greenspan, the “Inflation Hawks” ruled Fed policy. Greenspan, however, governed the Fed during an era of relative economic growth and expansion. Today’s economic climate harkens more to the dark days of “stagflation” presided over by Greenspan’s predecessor Paul Volker. The only palpable difference between then and now, is the skyrocketing interest rates that dominated the late seventies.
Despite the fact that all economic road signs continue to point the way towards recession, and likely much worse, most investment professionals continue to blindly cling to their ingrained belief that nothing could possibly derail the U.S. economy or significantly reduce the value of U.S. assets. Apparently, there is no end to their paradise of self-delusion.
Likewise, until now, federal policy-makers have been all but oblivious to the economic “red flag” warnings in the economy. Despite the continued evaporation of home equity, record consumer debt levels and drooping retail sales, Washington has “stayed the course.” The President, and his team of crack advisers, still contend that the fundamentals of the economy are solid. They have ignored the recent surges in oil, gold and other commodities, and argue that rising exports resulting from a weaker dollar is sufficient to keep the recessionary forces at bay. But as the effects of the subprime crisis spill over into the rest of the economy, and unemployment grows, the Fed along with Treasury will be backed into a corner.
In his first speech of 2008, the Fed Chair finally acknowledged the dire straits for which the economy is headed. .
He more than subtly hinted that further interest rate cuts are in the offing. Although Wall Street posted a positive response after his remarks, it is unclear whether the rise in the Dow was more a result of the speculation that Bank of America may acquire troubled mortgage lender Countywide.If Fed Chair is to act, he must act boldly. Even a half point cut such as the one implemented in November may not be enough. If the goal is to stimulate investment and to rescue distressed borrowers, then he must cut deeper. With the current Fed Funds Rate at 4.25, his target should be a drop to rates by at least two full points by the end of the third quarter.
According to reports, the Fed Chair has carefully studied the Japanese economic recovery in the wake of its own real estate collapse. Part and parcel to their package, were interest rates, which at half a point, still are among the lowest in the industrialized world. These low rates not only have stimulated Japanese borrowing and investment, but also created a vibrant secondary market for Yen. (Global “carry traders” have been borrowing in Yen only to reinvest it in instruments with higher yields.)
Whichever option the Fed chooses, the impact on the purchasing power of the dollar will be substantial. While it is unclear how this scenario will play out in the economy, I would encourage investors to begin diversifying away from dollar denominated assets. This means that portfolio’s constructed primarily of inflexible mutual funds are most at risk. In addition to foreign stocks, investors ought to give serious consideration to hard assets such as gold, foreign currencies and commodities. If you plan to continue holding positions in the stock market, then hedge your portfolio with index funds. The advantage of a well-managed index fund is that it can benefit the investor in both “bull” and “bear” conditions.
Don’t be thrown by the volatility of these alternate markets. In my way of thinking, it’s better to brave the risks of a new market than to run the risk of a complete portfolio meltdown.
To learn more about my market recommendations, visit our website atwww.globewestfinancial.com.
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