If you had missed the best 90 days of the S&P 500 over a 15 year period (1993-2007) your average annual return would have been a negative 7%.  If instead you bought the market and held onto it, that same return would have been greater than 10%. 

Last week’s economic data shows that “risk aversion hysteria” has a major impact on economic activity in the United States.

The total number of people receiving unemployment benefits (a.k.a. continuing claims) increased to almost 3.9 million in late October.  As a share of the workforce, continuing claims are now back to the peak hit in the aftermath of the 2001 recession.  Meanwhile, retail sales plummeted in October and are down 4.1% versus a year ago, the worst one-year comparison on record.

September’s international trade data showed a smaller trade deficit, but the underlying figures reported record declines for both imports and exports.

All of these figures are consistent with our view that the US has been experiencing a once-in-a-multiple-generation negative shock to monetary velocity, the speed with which money its way through the economy, as both business and consumers pull back from economic activity.

As a result, we are forecasting that real GDP shrinks at a 4% annual rate in the current quarter, the largest decline since 1982.  However, we believe the economy will stabilize in the first quarter of 2009, grow at a 2% annual rate in Q2 and then expand at a 3% rate in the second half of next year.

An economic recovery does not require monetary velocity to reaccelerate.  As long as velocity simply stops falling, a recovery can take hold. 

Loan data for October suggest this may already be starting to happen.  In October alone, banks increased commercial and industrial lending by 4.2%, real estate loans by 3.4%, and consumer loans by 2%.  While securitized non-bank lending remains locked-up, other lending continues.

In addition, the Federal Reserve has rapidly expanded its balance sheet to offset the drop in velocity.  Inventory ratios remain very low.  In other words, this is not the kind of environment that creates an endless downward spiral.

~ From First Trust

I’ve been a follower of economics since I had the opportunity to try to understand America.  I immigrated from Italy as a 10 year old, and everything was “new” to me.  In school I strived to understand cause and effect.  Having studied economics for almost 50 years, this article best describes how I feel about it all.  Enjoy!

Today’s Wall Street Journal has an interesting editorial about Washington’s potential plan for your 401(k) assets.

In light of those who foresee the current bear market bringing about the death of stocks, here are 10 Market Rules to Remember from long time strategist Bob Farrell:

(Photo:  azrainman)

1)  Markets tend to return to the mean over time.

2)  Excesses in one direction will lead to an opposite excess in the other direction.

3)  There are no new eras - excesses are never permanent.

4)  Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.

5)  The public buys the most at the top and the least at the bottom.

6)  Fear and greed are stronger than long-term resolve.

7)  Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names.

8)  Bear markets have three stages - sharp down - reflexive rebound - a drawn-out fundamental downtrend.

9)  When all the experts and forecasts agree - something else is going to happen.

10)  Bull markets are more fun than bear markets.

Hat Tip:  Carpe Diem blog

Conservatives should never say to voters, “We can lower your taxes.”  Conservatives should say to voters, “You can raise spending.  You, the electorate, can, if you choose, have an infinite number of elaborate and expensive government programs.  But we, the government, will have to pay for those programs.  We have three ways to pay.

“We can inflate the currency, destroying your ability to plan for the future, wrecking the nation’s culture of thrift and common sense, and giving free rein to scallywags to borrow money for worthless scams and pay it back 10 cents on the dollar.

“We can raise taxes.  If the taxes are levied across the board, money will be taken from everyone’s pocket, the economy will stagnate, and the poorest and least advantaged will be harmed the most.  If the taxes are levied only on the wealthy, money will be taken from wealthy people’s pockets, hampering their capacity to make loans and investments, the economy will stagnate, and the poorest and the least advantaged will be harmed the most.

“And we can borrow, building up a massive national debt.  This will cause all of the above things to happen plus it will fund Red Chinese nuclear submarines that will be popping up in San Francisco Bay to get some decent Szechwan take-out.”

Yes, this would make for longer and less pithy stump speeches.  But we’d be showing ourselves to be men and women of principle.  It might cost us, short-term.  We might get knocked down for not whoring after bioenergy votes in the Iowa caucuses.  But at least we wouldn’t land on our scruples.  And we could get up again with dignity intact, dust ourselves off, and take another punch at the liberal bully-boys who want to snatch the citizenry’s freedom and tuck that freedom, like a trophy feather, into the hatbands of their greasy political bowlers.”

~ From The Weekly Standard

 Hat Tip:  Adventures in Capitalism

This is unbelievable, but it is good news:

WASHINGTON - House Speaker Nancy Pelosi told the Wall Street Journal that she is considering a two-staged effort to boost the shaky U.S. economy, arguing for action now on a stimulus package of $60 billion to $100 billion, followed early next year by a companion measure that would include a “permanent tax cut.”

In an interview Thursday morning, the California Democrat pointed to weakness in the nation’s jobs market, and urged the White House, long skeptical of Democratic-led stimulus efforts, to work with Congress in the waning days of President Bush’s term.

“Let’s see if we can’t do something, working together now, that gives us a two month jump,” she said.  She said any measure enacted in a lame-duck session of Congress this month would effectively be a downpayment on additional measures enacted later.  “We’ll take the longer view as soon as we take over in January.”

Ms. Pelosi said she doesn’t favor a capital gains tax cut, as pushed by congressional Republicans.  But she did say the “second piece” of the Democratic stimulus agenda should include a tax cut.

The speaker said she prefers a direct tax cut over tax rebate like the one pushed by President George W. Bush a year ago.  The speaker said a direct tax cut can have a more immediate impact on the economy, especially if the government adjusts tax withholding tables to speed dollars into worker paychecks.  “The impact is faster than a rebate, which takes a few months get into people’s hands,” she said in an interview.

 ~ From Thursday’s Wall Street Journal

The election is done.  Time to focus on the upcoming recovery in the stock market and economy. 

Here is what I see happening. 

Let’s first look at monetary policy.  As seen in the below chart, the Fed is pumping massive amounts of liquidity into the financial system:

 
 
After a period of time banks will be saturated with lendable dollars and bankers will start looking for deals.  Instead of being incredibly defensive, they will be on the lookout for borrowers.  There are a lot of good ideas out there but the owners of these ideas need capital to bring them to market.  Growth has been held down by a sharp decline in velocity (the rate at which money changes hands) and fear. 

I expect this activity to slowly increase just from the fact that more money is being made available.  The problem during the credit meltdown was there were a lot of people with ample collateral but could not get approved for a loan. 

So are we close to the market bottom?

Hindsight is the only way to be certain but one indicator that tells me we are nearing a recovery is business inventories.  They’re way down because everyone has been holding back thanks partly to the media spreading recession/depression fears for the past year and a half. 

This tells me companies will eventually need to start producing more goods.  When they do start producing, activity rises as does GDP.  I could be wrong but my best guess is that by the spring of next year we will begin to see the visible traces of growth.   

Now on to fiscal policy - the taxation and spending that goes on in Washington. 

We have an idea of what our President-Elect wants to do but the real issue is what will he do.  Fortunately the high level advisors to Obama carry a lot brain power - especially former Fed Chairman Paul Volcker.  So I don’t expect anything disastrous to happen, just slower growth (than what a free market would produce) once policies are put in place.

As for the stock market recovery, I think it will be closer to a V shape.  Actually, there will be two recoveries - one in the stock market and the other in the economy but we will see the market recovery first. 

Here’s why:

Unemployment is a lagging indicator meaning the peak of joblessness is seen after a market bottom has passed.  A ramp up in business activity and production will not be seen in current jobless claim reports. 

Historically a stock market recovery takes off at least 6 months prior to a recovery in the economy.  Expect the economic recovery to be more U shaped as the economy continues to muddle along over the next few months.       

I will close this post with the following:  My advice to investors over the past several months remains unchanged.  The rate at which the Fed is creating money will eventually have some incredibly powerful effects on asset prices.  When will this be?  Impossible to say but what I am most certain of is that you will either be a net receiver or a net payer.  Buyers of tangible assets at today’s prices will find themselves on the receiving end once the market recovery arrives. 

Michael Cannon, a previous guest on our radio show and the Director of Health Policy Studies at the Cato Institute, talks about the problems with Obama’s health care plan:

Interesting commentary here from the Cato Institute’s Richard Rahn on who you elect to Congress and the impact on your stock market investments. 

Key Quote:  ” … over the last quarter century when the Republicans controlled both houses of Congress, the stock market rose by an average of about 20 percent per year.  When the Democrats controlled both houses of Congress, the stock market only rose an average annual rate of 6.9 percent for the Dow Jones and a tepid 5.1 percent for the Standard & Poor['s] 500.”

For those of you not familiar with the Cato Institute, they are a leading advocate on promoting the principals of liberty, free markets, and limited government.  Cato is the best organization I know of at getting this message out to mainstream America.  Here is their website, blog, and Twitter feed.