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Archive for July, 2010

A Rough(er) Patch Will Soon Develop

I haven’t written much for this blog lately (at all?), but I have been monitoring the market. Right now, I’m very bearish and am expecting a bear market to develop sometime within a year…perhaps as soon as next week. After the recent runup last week, sentiment has greatly improved (example: http://apps.thestreet.com/survey/results/rmBullsBearsBarometerPollResults.jsp?sid=40557&mode=pollresults). These types of results are very similar to what were seen in September 2008, and I expect a similar result to happen.

We’re about to hit many deflationary headwinds that simply are not discounted by the market in my opinion:

1. Tax increases. About $100 billion will be soaked out of the private economy to pay down the government deficit. Most of this is due to the expiration of the Bush tax cuts for those making $200k/$250k+. Not only do tax increases have the effect of taking money out of people’s hands, they discourage people from expanding and developing their businesses. Since their after-tax return is now lower, they will be less likely to take risks. Furthermore, due to the crash in small business lending, many small businesses are expanding from after-tax profits, not bank loans, and there will now be less of those to use thanks to the government.

These reasons explain why some economists apply a multiplier of 3 to tax rate cuts/increases. So $100 billion taken in taxes will have a $300 billion negative effect on GDP. This estimate was made by Christina Romer, who works for the White House no less. At $300 billion, that’s 2% of GDP…so we can expect a 2% drop in GDP from tax increases alone! Given we’re struggling to have much better than 2% GDP growth right now, tax increases alone might throw us back into recession.

I don’t think the tax increases will be fully discounted by the market until they happen. This was the case with the Reagen tax decreases (the reverse). Read Laffer’s article about this more in detail (note how the economy rocketed by over 7% for a full year during the Reagen stimulus, and we’re struggling for 3% during our peak in stimulus). This makes me believe we won’t see the worst of things until around March of 2011, as the deflationary effects of the tax increases become fully realized.

2. Europe is messed up, simply put. The recent stress tests were a joke. No one knows what is on their banks’ books, since the transparency levels there are much lower than here. One must ask…why were the stress tests not so stressful? The answer: we can’t handle the truth. Even under their ‘stressful’ conditions, Greece is still able to make debt payments and the stock market doesn’t fall by more than 20%. Doesn’t sound that stressful to me!

3. China isn’t so magnificent. China’s stock market is down 20% for the year. For those that remember, China’s stock market turned up much sooner than the US did (their bear market ended Nov 2008, ours did March 2009). This is why many view China as a leading indicator. Oh, has anyone checked out their property bubble lately either? It makes California look tame.

4. We’re at peak debt. Total government, personal, and business debt is estimated to still be about 390% of GDP, which is still an all-time high. While the consumer and businesses are deleveraging, the government is running insane deficits. So we’re simply trading in personal and business debt for unproductive government debt.

5. We’re at a general level of peace right now. If Israel/Iran blows up or North Korea goes crazy, look out below. The world is struggling in a time of relative peace, and that is a very very bad sign.

6. Have you checked out the ECRI weekly leading indicators lately? Eeeeek! The last time there was a drop of the magnitude seen lately was in the late summer of 2008…and we saw what happened soon after.