August 13 Is Bullish Day

It was twenty-seven years ago when we entered life on Wall Street. August 12th was the bottom of the market following the recession of the late seventies and early eighties where interest rates soared, inflation spiraled out of control, and unemployment pierced the 10% level. Stocks started to soar on high volume and the bull was off and running. Inflation was being tamed, interest rates were about to drop, and the economy was on its way to recovery. We can remember many professional traders loading up on call options as rising stocks generated more zeal every day. The bull was here to stay.

A score and seven years later investors ponder whether the current bull run is for real. The recession appears to be over but the economy is still weak. Retail sales numbers for July appear to be soft and the employment picture is not truly getting better. Of course, investors have driven prices higher with every earnings report that has shown improvement. As we have said in the past, earnings growth has been driven by cost cutting but sustainable growth will only be generated when corporate revenues improve.

Today's market participants can not expect interest rate to decline or inflation to be tamed or unemployment to abate. Those were the 1982 bull market drivers so what will drive the 2009 market higher? We are not sure. Perhaps China and India will continue to grow quickly and pull the U.S. out of its economic slump. This country certainly needs help from the global economy. The U.S. usually leads global growth but if stock investors are discounting better times ahead, the U.S. will definitely need help from abroad to drive exports and spur revenue growth.

We are in a cash driven market. The fear created in the markets by the financial collapse left trillions of dollars on the sidelines. It is hard for investors to watch stocks rise while they sit with a plethora of cash. Each surge in stocks draws in more money from those who don't want to miss the next bull run. We may want to believe the economy is improving but it has only really stabilized. Growth is a long way away and when back-to-school sales are weak the markets will suddenly become concerned about Christmas sales.

Cash for clunkers has created a surge in demand for new cars. This program has certainly provided stimulus in the same way the subsidies for first-time home buyers has rekindled the housing market. Unfortunately, these subsidized sales may be stealing from future demand. If consumer incomes don't improve and the inclination to save is rising, this economy cannot depend on the consumer for future growth. With no consumer, it is either up to big business or the government to drive growth.

Businesses take their cues from the economic outlook. If final sales are driven by the consumer and unemployment continues to be weak, it will be hard for businesses to invest in the future. Perhaps technology companies will be the beneficiaries of the economic weakness as companies will need to improve productivity if revenue growth will be dismal.

That leads us to the government to create growth. The stimulus plan has many wasted programs but the auto and housing industries have generated some positive results. The banks have been bailed out by Federal help also and perhaps the commercial real estate industry will also get a helping hand. Most of the fixes are short term and have contributed to the stabilization of the economy and the end of the recession.

Where does this leave us? We may have borrowed some future sales to jump start the weakened economy. All of these programs have added trillions to the government debt burden. The government is no different than a consumer or a business when it comes to debt. If a consumer's earnings decline and his expenses stay steady or rise, he his likely to accumulate a debt burden. Should this trend continue or one lose his job or his expenses rise (i.e. gasoline and heating bills) that debt burden will result in a default on a mortgage or personal bankruptcy. The same process is true for companies. Too much debt is leading to a huge wave of corporate restructurings and bankruptcies.

As for the government, the debt burden being created may help in the short run and the bull market may continue for awhile. However, at some point in the future the fat lady will sing. The United States will need to pay back its debts. Unless the economy starts growing exceptionally fast, which is highly unlikely, the government will need to aggressively raise taxes, as they are contemplating for the rich. Higher taxes will likely crimp economic growth and make the debt burden even worse. The only other logical solution is to devalue the dollar while printing more money. (We are assuming the government won't default on its debts.) This is a situation that seems likely to happen and the ownership of gold or other hard assets in the future may be the only safe place to hide.

August 13th is a good day to contemplate where we are in the next bull market. We remain concerned that growth will be slow in 2010 and that stocks are being driven by technicals. The recession may be over but the lack of revenue growth from companies, a weakened consumer, and the debt burdens of this country will ultimately come to roost.