As I posted this past weekend, I don’t know where the market will close tomorrow. What I can say for certain is that the the stock and bond markets are BOTH still very rich at these levels, in spite of the 2-day decline so far totaling about 8%. Furthermore, the root cause of the selloff is not even close to being addressed!
Beginning nearly 9 years ago, the Federal Reserve embarked on an unprecedented move to pump liquidity into the financial markets to stave off an unprecedented real estate crisis. In so doing, they “minted” nearly $4 TRILLION of currency, without a corresponding volume of economic activity. Since the supply of dollars increased without a corresponding increase in demand for dollars, the value of each dollar is now falling. A falling dollar means inflation, and will result in higher interest rates and higher prices, which in turn will hurt economic activity and earnings.
What the Federal Reserve SHOULD have done 9 years ago is let the faulty institutions fail, instead of coming to their rescue. That’s how capitalism is SUPPOSED to work.
The financial authorities now have an impossible dilemma on their hands.
Monetary policy, controlled by the Federal Reserve, can either leave interest rates alone and watch the dollar enter a free fall, causing inflation. Or, they can raise interest rates to protect the dollar and severely hurt the economy. Either way, the stock market goes considerably lower.
Fiscal policy, controlled by the Administration and Congress, can either lower taxes, leave them alone, or raise taxes. Congress just enacted a massive tax cut. Budget deficits are now higher, which in turn pushes the dollar lower causing increased inflation. If Congress reverses the tax cut, they will hurt the economy. Either way, the stock market goes considerably lower.
Many experts are predicting a 15% stock market correction, and then a resumption of the stock rally back to overpriced levels. Perhaps there will be a bounce off oversold levels in the next few days. Nobody can say for sure.
For now, I remain a stock market “bear”, and continue calling for a much larger downturn over the coming months than nearly anyone is expecting. I am not talking about 10%, 20%, or 30%. Instead, I am talking 50% to 60%, and possibly more! The root cause of this selloff is the potential for a collapse in the US Dollar. When that happens, the economic depression that “should have happened” just a few short years ago, will now have another chance. Except this time, neither the Federal Reserve, nor the Federal Government, will have ammo left in their economic arsenal to prevent what will now be a larger disaster.