My 1st Million At 33 – yes, you can do it too

Listening to the latest webcast at www.financialsense.com, I must say that I am amazed by the continual confidence of Jim Puplava in the Fed’s ability to have everything back in control again.  Essentially, he believes that Fed cannot afford to have two markets, both housing and stock markets, simultaneously going into deflation.  He believes that Fed will engineer a low point in the commodity market to serve as a pretext for possibly going on pause in the coming June 28/29 meeting.  Furthermore, he suggests that if US strikes a deal with Iran, US can take out the geographic instability premium in the crude oil price, and most likely gives a needed strong boost to the stock market.  Given just a big down day on Monday, it is simply hard to believe that this market will turn around from such a heavy bearish bias.  Furthermore, Bernanke has just spoken tough against inflation (which caused the big down day).  Despite all the bearish views, I do think that investors should take a page from Fed’s internal thinking (if possible), and think pre-emptively like Fed, instead of being reactive to the market actions.  After all, Fed does have a big sway over the current development in the stock market.

Assuming that we attempt to think like a Fed, what are the biggest problems in Fed’s view?  I must say that I agree for the most part with the speakers & Jim Puplava that the biggest problems the Fed face are the followings:

1. A housing market that is on the edge of going into dramatic slow down, due to all the ARM mortgage that are coming to term for re-adjustments.
2. A falling $US dollar that is at the point of breaking the support against various major currency.
3. A run-away bull market in the commodity arena, which endangers Fed’s credibility on inflation fighting.

With the above problems stated, what could be the solutions?

1. For problem #1, Fed must control or lower the long term interest rate so that refinancing into a fixed term mortgage (for the people who can do it) can happen in a less painful way.  If the ten and thirty years treasury bond yields rise too fast, the housing market for sure will go into a dramatic slow down.  In that case, US economy will face a significant retrench.  Both housing and stock markets in that case will go down.  Since Fed has prepared themselves by stopping the publication of M3 money supply, it is entirely feasible and possible for Fed to start monetize at the long end to hold the lines of mortgage interest rates.
2. For problem #2, The falling $US dollar in part is due to the US economy slow down, and in part due to the forecast of US interest rate pause.  Talking tough on inflation (and therfore bias towards raising interest rate) like yesterday certainly helps the US dollar (well, just a bit).  However, if ECB and Japan central bank are willing to put a stop in their (coming) hikes of interest rate, that will certainly help more.  In essence, to prop up $US, a “good inflation fight” must be put up.
3. For problem #3, if US is able to reach a deal with Iran, and bring down the premium in the crude oil price, for certain, the gold price will take the hint and go down more.  If crude oil keeps elevated and advancing, suppressing gold price will be a much tougher job.  Without such deal to happen, the only current way to control commodity bulls is through various market manipulation and coordination between various central banks (especially with England).

Despite #3, Bush administration seems to build up the standard hard-line (pre-)war rhetorics, and the stock market seems to be getting that message.  This is the thing that puzzles me.  Don’t Bush understand that it is critically important to lower crude oil price in order to gain politically?  The next war with Iran if it happens, will be much uglier compared to Iraq.  With the precedence of Iraq war, the stock market will definitely look at the war unfavorably.  Instead of buying on the news of the war like last time, I think the stock market will tank on the news of the war with Iran.

In any case, global stock markets are showing signs for the last gap of air.  If a stable bottom is not put in soon, the current wave of sellings will soon beget more sellings.  If S&P breaks 1240-1250 level, the market will look perilious.  If 1200 level is gone, it may be dropping fast to 1100, and then all the way to 900.  At that point, Bush will be losing not only the support from the general public (due to high oil price), but also the support from wealthier elites who have the most stakes in the stock market.

I think for the Fed to solve problems #1 to #3, it is an extremely difficult job.  And do you notice the almost flat-line in the yield curve?  That may be hardest part, to solve problems #1 to #3, without causing the yield curve to invert for an extended period of time.  A yield curve inversion at this time will most likely foretell a US recession within 6 to 9 months timeframe.  I don’t think Fed is ready to announce to the world that US recession is here or coming.  With the short term interest rate at 5% already, the next step-up to 5.25% will for sure invert the entire curve, assuming Fed is still controlling 10 & 30 years bond at near 5%.  However, if 10 & 30 years bond go much beyond 5.25%, both stock and housing markets will certainly face a tremendous downward pressure.  At 5.5% + 1% risk premium, the stock market P/E ratio needs to be compressed to (1 / 6.5%) = 15.4.  That may be a painful pill for the stock market to swallow.