Is Dow Jones Industrial Average headed to 10,000?

Posted by Shyam Moondra

The stock markets around the world are going through turmoil. The markets in China, India, and elsewhere are down 30-40 percent from their respective records set last year. Inflation is heating up everywhere, thanks to the high oil and commodity prices. Many countries in Europe and Asia have been increasing interest rates to fight inflation. These actions, combined with consumer's reduced capacity to spend, will slow down the global economy. Many of these countries are also experiencing reduced demand for their products and services from the U.S. because of the weakening economy here.

The U.S. has its own special set of problems. The credit crisis, which the government officials declared was under control not long ago, seems to be in the forefront again. After the government bailout of Fannie Mae and Freddie Mac, the investors are now fixated at who is next. It has become a guessing game for the economy watchers about which bank will go under. It has been said that around 150 banks, mostly regional banks, could file for bankruptcy. It’s like Savings & Loan fiasco all over again. These credit problems will have negative impact on the economy. Because of sustained high oil and commodity prices, inflation is creeping through the economic system and we will see awful inflation numbers over the next few months. Just today, it was reported that the PPI increased in June by 1.8 percent, the largest increase in 27 years. Those kinds of headlines will persist for a while. The housing industry was hit hard because of the mortgage mess and now it looks like the auto industry is on the ropes. The consumer-driven U.S. economy is sliding down because consumers are busy trying to cope with the high gasoline, heating oil, natural gas, and food prices. They cut-down their discretionary spending and leisure travel, putting airlines and Las Vegas and Atlantic City casinos in dire situation.

The only segment of the U.S. economy that was doing well was the exports business helped by weak dollar, but even that's slowing down because of the shrinking economic growth around the world.

Unfortunately, the large federal budget deficit precludes any dramatic stimulus effort by the Bush administration. The FRB has already reduced interest rates as much as they could. So there is nothing any one can do right now to turn things around. We may very well be headed for a prolonged recession, like the one we had during 1970-1975. The tougher times are still ahead in terms of high inflation, high unemployment, meager or negative economic growth, and continuing bank failures – all of these will eventually affect the corporate profits. While the U.S. stock market has declined over 20% from the peak of 2007, the extent of the economic problems around the world suggests that the worst may not be over. A stream of bad news about inflation, unemployment, and corporate profits over the next few months is likely to sink the DJIA to 10,000.

Should Federal Reserve Board increase the interest rates?

Posted by Shyam Moondra

Economy in deep recession, the unemployment rate zooming up, inflation out of control, corporate profits declining, dollar taking a plunge in the currency markets, and the stock market in a huge downward spiral. No, I am not talking about "today," I am talking about the 1970's.

The 1970's were the troubled years. Huge government expenditures necessitated by the Vietnam War and the oil embargo by OPEC (after the Yom Kippur War in October, 1973, which led to a big spike in oil prices), fueled the inflationary pressures throughout the economy. The people were losing their jobs and everything seemed to be falling apart. If there was such a thing as stagflation, that was it. President Carter had no stomach for the failed Nixonian style wage and price controls of 1971 (free-market economy and massive government intervention are like oil and water, they never mix!). Then in 1979, came to the rescue Paul Volcker, the FRB Chairman, who rapidly increased the interest rates to get some control over the inflationary spiral. The elderly people were in a dreamland earning more than 15% on money market accounts and CDs. The sustained high interest rates broke the back of the inflationary spiral. By 1987, Volcker left an economy that was getting ready for the biggest economic expansion we have seen in the modern history. The 1990's go-go years were the years when we had very low interest rates, low inflation, low unemployment, high house ownership, budget surpluses at federal and state levels, and "irrational exuberance" in the stock market. The people generally felt very prosperous and confident about the future.

What we see today is not much different from what we experienced in the 1970's. We have the Iraq War, which has drained our economy of at least two trillion dollars (and still counting), oil and commodity prices fueling inflationary pressures, joblessness increasing, stock markets in the dumps, and people are generally feeling financially insecured. May be what we need is the Volcker treatment of high interest rates combined with responsible fiscal policies (especially on the side of government spending) to bring back the happy days again. It will surely be a painful period of several years before we are able to put our economic house in order.

At this juncture, high interest rates would have more upside than downside. Higher interest rates will strengthen dollar, which will bring down oil and other commodity prices and thus lower the inflationary expectation. Lower gasoline and food prices would enable consumers to spend more on other things, thereby revitalizing the economy. Surely, higher rates will make it difficult for the housing market to recover, but the housing troubles have more to do with the fact that mortgages were given to unqualified people, who are defaulting on their loan repayments. Overall, higher interest rates will be more beneficial than detrimental to the economy and they might even boost the stock market (which may seem strange, but it did exactly that in the 1970's).

The stock market needs a positive catalyst

Posted by Shyam Moondra

The stock market suffered its biggest loss for the month of June since 1930. From the record high set last October, the DJIA is now down over 20%. The question is where do we go from here. Oil and other commodities continue their upward price spiral forcing many companies to increase the prices of their products and services. That means inflation will continue to lead the headlines in the coming months. That also means the next move by the FRB on the interest rate front is most likely to be upward. The consumers, hard-pressed by astronomically high oil and food prices and rising unemployment rate, are pulling back on their spending. The financial sector is besieged by non-ending mortgage securities related losses and the need to raise huge amounts of new capital, which will cause dilution in the coming years thereby lowering their per-share earnings. The credit crisis is also keeping the housing sector meltdown alive and well. Increasing energy and material costs and declining consumer demand are likely to make corporate earnings for the 2Q08 fall short of expectation. All these negative headlines in the coming weeks will be enough to sink the market even further.

The sad part is that FRB has run out of ammunition and President Bush and Congress don't have much in their arsenal either that could change the course of economy in the short-term. However, the best opportunity for a turn around now rests on a new administration that could take some initial steps to lay the foundation for a big turn around in the second-half of 2009.

1. Increase income taxes for the very rich and close corporate tax loopholes (e.g., off-shore tax sheltering) and use that money to lower taxes for the middle-class and low-income people that will fuel consumer spending.
2. Implement the plan recently passed by Congress to stop the wave of foreclosures that's causing continued slide in housing prices. The sooner we stop this downward spiral, the sooner we will get the housing sector moving again.
3. Invest heavily in the infrastructure projects and public transportation systems around the country to revitalize the construction sector and help reduce demand for the imported oil.
4. Initiate a more effective energy policy that combines heavy emphasis on alternative fuel sources and conservation.
5. Strengthen regulations of banking industry (including investment banks) to avoid any future credit crisis.
6. Strengthen regulations of energy and other commodity markets, especially those that are currently not monitored because of the so-called "Enron" loophole . This should help reduce manipulative futures trades by investors that have no commercial interests in energy and other commodities (e.g,, investment banks, hedge funds, and pension funds).
7. Investment banks, hedge funds, and other big players have turned the stock markets into casinos. We need to ban short-selling by these institutions (or at the minimum, restore the "up-tick" rule for short-selling) and also limit trading in derivatives. The markets have become way too easy to manipulate; we need to restore the role of fundamentals in investing.
8. We need to show our resolve in protecting dollar. Strong dollar will bring down oil prices that will immensely help in improving the psychology of the stock market.