The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (9 page)

Another option is that the Fed has found other ways to stimulate the stock market without explicit QE, at least temporarily. The question of direct Fed intervention in the stock market is always a tricky one. We brought it up in an appendix to
Aftershock
, Second Edition. It’s still not something discussed in mainstream media, even though it should be. However, the suspicion of it certainly goes beyond our doors. In fact, coauthor Bob Wiedemer attended a lunch of Wall Street analysts and investors in New York in August 2011 and decided to ask the attendees how many thought it was
possible
that the Fed was directly intervening in the stock market. Not that they thought it was happening, just that it was possible. Surprisingly, almost two thirds of the attendees raised their hands.

Certainly, there are days recently when the market has acted awfully funny. Most notably August 9, 2011, when the Dow was down 300 points in the afternoon and, for no significant apparent reason, reversed course, climbing very rapidly, and closed up 300 points by the end of the day. From that point forward, the market continued to climb in a bullish fashion with few retreats through the end of February.

But whatever the Fed is doing directly or indirectly to support the market, one thing is clear: They are very worried. How do we know they are worried? Because never in the history of the United States have they printed so much money so fast. And, unlike before, there is absolutely no talk about how to pull that money out of the system—another sign of their very serious concern about the economy. So, clearly, they are very worried, even though they tell us not to be. And, actually, we should be very worried, too.

The “recovery” is
still
driven by government borrowing and printing. Take away either one and we would be in a
deep
recession.

Government borrowing has soared since the financial crisis. As an example, in February 2011, the government borrowed more money than in
all
of 2007. As mentioned earlier, we are borrowing about $100 billion
per month
. It’s worth mentioning again because it is so important. That equates to borrowing about $1.2
trillion
per year or about 10 percent of our total GDP. Eliminate that borrowing and you effectively cut our GDP by 10 percent. And that doesn’t include the negative effects such a deep recession would have on consumer confidence, investor confidence, and the bubbles.

Even the small reduction in borrowing discussed at the end of 2011 (eliminating the Bush tax cuts, eliminating the unemployment benefits extension, and cutting Medicare reimbursement levels) would have reduced GDP by 1 to 2 percent. Well, GDP growth this year may be only about 1.5 percent. So we owe almost our
entire
growth this year to borrowing the money to avoid those reductions! That’s a fragile basis for any economic recovery.

Money printing is playing an important role as well. It has been critical to maintaining our stock market bubble. Without it, the stock market may have never recovered much from the financial crisis or certainly fallen again even if it did recover somewhat. And a falling stock market would have big negative impacts on the economy.

Combined, government borrowing and money printing are not only key to our current “recovery”—they
are
the recovery.

As of this writing in mid-June 2012, here are our thoughts on:

• Stocks
  
• Bonds
  
• Europe
  
• International equities
  
• Gold
  
• Silver and commodities
  

Believe it or not, we actually think 2012 might end up being a decent year for stocks. Stocks will likely be highly volatile, as they were in 2011. However, if stocks fall significantly, the Fed will likely intervene with yet another round of QE. This may be done surreptitiously, or it may go by another name.

This will work to boost the stock market—in the short term, at least. A big round of money printing could even send the Dow toward its all-time high of 14,164. When this happens, we will be much more bullish on stocks in the short term although there’s still plenty of long-term risk.

So when will this bubble pop? In the past, stocks have fallen within weeks after the quantitative easing ended. In the future, it may not be so clear cut. The next round of QE may be more open-ended and that will provide more ongoing support for the stock market in the short term. In the longer term, the stock market bubble will still pop, but it’s difficult to set a clear expiration date right now. Stay tuned and we will keep you updated as this develops.

In the meantime, high-dividend stocks of stable, conservative, large-cap companies such as electric utilities, Johnson & Johnson, and Procter & Gamble are still worth looking at in a conservative portfolio. There is less potential for short-term growth, but they also carry lower long-term risk.

Interest rates on bonds in the United States are about as low as they can go—meaning the potential for capital gains from bonds is pretty slim. However, there could be some small gains to be had in 2012. Financial uncertainty in Europe will likely continue to make Treasurys a relatively safe haven. However, if the Fed prints money in another round of QE, that traditionally has been a short-term negative for bonds since investors will be moving out of bonds and into stocks. And remember, even a relatively small increase in interest rates could send bonds downward very quickly.

So we recommend keeping shorter-duration high-quality bonds, such as two-, three-, and five-year Treasurys. In addition, there are special bonds, such as mortgage-backed bonds and TIPS (which stands for Treasurys Inflation-protected Securities), that are likely to outperform traditional bonds in a QE-type environment. Overall, they should be a good source for total return this year, although not as good as 2011. Exchange-traded funds (ETFs), such as “TIP” (for TIPS) and “MBB” (for mortgage-backed bonds), are potentially good ways to invest in those bonds.

As we predicted, the European Central Bank has turned to printing money in order to buy Italian and Spanish bonds to prevent the Greek financial crisis from spreading throughout Europe and threatening the collapse of the French and German banking systems. While the extent of the money printing is nothing compared to the Fed’s QE, it has prevented the European banking system from melting down for the time being.

In 2012 we can expect more of the same. Countries with large debts and weak economies, such as Italy, Spain, and Greece, will continue to run into liquidity problems and threaten to topple the banking system. The ECB, ever reluctant to print money, will nonetheless have no choice but to continue to print money to save the day. Of course, this will lead to more inflation eventually, but in the meantime it will have the intended effect of keeping the European banking system from collapsing. Ultimately, saving the banking system is the primary goal of the ECB.

In summary, we don’t expect the Eurozone to collapse this year or the euro to be abandoned. What we do expect is an increasingly reluctant ECB to print increasing amounts of money. No one will like it, but it’s the easiest “solution,” and politicians usually choose the easiest solution.

One caveat is that the Greek/Spanish/Italian debt situation could deteriorate more rapidly than a reluctant ECB is willing to act. This could cause a lot of panic around world financial markets, but we expect the ECB will be forced to act before it becomes a true Lehman Brothers–type meltdown (but no guarantee!).

Although international equity funds have been touted by many brokerage firms over the past couple of years as a way to diversify out of the U.S. stock market, they performed very poorly last year. Indian and Chinese markets were both down over 20 percent. Many European markets were down from 10 to 20 percent. You would have been better off in U.S. markets. Could there be a rebound this year? Sure, especially if the U.S. market rebounds due to some Fed money printing. However, just as we didn’t like them before, we still don’t think international equities are worth the risk of a longer-term hold. The issues we previously discussed regarding Europe and China will continue to weigh on the entire world economy and also on their stock markets this year. Could there be short-term gains? Of course. But, overall, we would continue to avoid international equities as having too much risk and volatility for the potential gain.

First, let’s be clear that we view gold as a long-term investment. With governments around the world turning to money printing in order to artificially prop up struggling stock markets and banking systems, the fundamentals in our economy are set up perfectly for a long-term rise in gold. When inflation goes up, interest rates follow, which will spell doom for stocks, bonds, and real estate. At that point, gold is the only place to turn for many investors, and it is likely to have explosive growth. According to some estimates, gold comprises only 0.14 percent of investable assets in the world. Less than a quarter percent is not much, so any movement out of stocks or bonds and into gold will have a
big
effect on gold.

Even in the past decade, with very low inflation, gold has been an excellent investment, quintupling in value over that span while the stock market performed poorly—the S&P 500 was flat, and the Nasdaq fell 50 percent. But we like gold for its future ahead, not for its past performance. Many see gold’s rise in the past decade as another bubble. But as we see it, the bubble has barely started. We won’t say how high we think it will go, but it could easily increase several times from where it is today before this bubble pops.

So why has gold dropped so far since late 2011? There are plenty of reasons why gold can go down in the short term, and we still expect some volatility between now and the dollar bubble burst. We’ve said before that there are signs of central bank manipulation, and we’ll likely see more of that in the years to come. The drop in gold price may also have a lot to do with the situation in Europe, where liquidity problems increase demand for dollars and make it necessary for financial institutions to sell assets like gold. This is similar to what happened in 2008, when the liquidity crisis sent the price of gold tumbling 30 percent in a matter of months. The important thing to remember is that gold has more than doubled since that low point of around $700/ounce. Even if you had bought gold at its peak before the 2008 financial crisis, your investment would have increased 60 percent by now.

By comparison, the recent drop in the gold price, percentage-wise, was only about half what it was in 2008, and gold was still up about 10 percent last year. Among the factors driving gold in 2012 will be increased physical demand in China, continued buying by peripheral central banks such as Turkey, Korea, and others, and continued financial uncertainty. We see no reason why the growth trend in 2011 won’t continue in 2012.

Note on gold ETF PHYS: PHYS doesn’t always track the price of GLD, the biggest gold ETF. The reason is that PHYS typically trades at a premium to the price of gold (similar to gold bullion coins). In recent months, the premium has ranged from 1 percent to 6 percent. While the price of PHYS is predicated on the price of gold, it is also affected by the change in the premium. As an example, if the price of gold was up 1 percent and the premium on PHYS to gold was also up 1 percent from the prior day, PHYS would be up 2 percent. Had the premium dropped 1 percent, PHYS would be unchanged. Sprott Asset Management, which manages PHYS, does an excellent job putting this data on the following web site:
www.sprottphysicalgoldtrust.com/NetAssetValue.aspx
. Historical data can also be found at the site.

In the long run, we expect silver to track gold pretty closely, meaning it will go up over time. In the short run, however, we expect silver to be more volatile than gold. This is partly because silver is an industrial metal as well as a monetary metal. Over half of silver’s production each year is used for industrial purposes. Silver’s long-term rise will be tempered over the next year by the declining demand for electronics, particularly from China.

Most commodities, including silver, are dependent on demand from China, which in recent years has radically increased its demand for food, coal, metals, and other commodities. This doesn’t bode well for the commodities market, because there are signs the Chinese economy is slowing down dramatically. It’s difficult to be precise because the Chinese government has a tendency to be less than truthful with its economic statistics. So don’t expect economic readings from the Chinese government to indicate that. Most likely, Chinese government statistics will indicate perfect government management of a controlled slowing of economic growth from white hot to red hot. Would you expect anything less from a dictatorship and heavily state-run economy? Of course, many people on Wall Street will believe it because they want to believe it. Also, inaccurate inflation reporting, as here in the United States, can make many economic numbers look better than they are.