Whatever…

Yes, today was a rough, rough day in the markets. No question about it. I’ve got a couple of things to talk about, so lets start with my current position on the Russell 2000- RUT(514.71 +9.68) - and why I’m not worried yet.

The economy is getting softer, that is a fact. The Russell 2000 is a bunch of small companies that are not nearly as globally connected as the big boys in the S&OP 500 or the Dow. When things get soft, the RUT tends to take it in the chin.

If you watch the charts of the SPX, DJI and RUT together you can see that the Russell typically moves a lot faster than the Dow or the S&OP 500 (see above). Over the past couple of months as volatility has jumped, you can also see that the RUT has moved even faster.

So, this morning we get a weak job number and the recession talkers are all ears. The market begins to drop and the RUT really takes it on the chin: recession = weakness in small companies. So, if the recession talks are in the wind, I’d expect the RUT to drop. This is why I’m not worried yet…

Today, the RSI on the RUT hit 23, anything below 30 is typically a signal of an oversold situation. 23 is really a sign that we should get a slight bounce next week. On Thursday the indicator was at 32, quickly working its way down - this drop was big… Watching the normal pattern of the RUT, I completely expect this bounce.

Anyhow, back to the trade. The RUT trade is at 670, about 50 points away from our current point in time. That is another 7% drop or so, I just don’t see it happening - at least not in the next 2 weeks!

So, since I’m still optimistic on my trades, lets talk about my optimism on the economy and why I think it is still good.

First off, the bad…

• Demand is down - homes are declining in value
• Job growth at 1% or less each year
• Interest rates are dropping rapidly

Now lets get to the good…

• After inflation, after tax income is up 2%
• August initial jobs were at -4K, revised +93K
  • This number gets revised every time
  • I’d expect that our current jobs number will come up quite a bit
• The vast majority of the reported job loss is in construction
  • DUH - housing is taking it on the chin, of course construction jobs are down.
• Q4 GDP likely to be 2.5->3% growth
• 5% unemployment rate - not to shabby

So, looking at all of this stuff what is going on? Well, the consumer is a little tight due to the housing market, and the economy is a little soft due to the gasoline(housing) being taken off of the fire. As a result of the softening housing market, a lot of construction workers are looking for jobs and the financial firms are having to write off sub-prime losses. However, the rest of the economy is in pretty good shape…

As the fed works this all out, it is in a really tough spot. Gold and oil are up, along with a bunch of other inflationary pressures. Ben and Co. need to make sure they get this right, the real risk here is … stagflation. Ouch.

If your not familiar with stagflation, basically it is low to no growth with rising inflation - bad news. Here is why this is a catch 22, taken from the wikipedia article on stagflation:

An important monetary mechanism to increase economic growth is by lowering interest rates, which reduces the cost for consumers to buy products on credit and businesses to borrow to expand production. While this can increase economic activity, it can also result in increased inflation. The monetary mechanism to reduce inflation is by raising interest rates, which increases the cost for consumers to buy products on credit and businesses to borrow to expand production. While this can reduce inflation, it can also result in decreased economic activity.

So, lets just hope we don’t end up with this mess.

A key to avoiding this is a strong dollar policy. The problem with that is of course, as interest rates go lower, so does the dollar. As interest rates go up, economic activity slows and the dollar becomes stronger. So, if the fed needs to turbo charge the economy, it needs to drop rates - but by doing so may accelerate inflation to a point of big troubles.

Personally, I agree with former federal reserve bank governor Wayne Angell. The federal reserve and the government need to team up and put together a policy that will lead to a stronger dollar. In my opinion the best way to do this is to lower corporate taxes while dropping interest rates. This gives us the chance to fix the credit crisis while bringing up the dollar by bringing more business to the United States.

I don’t see any other way around it. If President Bush can step up to the plate and put a solid corporate tax policy reform in place, we can pull out of this without any major issues. It would be one of the greatest soft landings in history. Something to applaud.

I don’t think it will actually happen, but I can hope right? I’m sure the folks in the federal reserve and the treasury department are talking about it. I’m confident that they can figure it out.

Stay tuned, it’s going to be a fun ride! Oh yeah, grab my feed!

Categories: Investing