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Why Middle-Class America Is About to Get SlaughteredBy
Tuesday, May 25, 2010
I spoke to a broker at Fidelity a few weeks ago. At the time, the stock market was rising almost every day. There was so much optimism in the marketplace it was almost surreal.
This broker spends all day on the phone taking stock orders from small investors. He told me his customers were shoveling their money into the market. "I have no idea where they're getting all this money from," he said. "But the volume is amazing."
The media urged investors on with a raft of bullish editorial. Barron's was probably the worst offender. Their most recent cover talks about "tantalizing" hedge fund opportunities. Last week's cover showed a man's bulging bicep with the headline, "Stronger than ever." The week before, Barron's suggested Johnson & Johnson's stock was about to soar as an improving economy lifts profits.
Even the president is doing his part. For months, he's been telling audiences he's fixed the credit crisis and the economy is growing again. He delivered this message again in Ohio last week.
The stock market had been rising for almost a year already. But between February 9 and April 23, it turned into a steamroller, rising on 37 of 52 trading sessions in an amazing 15% ascent in 10 weeks.
The relentless rise in the stock market propelled investor sentiment to new highs. Sentiment indicators like "dumb money" confidence, the ratio of bullish to bearish option trades, and the Investors Intelligence bull ratio all moved to multiyear highs.
The period from February to April was the perfect market action for attracting retail money. Imagine the mindset. "Honey, look at this. The president's quoted in the newspaper. He says everything's great in America and the economy is growing again. The stock market is up again today. I think we should get back in before it rises anymore."
The next day: "The market's up again, honey. Barron's says there's never been a better buying opportunity. Jones says his portfolio just had its best month ever. We have to get back in the market now, before we miss these gains."
My concern is, if the market falls, it'll generate a catastrophic loss of wealth for middle-class America and lead the entire globe back into economic contraction.
Unfortunately, that's exactly what appears to be happening now...
The stock market peaked on April 26. It's down more than 10% since. On May 7, we saw the largest one-day crash in stock prices in more than 20 years. On May 16, European regulators banned short selling on government bonds and large financial institutions in an effort to halt a crash in the euro. China's stock market peaked six months ago and is approaching one-year lows.
Commodities – perhaps the asset most sensitive to economic growth – are plummeting. As you'll read in Market Notes below, the CRB commodity index just broke down to new eight-month lows and looks like it is heading lower...
In short, there's big trouble brewing... And if the recent market action is anything to go by, almost every investment asset you can imagine is going to fall in price for the next year or two.
I know it's scary, but we're not entering an economic Armageddon. With the right preparation, you have nothing to worry about...
In the most recent issue of my 12% Letter, I advise readers to watch their stops and raise as much cash as they can. I recommend putting this cash into T-bills, the safe fixed-income investments we discussed in yesterday's DailyWealth column, and select dividend paying blue-chip stocks (like Wal-Mart and McDonald's) that perform well when people try to save money...
These recession-resistant investments will protect your portfolio from the trouble ahead. They'll keep your wealth compounding above 5% a year... And most importantly, they'll put you in position to take advantage of the host of opportunities that are bound to follow a downturn.
Good investing,
Further Reading:
Volatility will keep your retirement account and other long-term stock investments lurching up and down. If you'd like a sleep-at-night strategy for safeguarding your nest egg in this scenario, you'll find it here: The Ultimate System for a Volatile Market.
Traders take note: If Tom is right about a downturn ahead, that's going to mean a bull market in the Volatility Index (aka the VIX). As Tom wrote last week, "Using the VIX to trade will be one of the easiest ways to make money in the stock market over the next few years." Get details on two ways to trade the VIX for income and fast profit here: How to Make 15% Dividends and 50% Gains in a Turbulent Market. Market NotesINFLATION? COMMODITY PRICES JUST HIT AN 8-MONTH LOW The past few weeks have been tough on the "inflation is coming" argument.
One of the central investment questions of our time is: "Is the U.S. government's crazed spending going to stoke inflation and higher prices? Or is the consumer so tapped out that he can't buy anything... and is a long slog of deflation on the way?"
We can monitor the potential inflation problem by watching the CRB index. The "CRB" is the world's most widely followed gauge of raw-materials prices. It tracks price trends in energy (crude oil, natural gas), food (wheat, cattle, hogs, sugar, coffee, corn, soybeans), and metals (copper, silver, gold, platinum).
The CRB suffered a huge plunge during the 2008 credit crisis. This plunge bottomed around 200 in early 2009. The CRB staged a rebound into the 275 area... then entered "stall mode," trading sideways for nearly a year. And in just the past few weeks, the index hit its lowest low in about eight months.
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