I’ve done a lot of reflecting over the past several weeks. Today my youngest son finished his last day of high school and tomorrow is his graduation. I vaguely remember my high school graduation. Though I was excited and happy to be starting a new chapter of my life, I had no real idea what the ensuing years would bring.

At times I worry about the state of the world that my young son is facing, but I also envy the opportunities and experiences that await.

Below I’ve included a chart of the S&P 500 going back to 1970–the year I started junior high school. It is a logarithmic chart to keep market movement in perspective through those decades. You’ll note that I graduated from high school in 1976–the year of our nation’s bicentennial. I spent the next couple of years in Iceland as a missionary where I got my first exposure to the variables of international currency and my first experience with inflation that exceeded a 100% annual rate.

 
By the time I graduated from college in 1981, I was smart enough to recognize that the U.S. economy was having serious troubles. Unemployment and inflation were both high. My wife and I paid $40,000 for our first home a couple of years later and our mortgage interest rate was 14%. I was managing editor of a small newspaper at the time and my fist investing experience was with a company 401K.

Although unemployment and inflation are currently much lower, that 1981-82 period felt a lot like what we are experiencing now. And a look at the chart shows similarities in the pattern (highlighted by the green lines), if not in the fundamentals. The big decline from 1973-1975 looks similar to the 2001-2003 period. The current downturn resembles that of 1981-1982.

The fall of communism in 1990 was significant to the U.S. markets and to me personally. I was at the time working for a company that had a contract with the government of the Soviet Union to teach principles of capitalism to Communist leaders. Over the next several years I got a firsthand view as the former Soviet Union transitioned to a free market economy. Along the way I watched as the Russian economy dealt with triple-digit annual inflation.

My career with the investment markets was renewed in 1995 when I began my present position with Strategis Financial Group. Since then, I’ve seen one of the strongest bull markets ever followed by one of the most severe bear markets.

Early in 2004 my two oldest children both got married within a couple of months at about the same time the market started the sideways pattern with is still ongoing. Making money in the markets has been a struggle since then.

I don’t profess to have a crystal ball that gives me insight into future market activity. My best guess is that the next 38 years will be similar to the past 38. There will be volatility that brings good times and bad. But for the immediate horizon, the economy and U.S. consumers will struggle because of the high cost of energy.

When I watch my son tomorrow as he takes another step along the transition to adulthood, I’ll keep my fingers crossed and hope that the ensuing years for him and his generation will be as good as they have been for me and mine.
F.S.

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Since the middle of April, the equity markets have made a nice upward move, amounting to about a 10% gain for the Nasdaq. Right now, many investors who have been sitting on the sidelines are looking at that rise and wondering if now is the time for them to jump back into stocks.

Among investing professionals, the type of move we’ve seen is sometimes called a “sucker’s rally.” In a bear market, investors sitting in cash get impatient–especially when the market starts to make an upward move. Afraid of losing out on profits, those investors get sucked back into the market only to have it make another downward move.

Below is a chart of the Nasdaq over the past six months. Notice the nice upward move over the past six weeks. You can also clearly see that in spite of the rally, the index is still below where it began the year. In this instance I’ve used a candlestick chart because it makes it easier to see a couple of other points. The red candles are down market days while positive days are marked by the open or white candlesticks.

From December through March, you can see that the red candlesticks are dominant. That changed in mid-April, but the advance has not shown a lot of strength. If this were a powerful rally, there would be periods of five or six days in a row of open candlesticks.

In addition to any technical analysis, economic fundamentals would indicate that this is not a great time to jump into the stock market. High oil prices, inflation, falling consumer confidence, rising unemployment: all of these things indicate that market weakness is likely to continue. Summer tends to be a period of weakness for stocks as well.

One market sector that is bucking the trend and generally doing well is energy. But there are indications that energy might be nearing a top. Below is a chart showing U.S. Oil Fund ETF (USO). Since mid-February, this fund is up about 50%. In spite of the recent run up in the price of oil, this would probably not be a good time to buy this sector.

The gold line is a 50-day moving average. Notice that the fund is trending well above that level. The middle section of the chart is a moving average convergence divergence (MACD) of the fund. This indicator is showing that the fund is at an overbought extreme and a downturn is probably at hand. Finally, the bottom portion of the chart is a stochastic oscillator. It is also showing that the fund is at an extremely overbought level and should soon correct.

The only caveat is that oil right now could be riding a speculative bubble. When that occurs, the investment can remain at an overbought extreme for an extended period. Under normal market conditions, we could expect a downturn in oil prices for the next three or four months as part of a traditional intermediate cycle.

There is a lot of seasonal downward pressure on the market at this time of year. Your safest bet is to remain on the sidelines for now, even though a few sectors are advancing.

Have a great Memorial Day weekend.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group.  For information, call 800-279-3377.

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Many years ago I was involved in starting a business in Russia. This was just weeks after the collapse of communism and I was meeting with a Russian accountant who would be charged with the duty of keeping the company’s books. One of his first comments to me was: “What do you want the numbers to show?”

I asked what he meant and he explained that he could adjust or skew the numbers anyway I chose to reflect a profit or loss or to hide income or expenses. I was taken aback and explained that I wanted the numbers to reflect an accurate picture of the financial position of the company. He eventually agreed that he could do that, but his demeanor indicated that he felt I was quite naive.

I had a flashback to that incident this week when the U.S. Bureau of Labor Statistics released the latest inflation numbers. According to those numbers, on a seasonally adjusted basis (I’m not sure what than means), consumer prices rose just 0.2% in April. This reportedly included a 1.6% decline in petroleum based energy and a 0.9% rise in the food index.

I find this somewhat ludicrous because I go to the grocery store and to the gas station on a regular basis. I pay bills for electricity and for natural gas. In fact, the combination of energy and food costs is the second only to my mortgage as a percentage of my household income. And over the past several months, my perception is that costs for food and energy have increased dramatically. Certainly I have not seen the effect of any decrease in petroleum based energy costs.

It is difficult for ordinary consumers to dispute the government’s numbers on prices because most of us do not maintain an index of specific items that we update on a regular basis. So we are forced to merely roll our eyes and snicker when the government informs us that inflation remains in the low single digits and really poses no threat to the economy.

By the way, if you want to amuse yourself by trying to figure out how the government tracks inflation, here is a link to the official web site: http://www.bls.gov/home.htm

As I indicated last week, there are a number of ways the government can benefit by manipulating actual inflation and inflation numbers. For example, Social Security and other programs have built-in cost of living increases that are tied to inflation numbers. Keeping these numbers as low as possible avoids cost increases for programs that are struggling to remain solvent.

On the other hand, when inflation is high, consumers are motivated to spend rather than to save. It does not take them long to learn that as the buying power of their currency decreases, it is to their advantage to purchase desired items as soon as possible to avoid price increases. Consumer spending is the primary engine for the U.S. economy so this buying pattern helps keep the economy churning.

At some point inflation might increase to a level where its existence can no longer be denied or explained away. That isn’t necessarily a worst-case scenario for the government either. For example, many economists and analysts are concerned about the high amount of government debt and financial obligations.

To put this in perspective, let’s imagine that you as an individual are in a similar situation. You have debts that exceed your available financial resources. One option is that you can declare bankruptcy and avoid fulfilling your obligations. Naturally you would prefer to avoid that option. What if you had a printer in your home that printed perfect U.S. currency and there were no penalty if you used it? You could wipe out all of your financial obligations in a very short time.

Guess what? The government has those printing presses and they can run them day and night if needed. In a short time the government can print enough money to pay off all of the U.S. debt. You might think that the government would never do such a thing because it would devalue the U.S. dollar and destabilize the world economy. In reality, it has been done many times by many countries, including superpower Russia in the early 1990s.

The U.S. dollar has already been seriously devalued in the past few years. That is not totally bad. A devalued dollar means that U.S. products become much more attractive in foreign markets. At a low enough level, manufacturing would shift back to the United States and the trade deficit would become a trade surplus. U.S. automakers would love it if all the people in the world who want them could suddenly afford U.S. cars.

I am not implying that allowing runaway inflation is something our government is planning or prepared to do. I just want you to understand that it would not be the first time such a thing has happened and it would not necessarily result in a total collapse of the world’s economic system. It would certainly be uncomfortable, but it could also provide quick solutions to some sticky problems.

For now, Wall Street recognizes that the government is playing games with inflation numbers. Until that situation is resolved, it will be difficult for the stock markets to resume a long-term upward trend.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group.  For information, call 800-279-3377.

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If it seems to you that the rising oil price situation has dragged on for quite awhile, you are correct. What follows is the market commentary I wrote in April 2005–more than three years ago:

“I’m growing tired of writing about high oil prices, but unfortunately, the cost of crude remains the dominant feature of the economic landscape. Over the past week crude oil fell about 15%, but it must continue to drop and to remain below $50 a barrel before other market sectors will again regain leadership.

“Earlier this week I read comments from a couple of pundits who opined that $100 a barrel oil and $5 a gallon gasoline would resolve our problem of oil dependency. These are very smart folks whose opinion I value. But in this case, I also disagree. One argument was that at $5 a gallon, Americans would be forced to conserve on fuel.  The author noted that when gas reached that price in Europe, Europeans cut back on driving and eventually even became an oil exporter.

“I’ve spent a lot of time abroad, including in Europe. And when gas prices reached high levels there, the people did quit using so much gasoline because they had other alternatives. Europe has always had available mass transit for its citizens.
Mass transit works well there because population centers are tightly grouped and distances between centers are manageable.

“Those same factors do not hold true in the United States. While it is certainly true that the U.S. could and should do much more mass transit, there are vast areas across the country where it simply is not a viable solution. Because Americans prefer to live in single-family homes with yards, even our most populated cities tend to cover large areas, making mass transit a more expensive proposition.

“When gasoline reaches $5 a gallon, many Americans still will not be able to take the bus to work. Instead, they will have to cut back in other areas of their lives—meaning less discretionary spending. Multiplied by a couple hundred million people, the economic ripple effect will be devastating because consumer spending accounts for two-thirds of the U.S. economy.”

Well we’ve obviously blown right through the $100 a barrel level. Gas has not quite reached $5 a gallon, but it is getting close in some areas. Diesel fuel in my community is currently about $4.35 a gallon. While the economy is suffering, I suspect that what is next on our horizon is economic weakness on a scale we have never experienced before. I am truly worried that the U.S. is on the verge of extreme inflation.

I’ve lived in countries where double and triple-digit inflation persisted for years. I’ve also experienced hyper-inflation–rates approaching 1,000% or more. I don’t have time today to explain the repercussions of those situations, but suffice it to say that while it creates problems, it also provides easy solutions to some significant challenges.

I’m sure most of you have noticed some examples of dramatically increasing prices either at the grocery store or some other retail establishment. As some point soon, prices across the board will explode because of rising fuel costs.

I have a neighbor who is a furniture wholesaler. He travels throughout the world purchasing furniture from manufacturers for sale in the U.S. He noted that costs in China have risen about 20% in the past year. Combined with higher transportation costs some manufacturers are considering shifting production back to the United States.

As long as oil costs remain this high or continue to rise, it is going to be very difficult for American companies to profit unless they raise their prices. And it will also seriously impact the amount of disposable income people have, so the market’s will continue to struggle.
We’ve seen the S&P 500 gain back about half the loss from its October 2007 high. But this has been a bear market bounce. The trend remains bearish and economic and market fundamentals paint a picture of a deteriorating market instead of one that is strengthening. Remain on the sidelines or in defensive positions.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group.  For information, call 800-279-3377.

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When it comes to investing, we all want the same thing: extremely high returns with zero risk.

Unfortunately, such a situation does not exist. In most cases, there is a direct relationship between and investment’s potential for reward and its inherent risk level. In simple terms, the opportunity for high rewards carries inherent high risk. We can see a good example of this in some recent market activity. It has been difficult to find any industry sectors that have positive returns over the past six months.

Over that time the Nasdaq is off about 15%. Over the past six weeks it has actually had a nice rally. At one point in March it was about 25% below its October 2007 high.

On the chart below, the Nasdaq is shown as the black line. Keep in mind that the Nasdaq has a reputation for nasty volatility. It is not generally considered an appropriate investment vehicle for people who are retired or are moderate or conservative investors. It is easy to understand when one considers the steep loss this index has experienced over the past six months. On the chart, notice that I’ve highlighted a three-day period in November where this index dropped 5%.

The blue line on this chart is iShares Silver Trust (SLV). Precious metals have been one of the strongest sectors over the past six months. In fact, on this chart you can see that this fund is up nearly 15% over that time. Most of us would probably like to have that return. But the downside to the precious metals sector is its high volatility and risk. Look how volatile the blue line is compared to the black line. Notice that in March there was a period of just a couple of days where this fund fell about 25%. Most investors do not have the emotional fortitude to handle those types of swings. And it would be irresponsible for a professional investment manager to invest most clients in a fund with that much volatility.

The gold line is SPDR Series Trust S&P Homebuilders (XHB). We all know that the real estate sector has seen some big losses. But over the past three months, home builders have actually been one of the strongest sectors. Since bottoming in January, this fund is up about 25%. However, over six months its return is zero and there was a one-week period where it fell 17%. Again, this is an example of an investment that is inappropriate for any but the most aggressive of all investors and then only in small doses.

Below I’ve included a listing of the top performing ETFs over the past three months. I eliminated short funds from the list because I wanted to show you the strongest sectors, not the weakest. Notice that energy funds and precious metals are near the top. A few international funds are mixed in along the way.

Although these funds have positive returns for this period, most are too volatile for the majority of investors. The sector that offered the best return for the least risk during this period is government bonds. And you can see that the top funds in this category produced returns of 4% to 5%.

One other significant thing to note is that no major U.S. equity indices show up on this list. There is virtually no representation from traditional U.S. asset classes such as large cap stock funds, value, or even growth.

The U.S. equity market remains in a state of turmoil and there are no signs that the situation is going to change soon. Risk remains very high and the best course for most investors is to remain on the sidelines until we see long-term trends re-emerging.
F.S.

If you would like investment strategies that attempt to minimize risk but still provide the opportunity for solid growth, check out the offerings from Strategis Financial Group. For information, call 800-279-3377.

You requested this MarketOwl free e-newsletter. Please add support@marketowl.com to your e-mail address book to ensure prompt delivery.