by Mike Larson
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The municipal bond crisis we’ve discussed before is continuing to fester. The sovereign debt problems I’ve mentioned are continuing to threaten regional bond markets in Europe. And the rise in interest rates here in the U.S. shows no sign of letting up.
Despite all that, the latest economic data and the latest market action are pointing in the same direction. Specifically, they’re showing that …
* Foreign economies are booming! Reports around the world show retail sales gaining, factories humming, and employment picking up. That’s prompting foreign central bankers to hike rates in Asia, Latin America, and even parts of Europe.
In 2011, Russian GDP is forecast to rise 4.2 percent … Brazil and Turkey should grow 4.5 percent … Singapore and Malaysia should expand by 5.4 percent … and the granddaddies of them all — China and India — are expected to surge 9 percent.
* Inflation expectations are rising! The 10-year TIPS spread, a market-based indicator of U.S. inflation expectations, just hit 244 basis points. That’s the highest since last January.
At the same time, the University of Michigan’s latest poll showed that U.S. residents expect prices to rise at an annual rate of 3 percent over the next year. That has almost doubled in the past two years. The Fed may not see inflation pressures building, but the average man or woman on the street clearly does.
* The growth outlook is stabilizing! The U.S. is still one of the weakest economies on the planet. Unemployment remains high, construction activity is weak, and house prices and sales can’t get off the mat. But regional manufacturing activity is slowly picking up, retail sales were okay during the holiday season, and the private credit markets are starting to function again.
Meanwhile, long-term interest rates are surging despite QE2 … commodity prices are soaring (this week’s correction notwithstanding) … and stock indices are climbing steadily.
These indicators all signal that crisis-era policies like QE2, 0 percent rates, and gazillion-dollar stimulus packages aren’t needed any more.
I’ll tell you what pro-active steps you need to take to adjust to that reality in a bit. But first, let’s talk about the biggest concern for us all …
What we need to do, and soon, is shift from an overly stimulative stance to one focused more on fiscal and monetary policy restraint.
We need to stop saying “We’ll worry about deficits later” and start focusing on them now.
We need to stop flooding the system with way too much cheap money, and start letting the economy stand on its own two feet.
So what’s the Federal Reserve doing in response? What about Congress and the administration?
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They’re running full-tilt — borrowing, spending, and printing like mad!
Keeping the Pedal to the Metal …
and Driving Us Off a Cliff Again!
Take the Fed. Neither late-2010 speeches from policymakers, nor the latest meeting minutes that were released this week, suggest a throttling back of the $600 billion QE2 plan.
Indeed, the minutes read:
“While the economic outlook was seen as improving, members generally felt that the change in the outlook was not sufficient to warrant any adjustments to the asset purchase program” and “some indicated that they had a fairly high threshold for making changes to the program.”
Translation: We’ll keep gunning the engine!
Meanwhile, just a few weeks after pledging a new era of fiscal responsibility and releasing a supposedly “landmark” deficit-cutting plan, Washington politicians went back on their word. They announced a massive tax cut and stimulus package that will drive the budget deficit to more than $1.3 trillion in fiscal 2011.
The deficit in December alone came to $150.4 billion, a whopping $30 billion higher than the average forecast of economists.
No less than Bill Gross, manager of the biggest bond fund in the world at $250 billion in assets, called Washington’s actions folly. In his latest monthly outlook, he wrote:
“The problem is that politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion dollar annual deficit … All investors should fear the consequences of mindless U.S. deficit spending.”
So here’s a bold forecast for you — one you can take to the bank: Washington is going to get it wrong again!
After failing to hike interest rates or margin requirements enough to prevent the Internet bubble …
After keeping rates too low for too long after the dot-com bust, and helping fuel the biggest housing bubble in world history …
After failing to anticipate the credit crisis of 2007-2008, calling it “contained” right up until the very end …
The Fed is going to screw it up yet again. They’re going to overshoot by keeping the pedal to the metal for too long. That will lead to even more asset market volatility — fresh asset bubbles, then another bust.
Want Protection from Washington
Insanity? Then Do This …
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How can you protect yourself from the next big screw up in Washington? How should you position your portfolio?
First, sell what the Fed is buying. That means dump long-term bonds into the waiting hands of the Fed. The QE2 program is backfiring, and bonds should continue to fall in price.
Second, reduce your stock market hedges into the next inevitable correction. If there’s one thing we’ve learned from the last few bubbles fueled by easy money, it’s that asset inflation can continue for longer than you expect — and go farther than you expect. You don’t want to get aggressively short until it appears the bubble is about to pop.
Third, consider select investments in companies and sectors that hold real promise … the ones that don’t need the Fed’s funny money to do well. There are quite a few out there, many in strong foreign markets, a few in domestic ones. You’ll find some of my best ideas in the latest issue of Safe Money Report, which just hit subscriber inboxes.
Until next time,
Mike