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Nov. 1, 2010, 12:01 a.m. EDT
By Thomas Kee
LA JOLLA, Calif. (MarketWatch) "â? In recent months, Wall Street has used the prospects for quantitative easing to influence buying decisions, then they used the probabilities of a Republican-controlled Congress, and then of course, earnings.
No one can argue with the strong earnings season, even banks like Bank of America Corp. /quotes/comstock/13*!bac/quotes/nls/bac (BAC 11.56, +0.11, +0.97%) , Wells Fargo & Co. /quotes/comstock/13*!wfc/quotes/nls/wfc (WFC 25.99, -0.07, -0.27%) , Citigroup Inc. /quotes/comstock/13*!c/quotes/nls/c (C 4.18, +0.01, +0.24%) , and J.P. Morgan Chase & Co. /quotes/comstock/13*!jpm/quotes/nls/jpm (JPM 37.87, +0.24, +0.62%) were able to beat earnings from moving money out of reserves, but everyone knows that domestic growth will curtail unless the economy gets on track, and that is why the FOMC is trying to inflate our way to growth.
In this article, I will discuss my proprietary longer-term economic model, The Investment Rate. I will broadly explain its projections, and offer insight to future economic conditions. It is not about next week, or next month, but projects by years and decades.
The recent weakness in the dollar was caused by the prospects for quantitative easing, or QE2. By now, everyone recognizes this, and stock market investors are happy. Everything considered, earnings were great, and now investors expect earnings to be great next time too.
The immediate concern is, regardless of economic conditions, that margins will be squeezed because corporate America finds it very difficult to pass on higher costs to a consumer base that is suffering from so much unemployment. Some people will be able to pay higher prices, but most will not. Therefore, the weak dollar, because of QE2, influences commodity prices higher and puts a squeeze on corporate margins that reduces the outlook for earnings growth going forward. The smart ones hedge their costs prudently, but those hedges eventually expire as well.
The immediate prospects for corporate earnings are tightening, not only because of higher commodity prices due to what some think is a positive effort by the FOMC, but also to a fundamental shift in our economy as that relates to The Investment Rate. The Investment Rate is a tool that tells us the rate of change in the amount of new money slated to be invested into the economy by U.S. consumers over time.
It is this new money that moves the markets and the economy. Only new investment dollars can allow the market to grow; we cannot churn old money and expect positive results. One asset class may outperform another in that case, but the overall market cannot grow without the infusion of new money. The Investment Rate tells us the rate of change in the amount of new money every year.
I have been using The Investment Rate as a leading indicator since I developed it in 2002. It was then a bullish indicator because it told me that the amount of new money available to be invested into the economy every year between 2002 and 2007 would also increase every year during that time span. In 2007 I warned everyone that The Investment Rate was at a turning point in that demand had peaked and a transition lower would begin soon. On CNBC, I was nicknamed the Grim Reaper. The IR had turned bearish. Well, the Grim Reaper is back.
The third major down period in U.S. history began in 2007. It is nowhere close to over. During periods of weakness, akin to the Great Depression and the stagflation period of the 1970s, bounce backs are normal. In fact, we were long from March of 2009 until April of 2010. Admittedly, the past two months took me by surprise, but my longer-term outlook remains firmly intact. The recent increase is doing nothing to influence the longer-term trend. This is a bounce higher within a longer term down period. The only way earnings growth will continue is if it is focused solely overseas, and even with that, margins are still going to tighten given high commodity costs.
The strategy for November is straightforward. If the Dow industrials /quotes/comstock/10w!i:dji/delayed (DJIA 11,175, +56.46, +0.51%) remain below 11,220 buy ProShares UltraShort Russell 2000 /quotes/comstock/13*!twm/quotes/nls/twm (TWM 16.05, +0.02, +0.12%) , iPath S&P 500 VIX Short-Term Futures ETN /quotes/comstock/13*!vxx/quotes/nls/vxx (VXX 13.11, +0.01, +0.08%) , ProShares UntraShort Real Estate ETF /quotes/comstock/13*!srs/quotes/nls/srs (SRS 19.38, -0.31, -1.57%) , and ProShares UltraShort Financials /quotes/comstock/13*!skf/quotes/nls/skf (SKF 18.90, -0.15, -0.79%) and expect to squat on them for a while. On the other hand, if the market breaks above 11,220 buy ProShares Ultra Dow 30 /quotes/comstock/13*!ddm/quotes/nls/ddm (DDM 50.43, +0.48, +0.96%) and let it ride. If it breaks and then reverses back conversion strategies are necessary "â? 112220 is longer term resistance, and it needs to be respected.
I expect continued weakness in the U.S. economy, and the declines could even become severe after the FOMC decision, the election, and quantitative easing. Sell the news is a high probability, and should influence near term direction. My longer term forecasts suggest a Greater Depression is an equally high probability over time too.
The recommendations made in this article may have already been provided to clients of Stock Traders Daily and acted upon by Thomas H. Kee Jr. on behalf of the professionally managed accounts he controls. Read more on the Investment Rate here.
Jonathan Wald, formerly the U.S. news chief of CNBC, will be the program's executive producer.
15 min ago12:29 p.m. Nov. 1, 2010
- orion444 | 4:08 a.m. Today4:08 a.m. Nov. 1, 2010
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