Stockfessor

#67 Potential Dangers 2010 — Stock Market Forecast

Potential Dangers 2010 – Stock Market Forecast (#67)

Dangers and risks always exist even during a bull market. The key is to understand the nature of those dangers. Are they real or just fears? Do they portend a long-term trend, or just a knee-jerk reaction?

Despite all the daily ups and downs, a bull market winds up higher in a few weeks and beyond. On the contrary, a bear ends up lower and lower.

Economy & Jobs
Everybody worries about the current weak economy, but few think about where we have come from. Not long ago, the US economy hit rock bottom, bleeding jobs at the rate of 800,000 a month in early 2009. Twelve months later, the job loss was reduced to 85,000 in December 09. The situation is still bad but obviously we have turned a corner. At this rate of improvement, we may be seeing some job growth a couple of months from now.

As the public worries about job prospects, especially those who have been laid off, the stock market always looks forward. It sees an economic turnaround, albeit slow and fragile. This is a fact that actually counts, from worst to bad. No wonder the Dow and the Nasdaq indexes have risen more than 60% in 2009 as pointed out in my previous article (#66).

We may continue to worry about the economy. The fact is that we are going through a steady recovery since the dark days of the financial meltdown late in 2008. The fear about a second downturn is unwarranted. The economy may stop and pause for a while, but it is moving on slowly but surely.

At this stage, the momentum in the stock market does not originate from consumer spending. The reduction of corporate losses due to cost cutting, and merger/acquisition are enough to boost the market. So fearing a stock downturn is unwarranted except for short-term profit taking.

Interest Rates
The current recession requires the Federal Reserve to bring down interest rates to a historic low of 0.25% for a year now. Because the recession is so deep, the economy only responds slowly. It will take an extended period for the Fed to see good results before they start gradually raising interest rates back to normal again. In this environment, although the economy is moving slowly, the stock market is surging in anticipation of the near future. The stock market never goes according the present-day feelings of ordinary citizens.

As long as the economy remains fragile and is moving slowly like we see now, the Fed is unlikely to raise interest rates for fear of destroying what they have achieved so far.

Inflation
Inflation means rising prices. How can we have prices rising in a deep recession? In fact, the reverse is true because companies cannot raise prices for fear of losing sales that is hard to come by already. The talk about inflation right now is just fear or crying wolf.

Inflation is nemesis for the stock market. If inflation heats up, the Fed will get paranoid and start raising rates. The result is less cash flowing into the stock market, resulting in a precipitous fall. However, inflation does not come out of a sudden. Consumer demand has to increase first before we can even see signs of inflation. As long as the economy is fragile and jobs are hard to find, the ghost of inflation will have to wait.

Huge Government Deficits
The huge government deficits incurred for the past few years serves to fan the fear of inflation and the fall of the US dollar in the near future. The consolation is that inflation cannot occur now due to the fragile economy.

When the economy strengthens, inflation will come back, but the deficits may decline. Why? Tax revenues coming to the government will increase significantly when the economy picks up. To cut deficits, it all depends on the ability of the government to control its spending from now on.

Wild Cards
There always exist unpredictable circumstances that can play havoc with the stock market. The following lists some of them:

Central to inflation worries is the price of oil. The price of oil changes everyday on the world market. In the long run, we cannot escape from rising oil prices because of limited supply and limited alternatives. The fact that most of the oil reserves are located in the unstable Middle East renders oil prices volatile.

The banks are not out of the woods yet after all the damages they have done to themselves since late 2008. We may still be shocked by a major bank failure that can precipitate another crisis of confidence. But this is a remote possibility.

The fear of terrorism is real. A terror strike can be minor or significant. The stock market always responds negatively due to fear and emotions.

www.stockfessor.com
January 2010