Where Do We Go from Here?

The stock market has been going through a difficult corrective phase ever since President Obama took it upon himself to take the populist political approach of attacking the unpopular banks. Much has happened since that time to complicate matters. Here is my SWOT analysis of the issues facing the markets at this time:

Positive factors:

• Strong Monetary Growth. The pump is still primed and the system is awash in cash with no place to go. The stock market has always been joined at the hip with the money supply. I recommend reading Milton Friedman's Monetary History of the US and Beryl Sprinkle's Money and Markets.

• Positive Sloping Yield Curve. This is another indication of easy money, which always leads to positive economic developments.

• Fiscal Stimulus. This is a slight positive because the entire Federal spending program is an ill conceived pork barrel laden poorly targeted joke. Lord Keynes is probably rolling over in his grave and Milton Friedman is laughing from his.

• President Obama's Recent Conciliatory Tone of Compromise. Whether this is just a political gesture or the real deal is still not known. It is yet to be determined if the President is serious about compromise and listening to the obvious anger of populace as expressed by the polls, the Tea Party movement and the Massachusetts election results. So far the President has made conciliatory gestures which have been off set by political attacks on the opposition.

• Strong Corporate Earnings. Recent earnings reports from our leading corporations have been strong. Most importantly, earnings guidance has been strong. Of course, guidance can always be wrong. In my opinion, we must give the corporations the benefit of the doubt until evidence proves otherwise – especially given the strong growth trend that is in place.

Negative Factors:

• President Obama's stubborn insistence on large spending programs. Spending huge amounts on health care reform while cooking the books to make it look like we will be saving money is disingenuous and shows a lack of an understanding of basic economics. A nation cannot balance its budget and go on a wild spending spree at the same time. The much maligned Tea Party revolt has some very good points. The nation and the markets are revolting against a government that has apparently gotten out of control. The markets want to see the President back down from this unsound spending approach. We have to get our house in order or we will become a banana republic. Tough budgetary love is required. This will have as yet unknown economic consequences.

• Relinquishment of Presidential power to the Congress. The President has let Harry Reed and Nancy Pelosi dictate legislative policy. The markets want to see the President take the lead in proposing legislation. The markets do not want to see power hungry Congressional leaders with no economic vision or mandate for radical change control how our nation's budget is deployed.

• Broken legislative system. It is clear that our legislative system is not working. It may have worked 40 years ago, but it is not working now. Our founders wanted a system of debate and difficulty in enacting change. However, our country has now gone from difficulty to complete gridlock. The President needs to get a bi partisan commission of the best and the brightest in place to study the matter. He then has to propose an amendment to the constitution that breaks the log jam in a non pork barrel laden expedient manner that has input from both political parties. We are operating in a 21st Century light speed internet connected flat world. Our legislative arteries need to get unclogged and up to date.

• Toxic Bailout time bombs. Many of our states are already technically bankrupt and many European nations are in deep financial trouble. This is the next financial disaster that needs to be fixed. We can not quantify the size of the problem yet, but it is large and can become a huge drag on the world's economy. The question is whether the world will choose to bail out all of the troubled nations and states or work out a fiscally responsible (read bite the bullet) approach. A good first step is for Europe to admit that the hasty creation of the Euro was a mistake. That will enable European nations to tackle their individual economic problems without having to worry about propping up an artificial currency.

• China's monetary tightening. So far this is not a big deal because China is still pumping money into their economy at a breakneck pace. Stay tuned to see how this evolves, because China's monetary growth is unsustainable without causing all kinds of economic problems from inflation to real estate bubbles.

• Interest Rates are Starting to Creep Up. I believe that this will be a slow process that will have little short term affect on the markets. In many ways it is a good sign, because rates have been so low. Fed Chairman Bernanke acknowledged that he will have to raise rates in the not too distant future. This is an issue that must be monitored closely, but if handled properly is the right thing to do.

In sum, the world is now going through the aftershocks of last year’s monetary crises. Our politicians are caught up in a nasty game of recriminations designed for pure political gain. Our monetary authorities are under attack and the world’s economies are having a bit of a setback. It is going to take some time to work things out. Therefore, the markets are nervous.
My guess is that during the next year it is not going to be as easy to make money in the stock market as during the past year.

Therefore, until I see a true reversal back to the bull market uptrend, I will act as follows:

• Stay mostly in cash and keep my powder dry for long or short trading opportunities

• Trade the stock index ETFs with a downside bias every time I see stock market rallies that run out of steam.

• Go long selective special growth situation stocks such as CMG and MMR that are making all time highs despite the weak stock market. Conversely, go short very weak stocks.

I always start from a macro thesis and invest accordingly. The key is to be flexible and adjust as the facts evolve. I might start to change my tune tomorrow, but I will let the markets lead the way. If I start to see market leaders like AAPL, GOOG, PCLN, etc. start to run and make new highs, I will not fight the tape. If the President and Congress get their acts together, I will applaud and get more bullish.

Bull markets always climb up against a wall of worry. I have outlined the worries. Now lets see if they can be mitigated, one by one.