Dow Has Best Month Since 2002

Why I Remain A Pessimist

by Louis Scatigna

The stock market had the best performance since October 2002 with the Dow rising 8.6% for the month. The S&P 500 rose 7.4% and the Nasdaq registered a 7.8% gain for the month. Investors have turned opimistic that the worse of the recession is behind us and the economy and corporate profits will rise later this year.

The optimism may be short-lived in my opinion, let's discuss why I feel the worst is not over why this rally should be looked at with deep suspicion:

* Unemployment is at a level beyond the administrations projections and nationally at almost 10%. Some states are experiencing record high rates: Rhode Island 12.4%, Nevada 12%, South Carolina 12.1% and the worst,Michigan at an astounding 15.2%. To make things worse almost 700,000 workers will run out of unemployment benefits by October and that number will grow with each successive month. Until employment turns around there will be little or no economic growth.

* There are now a record numbers of foreclosures and that number continues to grow. In June alone there were 336,000 foreclosure filings. A large wave of ARM resets will happen in early 2010 only adding to the housing woes. 15 million homeowners are now "underwater", owing more on their homes than they are worth. Housing was the major cause of the economic crisis and until e see a drop in the foreclosure rate, housing will not have bottomed.

* Debt deleveraging is accelarating. Credit card defaults have now surpassed 10%, a record high and this figure is continuing to rise.

* Bankruptcy filings have reached over 675,000 for the first six months of 2009. In June alone there were 116,000 filings, a 40% increase over June 2008.

* It has been estimated that over 2.5 million workers have lost their health care benefits when they lost their jobs.

* The economy declined only 1% based on Friday's 2nd quarter GDP number. But the economy is totally dependent on government support. 2nd quarter GDP shows that government spending increased 10.9%, without that increase the GDP number would be significantly lower.

* The US budget deficit is at gargantuan levels. We used to sweat a few hundred billion dollar deficit an now that has ballooned to trillions. The Treasury borrowing needs will ultimately result in higher interest rates, a poison to a fragile economy and housing market. This week's huge Treasury auction did not go well. The 5 year treasury auction was especially weak, the worst since 1993. If foreigners boycott the auctions either interest rates will have to rise to attract capital or the Federal Reserve will print the money and buy what the world will not most likely both. This "monetization" of the US deficit will have a damaging effect on the US dollar resulting in an inflation problem this country has never experienced.

* This government has shown itself to be one of tax and spend. Huge government bail-out programs (cash for clunkers as an example) and massive healthcare reform will only add to the deficit in the years to come. To mitigate the rising deficit, the current government has made it clear that taxes will have to be raised and in some cases dramatically. If there is one thing history tells us it's that raising taxes in a weak economy will only have an adverse effect. Policies like "Cap & Trade" will raise the cost of energy for the entire country, in essence a tax on us all. Rumblings of enacting a Value Added Tax (VAT) are coming out of Congress. This in effect would be the same as a national sales tax, increasing the cost of virtually everything we buy or use. Government policy is taking the country down the road to bankruptcy.

* The U.S. has an estimated $40 trillion in unfunded liabilities. The baby boomers have just started to enter the Medicare and Social Security entitlement programs. Either the deficit will have to rise to unsustainable levels or benefits will have to be cut drastically damaging the standard of living of our seniors.

* Pensions nationwide have lost hundreds of billions during the economic crisis putting current and future retirees at risk. I fear retired people will be receiving letters notifying them that their pension is being cut due to lack of funding. Already pensioners are being warned that their pension fund is underfunded and cuts may be on the way. If this happens enmass a whole generation of Americans will be impoverished.

* States and municipalities are struggling with massive budget deficits as tax revenue plummets at record rates. California's troubles are just the first, many states are in the same boat. Unlike the federal government, states, cities and towns cannot print money to fund their deficits. We will see massive cuts in services and with that a decline in our standard of living.

* The U.S savings rate has increased from 0% (actually negative in 2007) to about 6.8%. This may sound like a good thing and it is in the long-term, but if Americans are saving they are not spending. Retail sales remain tepid and show no signs of improving any time soon. Consumers are struggling to pay down debt and are in no mood to pull out the plastic to buy things they really don't need. The consumer is 70% of the economy and any turnaround must be led by an increase in consumer spending.

* The banking system is still very fragile. Although some of the big banks have shown nice profits recently, it is based on using bailout funds and trading in the financial markets. Accounting gimmicks are making bank earnings look much better than they actually are. The next shoe to drop on the banks is the coming defaults on hundreds of billions in commercial real estate loans. Vacancies in both retail and office space continue to climb. Every Friday the FDIC announces a number of bank seizures. The FDIC insurance funds is quickly running out and Congress will have to tap taxpayer money to replenish it.

So as you can see there are many things to be concerned about going forward. The stock market has had a great run and perhaps is forecasting better times ahead but with all the above negative economic issues I think not.

Some historic facts to consider:

* The 1929-1930 stock market rally coming out of the crash of 1929 lasted 147 days and was up 46%

* Since the low in March, it has been 146 days and the advance is the same 46%.

* After the 1930 rally of 46% the U.S. stock market experienced a 700-day drop of 85%.

Be careful of rampant optimism, history tends to repeat itself.