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The stock market remains overvalued

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  • | 5:00 a.m. November 4, 2009
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Those of us who love bear-market rallies should be careful about looking through rose-colored glasses at this rally. It is far more likely to be a bull rally in a bear market, than it is the beginning of a new bull market. Consider the following evidence:

 1. Last week the government announced an end to the recession and resumption of sound economic growth. It was reported that the economy is now growing at the rate of 3.4% a year. It’s not true. The growth has come from the government borrowing money and, then, spending that money. They “borrow” the money by printing it and circulate it in our economy by paying government bills. The private sector remains in shambles. In fact, the government sector is in shambles, too, because it is being sustained solely by borrowing and increasing the deficit. Imagine a deficit of $1.4 trillion, or 12% of GDP, and one can easily see how stimulus spending can give the incorrect assumption that we have resumed positive economic growth. 

2. The dollar has dropped 20% in value against a weighted average of world currencies since March. And 65% of monetary reserves around the world are in dollars. Other nation’s economies, therefore, have a significant amount of their monetary reserves in dollars. One can see why the rest of the world is reluctant to hold dollars as part of their monetary reserves. Those countries have lost 20% of the value of their reserves in less than six months.

3. The U.S. government is currently paying 3.4% on its debt, which is too low to attract foreign investors for Treasury bonds, when the value of the dollar continues to go down. Yet, we cannot increase our interest costs. A 1% increase in interest rates, on total private and public borrowing of $57 trillion, will increase the cost of our indebtedness by more than $500 billion annually. That represents another 3.5% of GDP, in an economy doing $14 trillion a year.

4. Foreign investors who have purchased hundreds of billions of dollars of Treasury securities in the past are resisting further purchase of those securities. In fact, they’re trying to sell the securities they already own. The banks are buying Treasury bonds with our stimulus dollars. In addition to the dollar continuing in a downward spiral, the world is slowly aware of the fact that the U.S. has Social Security and Medicare “entitlements” that are unfunded, aggregating at least $118 trillion — eight times our current GDP. This is viewed as a tremendous drag on future economic growth and earnings. 

5. Suppliers in the Middle East are discussing the sale of oil and other commodities in a “unified” currency, instead of dollars. The “basket-of-currencies” approach is being pushed by Kuwait, Saudi Arabia, China, Japan, Russia, and various members of the EEC. 

6. Peter Bernholz, a prominent economics professor in Basel, Switzerland, has written about the world’s 12-most important periods of hyper-inflation. He discovered that hyper-inflation is likely to start when government borrowing for expenditures reaches 40% of budget. He writes: “For the United States, we have arrived at exactly that point. The deficit of $1.5 trillion amounts to 41.7% of the $3.6 trillion in government expenses this year.” 

7. As the stock market rises, gold is climbing to its highest price in history. Increases in gold prices of this nature advertise that the dollar is sinking and that something is dreadfully wrong with the economy. Housing prices remain weak, and commercial real-estate problems are beginning to indicate that sector of the economy may soon come crashing down. Gold economist Jeffrey Nichols points out that the stock-market crash of 1987, the Gulf War of 1990, the Mexican peso crisis of 1994, the Asian currency crisis of 1997, the bubble of 2000 and the U.S. housing bubble that ended in 2007 have all been met with the same solution: more borrowed money and a lowering of interest rates. Nichols also states, “Rather than allowing periodic recessions and bear markets to purge the excesses of each prior bubble, the Fed stimulated the economy with massive doses of new credit, more injections of cash and lower interest rates.”

Gold has been in a bull market from 1987, when it was under $300 an ounce, until now, at $1,050.

8. This will be the worst decade in stock-market history. From January 1930 to December 1939 the market showed a loss of 1.7%. From January 2000 to the present, the S&P 500 has lost almost 14% of its value. The effect of the stimulus package and bailing out banks is that the market has enjoyed a nice run-up of about 3,000 points. The truth, however, is that the current market now represents another bubble. It is overvalued, and the fundamentals in the economy that ordinarily create good corporate earning gains are simply not there. 

The bottom line is that this country is “bound up” by its own debt. Our economy is literally choking on debt payments. Credit expansion through debt, instead of through savings, is the source of our present difficulties.

The government’s fiscal response to our current debacle is a near-perfect example of what not to do when trying to regain solid economic footings. Not until job creation picks up can we expect the economy to resume a posture of growth. Without the stimulus spending, without interest rates at almost zero and without the creation of high amounts of new money, it’s likely the stock market, and the economy, would collapse. The first hint that we may be in for a prolonged and unpleasant recovery will be negative action in our securities markets and continued decrease in the value of the dollar.

Thomas Jefferson said, “I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.” Ben Franklin said, “He who goes borrowing, goes sorrowing.” Bingo! Again, we have ignored our wise old founders. All of the problems in this economy emanate from our government trying to take care of us and then printing money to pay for it. 

Keep — and accumulate — cash. Wait out this mess before putting capital at risk.

Caveat emptor

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.


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