Stock Market16 Nov 2009 02:02 pm

If the economy stays bad and the dollar continues to erode yet not collapse the stock market will likely reach new all time highs before a major correction ensues. If the economy rebounds any time soon the stock market will plummet.

This may sound counter-intuitive or ironic but it probably isn’t. The Nasdaq 100 is up near 80% since March. All the major indexes are enjoying the strongest and swiftest rallies in the history of the market. When one looks at why the market is skyrocketing the answers are not for the reasons touted by most of the market analysts and the media.

The first part of the rally was purely a relief rally based on the fact that a financial tragedy did not occur in the spring. The first two months and 20 to 30% rise was somewhat typical of bear market rallies.

Our solution to the overwhelming debt and tumbling real estate market was to stimulate the economy through massive bailouts flooding the market with low interest loans and cash.

Those struggling financial institutions and businesses receiving bailout money did not put the money to work in the real economy. Instead, they took money from the loans and used it to borrow more money and bonds with higher interest rates than the loans they got from the government. This allows them to make a sizable profit on the money they received thereby allowing them to claim substantial profits for their businesses.

Getting loans at 0 to .25% and than buying financial instruments yielding 3 to 4% or even more is a simple way of making money.

The loan money was also used to buy stocks which had been hammered in the stock market decline of last fall and this spring. As long as interest rates stay low and the market continues to climb banks and corporations using these techniques will reap in huge profits for corporate heads and the top shelf of business officers.

This party of using stimulus money and continued use of financial debt instruments will continue as long as the dollar stays soft and interest rates stay low.

The Fed has led these individuals to believe that they will keep interest rates low as long as the economy flounders and needs assistance. This is why the market rallies almost every time the economic news shows a struggling economy with a stalled “recovery”.

If the economy truly began to recover then businesses would invest their money in business expansion and hiring new workers rather than stock, cheap loans and financial instruments. A growing economy would cause interest rates to rise. Any rise of interest rates would stop the current game and the current stock market bubble would pop.

If the stock market were to correct, the dollar would rebound due to the fact that people would be taking their money out of the market and going to cash. People going to cash seldom borrow more and these two facts put together would cause the the dollar to rebound.

The current stock market rally is not about a rebounding economy. but rather a product of low interest rates and a falling dollar. The current rally could end rather abruptly if any of the following happen:

1) interest rates rise
2) the dollar strengthens
3) the stock market corrects
4) the dollar decline quickens into a collapse

I do believe this bubble is about to pop and the game is about to end badly. Yet, I must admit I’ve always underestimated the durability of these bubbles. I was a year or so early with the popping of the housing bubble and a good two or three years early regarding the last top of the stock market.

One thing I can say with a high degree of certainty is that the real economy will not rebound or grow in a legitimate manner until this financial game and market bubble pop and let themselves truly unwind.

Yet, this market could indeed set new highs before the bubble pops. For the sake of well over 98% of the people in this country lets hope the bubble doesn’t inflate much further.

Jim Guido

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