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Our Government-Driven Stock Market   October 11th, 2010
Government policy and politics are driving the market       

 
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Some news articles are breathtaking to behold. For example, this one that says that the stock market has rallied above 11,000 because... (wait for it)... the economy is bad. At least that's what it's really saying.

Stocks rallied, with the Dow crossing 11,000 for the first time in five months, after a sharp drop in the overall jobs figure in September boosted the chances of stimulus measures from the Federal Reserve...

The economy lost 95,000 jobs in September, the government said, though the private sector added 64,000 jobs. Unemployment rate remained unchanged at 9.6%.

"The September report is another sign that the recovery remains on shaky grounds," said Peter Tuz, president at Chase Investment Council. "But the economy's sluggishness also increases the odds of the Fed pumping more money into the financial system, which is viewed as a positive sign among some investors, because it adds liquidity to the system."


Translation: Stock market investors think it's good news that there are fewer jobs because that means the Federal Reserve will probably inject another dose of printed money into the economy which can be used to pump up the stock market.

So investors are happy because another bubble is being inflated by the Federal Reserve. The last major bubble was the housing market and we know how that turned out. The truth is, the investors aren't necessarily wrong--if you invest in a bubble and get out before it pops, you make money. The problem is that it will pop.

But the reality is that the stock market has been--and continues--to increase not because the fundamentals of the economy suggest a recovery, but based on the anticipation of government intervention in the form of printing more dollars. This is consistent with commodity prices--such as oil and especially gold--going up. The prices of these commodities are going up as a result of the real value of the dollar going down since so many are expecting more dollars to be printed out of thin air.

Something else to consider is that, unless changed by a lameduck Democratic Congress, taxes will be increasing after December 31st. If a bubble is forming because of the Federal Reserve's newly printed money, and if investors know that any gains they earn after December 31st are going to be subject to a higher tax, I would expect to see a lot of selling sometime before the end of the year so they can lock in their profits at today's lower tax rate.

Additionally, investors have been able to make a nice profit over the last 18 months or so. I have no idea how long investors have held those stocks, but those that have made large paper gains and are planning on cashing out sometime in the next few years will be under pressure to sell before December 31st to lock in profits at the current lower tax rate.

Without even talking about international aspects, the housing market, or potential foreclosure moratoriums, etc., there are still plenty of reasons we might expect a significant correction in the stock market before the end of the year.

Two things that might be able to help us avoid it (or reduce its size) is if the lameduck Congress prevents taxes from increasing, and also the possibility of strong Republican victories in November. A good Republican showing might minimize the market correction as investors look for the potential of a better business environment for both investors and the economy at large. On the other hand, a not-as-good-as-expected showing by Republicans in November might actually amplify or accelerate a sell-off as investors capture their profits and hunker down for another two years of bad Obama policies.

The government and political considerations are, amazingly, the primary driver of the stock market right now--not business fundamentals. If the Federal Reserve prints money to buy government debt, that inflates the stock market. Then the stock market will fall before higher taxes kick in--and when investors take their money out of the stock market in times of uncertainty, it usually goes into gold and government debt. So first the government will print money to fund the debt, then they'll nuke the stock market and investors will loan their money to the government to fund the debt.

It's really just about equivalent to a classic "pump and dump" scheme. But don't expect the SEC to investigate this particular scam anytime soon.

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