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Five Things You Need to Know: Point of Recognition Still Ahead of Us


Unfortunately, the moment when we collectively realize the true magnitude of the economic downturn lies ahead.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

The Fed's Zero Interest Rate Policy: Bull vs. Bear

So, that's it. The fat is now in the fire. The Federal Reserve slashed the Fed funds rate, exceeding market expectations and finally bringing their target for the overnight lending rate in line with the effective rate (see Five Things, December 15th).

What does this mean for the market? The 2 sides are pretty much as follows:

1. Bullish Take: This week, the Federal Reserve cut its overnight lending rate, the Fed funds rate, 75 basis points to a range of zero percent to a quarter of a percent. This is an historic step, marking the first time ever the Fed funds rate has been reduced to as low as zero.

In doing so, the Fed has finally acknowledged the tough economic conditions we've been experiencing on Main Street for quite some time. But more importantly, this move marks the beginning of the end for this bear market. With stocks down nearly 40% year-to-date, and - incredible as this may seem - down 5% over the past 10 years, now is not the time to be turning bearish. That time has long since passed.

2. Bearish Take: If there's one thing we've learned this year, it's that not even the bears have been bearish enough. The hope among bulls is that the Fed's zero-interest-rate policy will mark the end of this deflationary debt unwind, effectively punishing savers.

But hope is not a viable investment strategy. Instead, what the Fed has done is push all their chips into the pot, gambling everything on one final card. Stocks are no longer being priced according to fundamentals, because they're now simply pawns in the Fed's giant credit market gamble.

Unfortunately, this reckless gesture sets the stage for a more likely negative outcome, and that's full-blown deflationary collapse and a subsequent crisis of confidence in the central bank itself.

3. Before the Point of Recognition: Deflation is Good News

When I run across commentary pieces like this one, by David Leonhardt in the New York Times this morning ("Finding Good News in Falling Prices"), I know we have not yet reached the point of recognition: The moment when we collectively realize the true magnitude of the economic downturn and therefore experience the full force of the economic pain.

"[A] truly destructive cycle of deflation is still not the most likely outcome," Leonhardt writes. "For one thing, the price of oil cannot fall by another $100 in the next few months. For another, the federal government will soon, finally, be fully engaged in trying to stimulate the economy."

While it's true that falling prices alone are not bad, it's the confluence of factors leading up to those falling prices that causes problems, especially when the central bank is doing everything in its power to prevent falling prices, even going so far as to intervene in markets and directly purchase assets to prop up those prices. In our case, those factors are simply too much supply of consumer goods, houses and cars, and too much debt with too little real income.

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No positions in stocks mentioned.

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