Start the Party—or Not?

10/27/2006 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

Economic guru James Stack always backs up his positions with thorough research, and in his latest missive, he cites a wealth of statistical data to support his current less-than-bullish views on the economy and market…

“A new, all-time record high above DJIA 12,000 has been reached – and finally on a closing basis! Corporate earnings are looking fantastic. Oil has fallen from $78 a barrel to under $60, while gasoline prices have dropped 22% in the past month.

“So, why is it that the Conference Board’s survey of CEO confidence has fallen to the lowest level since the depths of the last recession, with only 16% of CEOs claiming the current economic environment is better than 6 months ago and only 16% expecting economic conditions to improve in the coming months?

“With its fifth birthday in sight (next month), this economic recovery is already one of the longest recoveries of the past 106 years. In fact, only four were longer.

“The current rally on Wall Street started just two weeks after the Federal Reserve’s 17 th (and final) interest rate hike. But Paul Volcker, the #1 Champion Inflation Fighter of the 20 th Century, holds a different viewpoint, commenting that the inflation rate is creeping up, accompanied by psychological and political pressure to not do anything about it.

“So there’s a high probability that Wall Street’s expectations of monetary easing are a bit too high. And if a soft landing is not achieved, then this bull market’s days are likely numbered. The yield curve is inverted – with short-term interest rates already above long-term rates. In 6 out of 7 past such instance, the economy has landed in recession.

“The worst case scenario for the stock market, and potentially for a rapidly deteriorating housing sector would be for the Fed to be forced back into a tightening mode. Yet that could very well happen by the FOMC meeting in mid-December.

“There are certain technical and fundamental prerequisites that must drop into place to confirm a soft landing, and the potential for another safe upward leg to this bull market: A further cooling in the economy, and a positive turn in our MEP Monetary Model. IF a soft landing is to be achieved, this MEP should turn positive in the weeks or months immediately ahead.

“In the meantime, we are comfortable with our defensive, partially-hedged position. We are leaving some profits on the table as the DJIA celebrates its 12,000 threshold. However, that comes after our portfolio beat the DJIA by 5-fold in 2005 and 4-fold in 2004.”

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