The Good, the Bad and the Truth

Feb 8 13:01 2009 Michael Lombardi Print This Article

Let's start with the bad news first:

This morning,Guest Posting the world will be fixated on the January job numbers coming out of the United States. There is no doubt that the number of jobs lost in U.S. (598,000 in January) is devastating.

In my opinion, the stock market has already discounted the job loss numbers. In other words, the market has already lowered the value of stocks to reflect the job losses and the ensuing negative effect they will have on consumer spending. As I have said many times before, the stock market is a leading indicator discounting what is going to happen in the economy six to 12 months ahead.

Back to the bad news numbers... Below I list three of the worst years of the stock market over the past 100 years and what happened to the stock market in the following year:

1930: Stock market drops 34%; the next year, the market drops 53%
1931: Stock market drops 53%; the next year the market drops 23%
2008: Stock market drops 34%; the next year the market drops ?

The question, of course, becomes whether the stock market will drop 23% to 53% this year, like it did in the two years following 1930 and 1931, or whether the stock market will rally this year from 2008's poor performance.

Bluntly, if the stock market is down 23% to 53%, it will offer an unprecedented buying opportunity for smart investors. On the other hand, the economy will be headed for a re-fall...a quasi depression. (For the record, the stock market is down eight percent so far this year.) That is the bad news.

Now, here's the good news:

The amount of money and support the government has been throwing at the U.S. economy in its effort to turn the situation around has been beyond any other government effort in history. Please look at these numbers that follow. They list the U.S. government's approximate cost for the events that have unfolded during history:

$250 billion for the savings and loan crisis of the late 1980s
$450 billion for the Korean War of the early 1950s
$600 billion for the Iraq War that started in 2003
$680 billion for the Vietnam War that started in the 1960s
$850 billion for the NASA program since inception
$3.6 trillion for World War II, 1941-1945
$7.0 trillion so far for the economic "bailout" started in 2008

If we add it all up, the bailout of the U.S. economy that is currently underway has already cost more than the S&L crisis, the Korean War, the Iraq War, the Vietnam War, the NASA program and World War II all combined together.

So, the question, in all logic, is: How can the economy not recover with all these government stimulus packages and bailouts?

Now the truth...

How it will all play out in the end, no one knows for sure. But, as investors, we can hedge our bets by remembering these key points:

Firstly, the stock market is a leading indicator and we need to watch it for direction. What we hear in the news (like today's job loss numbers) has already been discounted by the stock market. Watch the action of the stock market for economic direction, not the general news.

Secondly, let's not lose our common sense and logic. In the 1930s, the government thought the best medicine for the economy was to tighten international trade rules, cut government spending and raise interest rates. A total of 10,000 banks failed during the Great Depression, which means depositors simply lost their savings.

Today, the government is doing the opposite: trade rules are lax, government spending is unprecedented, interest rates have been reduced to zero, and we have deposit insurance for the money we have in our banks.

In the end, and as I have continued to say, I believe the job losses, which are a result of the cleansing of the excesses of corporate America, will make American corporations more efficient, more competitive and more profitable. That is what the stock market currently sees...and that's how I believe the economy will eventually turn around.

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About Article Author

Michael Lombardi
Michael Lombardi

Michael Lombardi, CFP, MBA, bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely,  taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Today, Michael only employs the top market analysts and editors. Some of our recommendations have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management.

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