Wednesday, October 14, 2009

Dow Hits 10,000 as Storm Clouds Gather

Dow Jones 10,000 arrived on Wall Street today for the first time in a year. It’s a milestone of sorts, and it certainly represents a vote for investor confidence in economic recovery. Blowout profit reports from Intel and JPMorgan helped fuel today’s 145 point gain. So did a retail sales report that excluding Cash for Clunkers was actually quite strong.

Profits are the mother’s milk of stocks, business, and the economy. And top-line sales revenues now appear to be bolstering the corporate cost-cutting effort. As long as these earnings keep coming in strong, stocks will keep rising. My hunch is that we’ll move back to pre-Lehman levels — to over 11,000 on the Dow and over 1,200 on the S&P. And backed by an easy-money Fed, the economy will probably grow in a mild V-shape of something like 3 to 4 percent for the next year or so.

But storm clouds are gathering. And a big one is the sinking dollar. No one in the Obama administration or at the Fed seems to care about it. In fact, they are probably applauding the lower dollar as a sort of 1970s way of boosting exports and the manufacturing heartland in the Midwest. But the falling dollar is bad for consumers. And it ultimately will cause higher inflation, as signaled by the rising gold price. There also are future tax hikes and the explosion of spending and debt. All of this is why it’s hard for me to be a long-term bull.

The great market boom of 1982 to 2000 was basically characterized by low marginal tax rates and King Dollar. Unfortunately, the 21st century has seen a weak dollar and more recently rising tax rates that are coming due in 2011 (if not sooner). In other words, the prosperity-inducing Mundell-Laffer supply-side model is being reversed.

As Art Laffer put it to me, we are stealing demand and production from the future. So even as we get a V-shaped recovery now and into next year, 2011 may pay the piper for both low growth and higher inflation.

Stocks could have another four to six months to rally. And that’s great for increasing the wealth of the investor class, and maybe even enhancing the animal spirits a bit. But the policy mix is wrong. Health-care entitlements and taxes punctuate the wrong-way policy mix. And what’s left to be seen is whether the Republicans can successfully challenge the Democrats with a true supply-side economic-growth and job-creating platform.