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Domestic Economic Headwinds

If you watched the move Inside Job then you realized as it ended that we were in fact living the sequel. The movie is far from over. The problems are far from being addressed. The solutions may be close but the leadership needed is no where near.

Week after week I may sound like a broken record. Like someone who has missed the bull run and trying to defend lost opportunity. At some point this market will turn. Those who said they will get out at or near the top will again be proven wrong. Their paper profits will turn into paper losses and they will argue they "cannot afford to sell." What has frustrated the bears will one day frustrate the bulls.

Patience and waiting for the right opportunity to present itself is the key to a successful investing career. If you missed the 2008 market crash I truly believe you will be given an even greater opportunity in the near future. If you missed the 2009 100% equity bounce, well you may need to wait years for another. I believe that when this market truly turns the bounce will not occur for there are serious structural problems within the US economy that have yet to be addressed.

Each day US equity prices push to multi year highs all while the US economy is flashing major headwinds and at an increasingly alarming rate.

Gasoline prices have risen 44% since August 2010 and now average $3.88 across the US.

Over the past month four regional Fed manufacturing surveys have shown a severe reduction in growth rates Philly (43.4 down to 18.5), Kansas City (27 down to 14), Dallas (24 down to 8 ) and Richmond (20 down to 10).

Bill Dudley NY Fed President had the following to say on April 1, 2011. "The recovery looks to be better than six months ago but not as good as a month ago."

Housing has not only double dipped but price deflation has accelerated.

Weekly jobless claims have averaged 406k the last four weeks up from 390k the previous four weeks. The most recent 429k was the third report above 400k. Clearly a disturbing change in trend and one that does not bode well for Friday's NFP report.

The banking sector already struggling with reduced profitability has now lost their ability to earn 10-15 bp risk free through the Federal Reserve interest on reserve arbitrage trade due to the new FDIC fee assessment. As a result the Federal Funds effective rate continues to stay at depressed levels now 9bp.

GDP for Q1 was an anaemic 1.8% down from 3.1% in Q4. With a reduction in government spending, end of the inventory build cycle and a deteriorating trade deficit the economy is quite possibly headed for contraction as early as Q2. What truly makes this scary is the already depressed labor market, consumer and inability for future government stimulus.

The 2012 political campaign for the White House has begun in earnest and the debt ceiling discussions will be the first real battle ground. In reality the debt ceiling will be raised (again) but the damage to the bond market may cause higher rates across the yield curve.

Consumer income has shown growth regularly but behind the numbers it is 80% funded by government aid. In other words since the recession ended there has been only 20% organic income growth.

Inflation expectations as measured through the TIPS market have increased from 1.7% in August 2010 to currently 2.6% and showing no signs of slowing.

The Federal Reserve downgraded the US economy, increased (albeit still low) concerns over inflation and signaled an unclear future to additional QE "tradeoffs for QE3 are less attractive."

The above are purely domestic headwinds and they don't include issues like municipal debt, state pension deficiencies, falling real estate tax revenues and more. Add in the foreign headwinds such as the pending Greek debt default and/or restructuring, run on Irish bank deposits, deteriorating Japanese economy, war in the Middle East and the story becomes almost that of fiction.

Inside Job will be a family movie when the harsh reality of the sequel is revealed.

"Ignoring a fact never fades away its reality."


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