Financial Markets Sell-off Fundamentals, Two Weeks Later

By: Michael_Pento

Nearly two weeks removed from the “scary” 500 point Dow drop, Wall St. Strategists have been correct thus far in saying the slide had nothing to do with foreign central banks dumping U.S. treasuries—that's not a problem yet . However, it should be clear that the decline has everything to do with the gradual contraction of global liquidity imposed by central bankers from the globe's fastest growing economies.

Central banks in China and Japan made moves to tighten liquidity and curtail the rampant growth in their money supplies-- with rumors from India that it may join in the squeeze. Gold's fall in the immediate aftermath was a validation of this view. To be clear, any deflationary trend will be slight and temporal in nature and I maintain my secular view that the trend towards rampant global inflation is still intact. However, it would be foolish to ignore the affect this liquidity squeeze will have on most markets, including gold.

Since gold is money, and its long term value is dependant on the inflation rate of the currency it is measured in, the commodity signaled that the slow removal of excess global liquidity may be for real; if it is, it will greatly exacerbate the already weak U.S. economy. Add to that the contraction in credit due to the collapse in the sub-prime mortgage market and you have a recipe for a recession and a protracted market decline.

Watching the Fed
Since the economy is already flirting with recessionary levels, Mr. Bernanke may be forced to flood the system with money in order to counteract the forces from overseas central banks, his attempt to rescue the housing market and the economy. If successful, he will be lauded as the next maestro but like all bailouts, no such rescue will come without consequences, including further devaluation of the dollar and rampant inflation. Look for this market correction to continue until gold stabilizes, giving the signal that the liquidity squeeze is over; the metal's recent bounce from its lows doesn't yet give the “all clear.”

The Market and the Economy
Unlike what most strategists claim, it is important to emphasize what the trailing PE ratio is, not some ebullient guess as to what next year's numbers might be. The S&P is currently trading at 17.6 times trailing earnings and those earnings are falling along with G.D.P. growth.

Further evidence of the weakening economy can be seen in today's non-farm payroll numbers. The 97,000 new jobs created were well below population increases and continued to show a weakening trend. The number of jobs cut by the construction industry (62,000) demonstrates the continued impact housing has on employment and the trouble in the sub-prime mortgage market will become a more salient issue in 2007, according to CreditSights Inc. Their research indicates that the second leg of the housing correction is still ahead of us with an additional 500,000 foreclosure homes coming on the market.

This trend towards anemic job growth should only grow worse and may cause the credit crunch to spill over into the prime mortgage market. In light of this scenario it seems prudent to remain cautious, maintaining overweight exposure to cash and dividend paying foreign stocks.

By Michael Pento
Senior Market Strategist
Delta Global Advisors, Inc.
866-772-1198
mpento@deltaga.com
www.DeltaGlobalAdvisors.com

A 15-year industry veteran whose career began as a trader on the floor of the New York Stock Exchange, Michael Pento recently served as a Vice President of Investments for an independent brokerage firm on the East Coast. Previously, he managed individual portfolios as a Vice President for First Montauk Securities, where he focused on options management and advanced yield-enhancing strategies to increase portfolio returns. He is also a published economic theorist in the Austrian school of economic theory.

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