US heads for 'major slump'

According to America's many stockmarket bulls, 30 June will be a big day for them. Why? Because that's when the Federal Reserve is set to hike rates for the first time in four years, thus bolstering confidence (because the move will confirm America's "self-sustaining recovery") and hence equity markets.

But we think investors should ignore the bulls and their over-optimistic nonsense. The truth is that the economy, which has been sustained by massive tax cuts and billions of dollars of mortgage refinancing income, is set to lose momentum. This month sees the last of the tax cuts, and the rise in long-term bond yields (and hence mortgage rates) along with expectations of Fed tightening has already led to a collapse of refinancing, now 83% below last June's level. It seems, as Fred Hickey points out in The High Tech Strategist, that for consumers, "the game of using a house as a cash machine" is over. That means that consumption - which has been single-handedly holding the US economy up for years - can't help but start to fall off in the coming months.

In addition, wage growth has been anaemic and the employment surge of recent months is down to a dramatic upward adjustment of the Government's estimates of jobs created from new businesses - not anything real. And year-on-year profit growth is set to slow dramatically from the third quarter given the rocketing growth rate at the same stage last year. The bulls' silliest argument, says Fred Hickey, is on market valuations. Despite the gains of the past 14 months and the fact that traditional valuation measures indicate "one of the most overvalued markets in history", analysts keep banging on about the "most oversold market in 20 years". When stocks are oversold, fear is rampant, heralding a bounce-back as investors once again concentrate on good news - witness the CBOE Market Volatility (VIX) fear gauge, which spiked to around 50 at the October 2002 market bottom. At present, the VIX is at a ten-year low in the high teens. The combined valuation of tech blue-chips eBay and Yahoo (on p/es of 108 and 146) is $100bn, or 22 times joint sales; at the oversold 1990 bear market nadir, Microsoft and Intel were together worth 1.5 times sales.

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Later this year, there will be a moment of truth when investors finally realise that the Fed - thanks to the inflation it has created with its wanton monetary policy (see page 12) - won't be able to cut rates to prop up the faltering economy. Then the market will really see "a major slump".