The Financial Times (FT) on Friday ran an important article commenting on the quarterly fall in U.S. corporate profitability.
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"(U.S.) profits growth has turned decisively down and the end is not yet in sight." wrote Gabriel Stein of Lombard Street Research in a note to clients yesterday. He went on, "One of the key points about the U.S. economy in recent years has been the spectacular rise in corporate profits in absolute terms and as a percentage of GDP. Now there are clear signs that this is changing."
As our readers will know, we and our sister publications have been forecasting recession for several months.
Also, although heavily criticized, the old ‘sage' Alan Greenspan may have been correct in forecasting a 33 percent chance of a U.S. recession.
If these quarterly figures do indeed represent a trend, the U.S. markets look expensive. Our readers will know that we have warned them to exercise major asset reallocations to overseas stock markets, if they wish to invest in stocks.
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Normally, the news of recession would encourage the Fed to lower rates.
However, as we have written for most of this year, the Fed also faces two other major counter forces that call for higher rates.
We have long believed that stealth inflation is concerning to the Fed.
As we have also mentioned, the Fed now faces a new challenge, the defense of the U.S. dollar, a task with which it is unfamiliar.
Both these factors will press the Fed to raise rates.
In addition, we have expressed increasing concern that the American economy now faces stagflation (inflation and recession, at the same time).
History shows that most governments and central banks hesitate to raise rates to kill the most damaging element (inflation) of stagflation. This inevitably leads to longer and more serious stagflation, requiring yet more painful corrective medicine — as rates have to be raised higher for longer to kill the inflation that has, by then, been given time to take hold in the national mind set, from which it is difficult to dislodge.
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On March 28, Fed Chairman Ben Bernanke confirmed our stagflation fears when he said, "the risks to growth and inflation have increased in recent weeks. …"
As we write, news is immerging on CNBC that our President has yielded to Congressional pressure to retaliate against industrial subsidies for Chinese exports.
This will have the effect of raising the prices to U.S. consumers of certain Chinese products, which will be inflationary. This has caused selling pressure on the U.S. dollar.
This will put yet further pressure on the Fed to raise rates, both to combat inflation and to defend the U.S. dollar.
With corporate profits falling and the increasing prospect of higher U.S. rates, the U.S. stock markets will look progressively more expensive.
We continue to urge those of our readers who wish to remain invested in stocks, to increase their allocations to overseas markets.
For our conservative readers, we continue to urge them to be patient and to remain heavily allocated to: cash, high coupon, high quality short-term bonds and gold.
Editor's note:
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