http://blog.mutualdecision.com/articles/2007/12/17/vicious-circles en-us 40 Insight from the minds behind MUTUALdecision <div>For the week, the Dow was down 2.1%; the S&amp;P and NASDAQ were off about 2.5%.&nbsp;The new news was inflation.&nbsp;The Producer Price Index increased by 3.2%, in November and 7.2% for past twelve months. The Consumer Price Index was up 4.2% for the same twelve month period.&nbsp;The primary culprit was energy.&nbsp;Gasoline prices increased 35% last month.&nbsp;The only reason the CPI wasn&rsquo;t up as much as the PPI is that energy companies have been reluctant to pass along price increases for fear of government backlash.&nbsp;Energy prices have been rising, in part, due to a declining dollar.&nbsp;With a $60 billion <u>monthly</u> trade deficit, the world is awash in dollars.&nbsp;This puts further pressure on the dollar, driving up the cost of imports, particularly energy.&nbsp;This is a vicious circle.</div> <div>&nbsp;</div> <div>The old news last week was the housing and financial issues.&nbsp;The financial crisis has tightened credit standards for all potential mortgagees.&nbsp;(These tough new lending standards are spreading to auto loans and card cards.)&nbsp;Tight credit slows down the demand for homes, both new and used.&nbsp;The result is more homes on the market and for a longer time.&nbsp;This puts pressure on housing prices which reduces, or wipes out the homeowners equity, making refinancing or moving more difficult.&nbsp;This is another vicious circle.</div> <div>&nbsp;</div> <div>The international central bank coordination announced by the Fed last week doesn&rsquo;t address any of the above problems nor does the cut in the Fed Funds rate.&nbsp;The Fed can&rsquo;t force financial institutions to lend and lending won&rsquo;t return to normal levels until banks balance sheet problems are cleaned up.&nbsp;And, in view of the recent inflation numbers, the Fed finds itself in a difficult situation because further lowering interest rates to stimulate the economy will also stimulate inflation.</div> <div align="center"><strong>&nbsp;</strong></div> <div>Investors were talking about subprime mortgage problems back in April, yet it took until August for the market to react.&nbsp;The same may be true for energy prices and inflation.&nbsp;We&rsquo;ve been watching $90 per barrel oil for months but it appeared to have no effect on the economy.&nbsp;Now we may be in for a six to twelve month period of high inflation as we experience the downside of a weak dollar and our dependence upon foreign oil.</div> <div>&nbsp;</div> <div>The economy is operating at close to stall speed but the outlook isn&rsquo;t entirely bleak.&nbsp;Retail sales were up 1.2% in November and the employment market is strong.&nbsp;The U.S. economy is resilient, witness its ability to absorb the financial meltdown of the late 1980s.&nbsp;Remember the RTC?&nbsp;However, the odds of a recession are somewhere between likely and probable.&nbsp;The prudent investor should prepare for a recession and a period of higher inflation (bad news for bonds).&nbsp;Conservative stocks, mutual funds and ETFs are in order, along with short term bonds.</div> Mon, 17 Dec 2007 14:10:00 -0600 urn:uuid:587c32d9-391d-4321-be27-2e39e39054d1 Bill Byrnes http://blog.mutualdecision.com/articles/2007/12/17/vicious-circles Market Mutual fund blog Mutual Funds Market Economy Recession Outlook