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April 2012 A Teeter-Totter and the Wall of Worry I had to stop by the local playground today to see if they still had this wonderful ride from my youth. The teeter-totter is a nifty low-tech ride--maybe you called it a see saw?--with surprising educational attributes. Amazing: a big kid and a little kid could enjoy this ride together (especially so when the big kid was your parent!). Occasionally, of course, the ride would seem to fail and you could get stuck in midair, legs flailing as you both attempt to get moving again. Some days that's how the financial markets seem to behave (you saw this coming, right?), not quite ready to go up and . . . not quite willing to go down, seemingly waiting for some unknown force to take over. Investors have little to complain about after "the biggest quarter since 1998." Valuations of the US stock market are good – sort of that Goldilocks thing, not too hot and not too cold. The most used barometer of overall valuation is the P/E, the Priceto-Earnings ratio, currently hovering around the 15 range, with something over 20 being too hot and something under 10 being too cold. We've stayed at this valuation, in spite of a substantial run-up in the stock market, because corporate earnings keep improving. The economy is alive, and though it may be plodding, it is at least plodding forward. Ultimately, we'll see more jobs and, the Holy Grail of economies, more spending. Two factors hold back job creation right now. First, companies are beyond cautious nowadays, even though they are sitting on pretty substantial piles of cash. Caution takes the form of sluggish hiring and a reluctance to buy new equipment for the purpose of expansion. Second, bank lending is still anemic. More vigorous growth won't happen, can't happen, until banks willingly, eagerly, lend money to businesses small and large. That's just axiomatic. The see saw hangs there until the money flows. A more recent challenge at some playgrounds is the artificial rock climb. As a kid, I would have loved one of those. The analogy here is to Wall Street's "wall of worry." We are certainly climbing that wall these days. There's plenty to worry about. Mind you, this is a normal and healthy exercise. But are we ready for the market to take back as much as 50 percent of the recent run-up? That can happen before a resumption of upward movement. These swings of the pendulum describe the history of Wall Street. That's why we call them normal. When will the next downswing occur? We're at dizzying heights right now. The players don't seem nervous; they're enjoying this powerful upside. I am enjoying the ride too but am watching carefully for signs of a change. Where do we look for solutions? Perhaps not to the usual sources. The Federal Reserve is under continuing attack for its manipulation tactics. The goal: to keep interest rates artificially low until the economy truly recovers, perhaps mid-to-late 2014. The continued easing of monetary policy by means of QE 1, QE 2 and Operation Twist is a major concern for many economists. (For more on this, Google Operation Twist; read the Guardian article.) The complaint is that these initiatives really do little of substance for the economy as a whole. They do allow asset prices (i.e., stock market and commodities) to increase value, but at the same time lay the groundwork for a substantial inflationary swing in the future. So far, there is little or no inflation and the good news about inflation down the road, strangely enough, is that our enormous debt will be easier to pay with inflated dollars. So, folks, join me on the teeter-totter? Or do you prefer the wall of worry? See you on the playground. Tonge Investment Services 22 Common St., Waterville, ME 04901 T: 800 546 7762 E: [email protected] W: www.ricktonge.com c 2011 All rights reserved