Here’s a brief summary of the US Economy from my point of view:

The Fed

After 7 straight sessions of holding interest rates at 5.25%, the Fed doesn’t look like it’s on course to raise or lower rates anytime soon.  They continue to warn about inflation risks, although they maintain that inflation will moderate back into the “soft” inflation target of 1-2%.  Wall Street and the media are starting to get irritated by the inflation targeting Fed rhetoric - Bernanke keeps insisting on a target but has yet to define it explicitly.

As long as inflation data remains tame, look for the Fed to lower rates this summer to try to save the housing market.  The Fed will probably only start raising rates if core inflation inches up to the 3% level (it has been hovering around 2.5% for some time now).

Inflation

In my mind, inflation is going to be the most important determinant of the housing market and the stock market over the next 3-5 years.  If the Fed is forced to raise rates to fight inflation, you can kiss stocks and real estate goodbye.  On the other hand, if inflation continues to be a non-threat, look for stocks and real estate to remain nominally high.

It’s a funny paradox.  The government needs *inflation* to be high to reduce the likelihood of a nominal drop in the stock market or home prices.  But it needs *inflation data* to be low so that it is not forced to raise rates.

My view is that inflation data will remain above the comfort zone for some time, especially as rents catch up to home prices (remember, rents make up 30% of the CPI), agriculture prices continue to increase, and oil stays in the $50-70 range.  I would be very surprised if the core drops below 2% year-over-year anytime soon.

Real Estate

This Spring and Summer will be a huge test for the real estate market, as many sellers put their homes back on the market.  Real estate transactions typically pick up during the nice weather, so we will really find out whether buyers come back to the market.  My prediction: too many sellers, not enough buyers, and a slowly but surely deflating home price bubble.

US Dollar

The dollar has shown amazing resiliency in the last two months in the face of a huge budget deficit and a continuing trade imbalance with the rest of the world.  This is still in the context of a 40% decline versus the Euro in the last five years, but the dollar pessimists (myself included) have constantly been guessing for a far worse outcome.  I will be following it closely over the next few months.

Gold and Oil

As usual, gold has been extremely volatile.  It hit a 6-month high at $660 this week, only to fall quickly back to close the week at $645.  Gold watchers are optimistic these days, pulling for a breakout to the $675 to $700 range, but sometimes too much optimism can result in flat prices.  Gold probably needs another month or two in the $620-650 range before we see a big move up or down.

Oil has bounced back from a temporary low below $50 a barrel.  I just can’t imagine it will creep down there again.  Look for it to hold in the $50-70 range for some time.  This probably means good profits for energy companies in the next 5 years.

Economic Growth

It’s strange that GDP can come out at 3.5% annually for the quarter (that’s great growth) while many of the other indexes are showing signs of weakness:

As you know, I’m looking for a slowdown caused by housing, which leads us to:

The US Stock Market

If you’ve got to be in the US stock market right now, then try to find quality stocks that will survive a recession.  Companies like Berkshire Hathaway, Exxon, Walmart, Target are probably good ways to preserve investment value.  I’d stay away from the Googles, Amazons, Ebays - anything where prices have built in massive earnings growth.

I still think the US stock market is overvalued, but the future will depend heavily on earnings and inflation.  If earnings can continue to be high in the face of rising wages, then the stock market may be saved.  I’ll create my new index of Google-Starbuck’s earnings - two companies which I expect will get hit hard in a slowdown.  If earnings at Google or Starbuck’s start to slow, then watch out!

Chinese Stock Market

Looking for the bubble to burst?  You’ve found it in China.  It’s now a matter of when, not if.  Marketwatch and other financial coverage keep printing articles about how out of control it is.

When people are taking out home mortgages to invest in the stock market, it’s time to get out, out, out.

Global Warming

Haha, just kidding.  Who knows…

Getting back into the swing of things…