The Fed has spoken -- and will speak again -- as its members walk the narrow line between fear of strong inflation-producing growth and economic weakness brought on by the higher rates they impose. In fact, the economy has hugged that center line for so long that we seem to have forgotten just how frightening those extremes can be.Memories of recessions, job loss and home foreclosures are in the shady, distant past. Inflation, with soaring prices and interest rates, is thought of in historical terms. The word "stagflation" -- a combination of inflation and higher rates, with a slowing economy -- seems to have left our vocabulary. But as was said long ago by the philosopher Santayana: "Those who do not remember the past are condemned to repeat it." So maybe it's time to take a look at history, and where we stand today in the economy, so you can prepare both your investments and your personal finances for those unhappy possibilities. Market historian James Stack, publisher of the InvesTech Research Market Analyst, has done just that in his most recent issue. If Stack's excellent track record and his historic economic statistics don't entice you to rebalance your investments because you take a longer-term view, they certainly should cause you to do some rethinking of your personal financial balance sheet and take immediate steps to deal with any variable-rate debt, such as an adjustable-rate mortgage or credit card debt.
Meanwhile, Stack's "negative leadership composite," a proprietary index based on the number of stocks hitting new lows, is now deeper into bearish territory than at any time since the 2000-02 bear market. He points out that on each of the 100-point rally days since the market peak, there have been more than 100 stocks hitting new 12-month lows. Finally, more than $2 trillion in adjustable-rate mortgages, or about 25% of all mortgage loans, come up for interest rate "resets" in 2006 or 2007. These resets will be at much higher interest rates. Those facts have Stack and other bearish forecasters deeply worried about the market. But here's my prediction: While any potential bear market will get all the headlines, far more damage will be done to the personal finances of American families by the impact of rising rates on their ability to stay in their homes.
Meanwhile, Alan Abelson, in Barron's, reported that "the U.S. banking system is more exposed to the real-estate sector than at any time since the end of World War II
with $3 trillion in direct mortgage loans sitting on their books -- a record 43% of bank assets." Of course, these statistics don't mean that your house will drop in value. And it isn't necessarily important to you, unless you need to sell your home. It does mean that as all those adjustable-rate mortgage holders start facing higher monthly payments, some of your neighbors might become desperate to sell. And once that cascade of selling by people who can't afford to wait out the decline makes headlines, it will be too late to reorganize your personal finances. While you might not think you're vulnerable to a slowing economy, rising unemployment, falling home prices amid higher interest rates and possible stagflation, it's certainly worth doing a "what if" check. For example, what if there were no more overtime, or what if one spouse lost a job or had work hours cut back? And what if you were counting on a bonus to pay those year-end bills, or what if gasoline and home heating prices continue to rise? It's human nature to avoid thinking about those dreary possibilities when the economic news still appears pretty good. But it's not only Boy Scouts who need to "be prepared!" That's The Savage Truth.