Watch for the Stock Market Pullback

By: Peter_Navarro

The US stock market continues in a decisively bullish uptrend on the basis of an improving economy. The consensus -- often a dangerous thing but probably right this time -- is that the economy has hit bottom; and numerous indicators suggest that it is on an upward swing.

The most important short to medium-term driver of economic growth -- and this bull market -- is business inventories. They are as lean as they ever get, and the thinking is that as manufacturers up their production to restock warehouses and shelves, an investment led stimulus will provide the next leg in the upturn, which has been triggered, at least in part by the fiscal stimulus. That this is clearheaded thinking is evident in one of my favorite of leading economic indicators: the ISM Manufacturing index. The chart below clearly indicates a strong upward trend after the index bottomed last December.

For the foreseeable future, there should be relatively clear trading skies ahead. The big very short-term danger is a pullback as some traders take some profits and other traders reassess whether this recovery is for real.

The longer-term danger, which could begin to manifest in just a matter of months, has to do with a variety of negative forces bearing down on the US economy.

One force is government policy. I'm all for healthcare reform, but the wasteful garbage working its way through Congress under pressure from the president would add a significant layer of costs onto an already fragile private sector and a loaded-with-debt public-sector.
A second negative force is all money washing through the economy from the various fiscal and monetary stimuli. This genie is out of the bottle no matter what reassurances we get from the Fed about exit strategies. The inevitable result must be a declining dollar, rising inflation, and another likely commodity and energy bubble -- and of course contractionary Fed rate hikes.

Still a third negative force is the employment situation. The markets rose last week not because this economy is generating jobs but rather because the pace of job losses slowing. This is a misplaced optimism if you look at the chessboard properly. In order to have long-term job growth recovery, the US has to have a stronger manufacturing base. This issue has not been dealt with by the Obama administration, and it is the single greatest obstacle to long-term prosperity in this country.

As a final comment, as I was watching the president give a speech in Elkhart, Indiana last week, I didn't know whether to laugh or cry when the president made his claim that it would be education that would get us out of this whole mess. The president was absolutely correct, of course, that we need to teach our children well if they are to compete in the coming decades. However, here in California, all I see is massive budget cuts, teacher cutbacks, contracting school programs, and the descent further into mediocrity not just at the K-12 system but also at the university level where I teach. My fear is that the kids that are in high school and college now will be a lost generation, robbed of a high quality education and facing few prospects in the economy. We will see how that plays out, but Obama is not going to be the "education president" any more than Bush was unless he deals with the basic reality of America's declining manufacturing base and the desperate need for trade reform.

On the need for reform, see the new book by the Alliance for American Manufacturing climbing up the charts on Amazon -- I have a chapter in that book along with others like Clyde Prestowitz. It's a pretty good overview both of the problems we face and possible solutions. If you buy the book, please read it carefully, send your congressman a letter or e-mail about the importance of manufacturing in America, and then forward your copy of the book to the White House.

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———- Peter Navarro is the author of the best-selling The Coming China Wars, the path-breaking The Well-Timed Strategy, and the investment classic If It's Raining In Brazil, Buy Starbucks. Peter’s latest book is Always a Winner: Managing for Competitive Advantage in an Up and Down Economy. Peter is a regular CNBC contributor and has been featured on 60 Minutes.  His internationally recognized expertise lies in his "big picture" application of a highly sophisticated but easily accessible macroeconomic analysis of the business cycle and stock market cycle for corporate executives and investors. He is a Professor at the Merage School of Business, University of California-Irvine and received his Ph.D. in economics from Harvard University. Professor Navarro’s articles have appeared in a wide range of publications, from Business Week, the Los Angeles Times, New York Times and Wall Street Journal to the Harvard Business Review, the MIT Sloan Management Review, and the Journal of Business. His free weekly newsletter is published at www.PeterNavarro.com.

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