I heard a segment on the radio this morning and another naive American was saying we should send all the illegal immigrants back to the countries they came from.  Unbelievable.  Like so many others, this person doesn't realize the economy is primarily made up of consumer spending and consumer spending is a function of the population.

It is estimated there are about 12 million illegal immigrants living in the US.  That's about 4% of the total population.  If you somehow managed to find a way of getting all those people OUT of this country, you would drop consumer spending by about 4% and we would experience the biggest recession since the 30s.  These people earn money and they also spend money.  You can't get rid of one side of the equation without getting rid of the other.

I don't have a solution for this country's immigration problems but sending them all out of the country would be the worst of all possible scenarios.  I only wish the average American was educated enough to see the contradiction in their own argument.

Obviously, the markets rallied pretty hard on Friday after the Fed made its presence known by lowering the discount rate 50 basis points.  But honestly, I don't trust that rally at all.  The market wide P/E ratios are still a bit high and there's really no reason for investors to be optimistic about the future, at least not in the short term.

I'm not suggesting the yield objectives should also be similar between stock and bond markets but during a time when there isn't any particular optimism in either market, they should indeed be similar.  Of course, the stock market always a bigger upside because the underlying stock's earnings can grow over time.  Bonds, by definition, offer stable returns.

 Anyway, there's no reason to believe corporate earnings will rise in the next couple of quarters.  A lot of people are actually speculating the economy may slip into a recession in the next year or so.  And corporate earnings were also pretty impressive this past quarter.  They've been growing by double digits for 14 consecutive quarters now.  It can't last forever.

I still think a Dow Jones P/E ratio around 18 is probably reasonable right now.  It's currently sitting at 20.3.  So what happens now?  Well, no one knows for sure but I would expect the markets to go lower - maybe not right away but soon.

If copper dropped below 320, I suspect it will drop further.  It will probably go down for a week or so and then turn around and rally back, test 320, probably fail, and then start going back down again.

Regarding interest rates, it depends on the borrower.  For the government or other large A-paper borrowers, nothing has really changed.  But for everyone else, borrowing costs have definitely gone up.  When financing becomes more expensive, economic activity is expected to go down.  When economic activity goes down, the demand for commodities goes down also, dropping the price for copper and oil (now down at $70).

Personally, I think a lot of this is speculative right now.  The pricing adjustments may be exaggerated in the short-term.  But if copper dropped significantly below 320, I would expect that same number to represent resistance (a price ceiling) from now on – at least for a while.

The stock market tumble is also driven by dropping corporate earnings.  Three months ago, the Dow Jones P/E ratio was 18.  Then, a bunch of Dow companies reported poor earnings so the P/E ratio went up to 21.  That’s just too high right now.  In fact, you can think of it as the inverse of interest rates.  When you buy a stock, you’re effectively buying the company’s earnings.  So if the P/E ratio is 20, you’re basically expecting a 5% return (100/20=5).  But interest rates in the bond market are higher than that.  Furthermore, stocks are more risky than most bonds.  So let’s assume an interest rate of 6.5%.  That would result in a P/E ratio of 15.  Now, that might be a bit low but I think 17 or 18 is probably about right.  Let’s take the average: 17.5 or a yield of 5.7%.

Today, the Dow P/E ratio is 19.6.  To get down to 17.5, stock prices have to drop by another 10.7%.  That would put the Dow at 11277.  Wow.  That’s a big drop.  But it’s possible.  It might take a few months but I think it’s possible.  And then, if corporate earnings drop further next quarter, it could drop even more.

For the time being, the Dow’s got strong support at 12000 so I expect the initial drop to end there.  It will probably bounce off, go up for a bit and then come back down, test 12000 and eventually breach it to the down side.  That’s what I expect.

Excitement is building as launch day approaches.  We've been busy at work preparing the websites and content for our much-anticipated launch in the next week or two.  More than 20 chapters have already been written and recording will begin in the next few days.  This is expected to be the biggest free information offering we're aware of.  Stay tuned!