Lately I've spoken to many investors who said they cannot see the markets moving any higher from the current level. They are so shell-shocked by the bear market that they are downright gloomy about our economic situation and don't think it could actually improve.

Add to that a government that is putting on programs and regulations so fast that our collective heads are spinning, and it's enough to give even the most ardent optimist some legitimate pause. The future ramifications of all these actions are creating a lot of justifiable concern for the future.

At Paragon Wealth Management, we are monitoring the potential risks and analyzing what the impact on the markets could be in order to give us a game plan if certain situations, such as inflation, should unfold.

In the past I've spoken about the recency effect, which is the tendency for people to extrapolate current conditions into the future. It is admittedly hard to have foresight when current conditions are bleak. I believe this behavioral phenomenon is a main reason why many are skeptical of a market advance.

How can we have a clear head and look through the current situation to see what is ahead? How can we prevent current events from unduly clouding our judgment about what the future holds? When it comes to discerning the effects of current government actions I think it is helpful to separate what the impacts are in terms of time.

THE EFFECT OF THE GOVERNMENT

Stimulus Package:
Short-term Effect- Expenditures boost GDP in the near-term and possibly aid/magnify economic rebound.
Cost/future Effect- Drag on future growth as borrowing must be paid off. Lower future GDP growth.

Fed Quantitative Easing
Short-Term Effect- Floods market with liquidity and low interest rates, which help to spur economic activity.
Cost/future Effect- Inflation. Higher interest rates.

Health Care Reform
Short-Term Effect- Cheaper health care provides more discretionary income possibly boosting GDP.
Cost/future Effect- Higher taxes to pay for growing entitlement results in lower GDP growth. Quality issues.

Cap-and-Trade
Short-Term Effect- No immediate negative effect as initials credits given away for "free".
Cost/future Effect- Higher taxes. If new energy sources unreliable/inefficient and more expensive then GDP growth could suffer. Serious fraud abuse.

Regardless of whether you agree with the government or not, these actions will provide benefits in the short run that must be paid back in the long run.

I don't think it is a stretch to say that most politicians don't care about the long run. They almost always focus on providing the goods right now, and that is how they get elected. Government can only spend money by borrowing, taxing, or printing money. Too much of any one of these impedes economic activity. The first two are not inflationary while the latter is the essence of what inflation is.

CONSEQUENCES OF DEBT

There is nothing wrong with borrowing money -- as long as you can afford the payments. The mistake that is usually made is that many assume they can make the payments and fail to account for future possible hardships. The other common mistake is that we often keep piling on the debt until we can't service it anymore.

Government actions are no different. The more it "spends" now the more it has to pay back in the future. Where the breaking points is a matter of great debate. One thing for sure is that future GDP growth will be lower because of the obligations we are taking on now. There is no way around it. Notice that I said GDP growth will be slower, but not that GDP won't grow. This is where many pessimists miss the boat. They naturally assume the worst from all of the government actions and take the worst case scenario.

For example, all of the monetary easing actions by the Fed have been unprecedented. These actions have the potential to create serious inflation down the road with some suggesting that we could be in for hyperinflation akin to what Germany experienced in the 1920's (we all know what that led to).

The pessimists assume that this situation is inevitable and there is nothing the Fed can do to stop it. But what if the Fed's actions can stop inflation or at least mitigate the negative effects from it. Shouldn't this be considered? When and how any versions of this scenario unfold are too hard to predict. My point is that it doesn't have to end in disaster!

GOVERNMENT ACTIONS

Now back to the immediate effect of the government actions. However inefficient, the net effect of these actions will be to boost economic activity in the short run.

So how long is the short run? No one knows, but I would say at least one to two years. We have also said that despite all of the confusing government actions, the economy will turn on its own accord because America is a dynamic place, and the natural state of the economy is to grow. People want to improve their economic situations. We might have 10% unemployment, but we still have 90% employment! Imagine what could happen if the economy is turning around right now and then that is coupled with the fiscal stimulus from the government. You could have GDP growth sooner than most expect! That means the stock market could be poised to continue the significant rally off of the March 9th lows.

The scenario that seems the most likely to me is that the economy will snap-back over the next year or so and then plateau with slower growth after hitting the headwinds previously discussed. Right now our economic models are confirming this scenario.

PARAGON'S APPROACH

This doesn't mean I think the market will go straight up or that I am a "perma-bull" and oblivious to the risk that exist. Market and economic factors are constantly changing. At Paragon Wealth Management, we believe in taking a flexible approach to the market. Right now all of our economic, valuation, momentum and sentiment models are telling us to stay in the market. Until they change we will stay allocated to those areas we feel have the best potential.