Fed Rate Cut Ignites a Short-lived Stock Market Relief Rally

By: Paul_J_Nolte

In this day and age of instant access/analysis and reactions, how can one person have such an effect upon the markets…and it is not the Fed Chief. Could it be that one trader, working for Societe General, create such a mess that the unwinding could push down all the markets around the world and force the Fed here to cut rates by 75 basis points (bp)? Given the relatively unchanged market from the prior week, maybe – however looking at the trading activity for the week, it is a difficult argument to make. As usual, the trading of the week, as well as the news answers fewer questions than it creates, but a few interesting nuggets may be gleaned from some of the very thin data.

First, the housing sector – much beleaguered (and a top performing sector) has seen refinancing activity triple over the past three weeks and new mortgage activity has picked up. Jobless claims fell again and remain within a two-year range that may indicate the job market is OK, but we will get the non-farm data on Friday – which will also be loaded with other economic data. Oh, and the Fed actually meets to decide on whether they should cut rates some more. A few more questions may get answered this week – it should be interesting!

Nearly every business program had someone commenting upon whether the “bottom is in” for the stock market. Ultimately we will wade into that pool, our quick analysis is that it is too early to decide. Our indicators are all pointing to a rally (as they did last week, just took a while to get going!), but we remain concerned that whatever rally occurs will likely hit the 1370-1420 area and get stopped. While a decent profit can be made, it may be nothing more than a relief rally that ultimately turns lower and becomes a full-blown bear market that could see the SP500 get below 1200 sometime this year. Comments about earnings have also been making excuses for the overall weakness of the financials (if not for the financial sector, earnings would actually be higher than a year ago).

However, it does sound like the excuses about inflation without food and energy (that no one uses). While the rest of the economy is not in the “depression” like financials, the overall effect of tightened loan standards, slowing consumer spending and lower employment rates are impacting the economy and businesses in general. We are unlikely to know the full breadth and depth of the problem for months to come.

The “surprising” cut by the Fed (the only surprise was the size) has pushed short rates down a full percent and a half since Halloween. The long-term bonds have only fallen by roughly 50bp, creating a more “normal” yield curve and under which banks should be relatively profitable. The bond model continues to point to still lower rates ahead and has done so since mid-August. However, as was the case in the '00-'02 period, lower interest rates did not mean a stock market that rose. In fact, this most recent decline in rates has occurred with the stock market declining 8% since late August. A concern for bond investors is the still persistently higher commodity prices – running at a better than 10% annual rate since August.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2008 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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