Was the Fed Too Hasty?
by Paul J. Nolte, CFA
October 1, 2007
What a quarter � from the heights to the depths and back again, the quarter ended with the SP500 up a modest 1.5%, barely above the rate earned on bonds with a lot less gray hairs. Yields fell during the quarter, with short rates falling a full percentage point, while long-term bonds dropped a quarter percent. The news last quarter has been splashed all over the media � from liquidity crisis to real estate blues to just maybe a recession. But the money management business is never about what was done yesterday � what are y�all doing for me lately? The quarter should start off with a bang, as the week is full of market moving economic reports � from manufacturing to employment. Given that last month was so terrible, investors will be watching Friday's employment report very closely for signs that we are either entering or on the cusp of a recession. For many, two consecutive months of a decline in non-farm payrolls is a sure indication of recession. While we are not there yet, Friday's report should provide fuel for further rate cuts by the Fed or that they were premature in cutting so aggressively. Either way, we are looking forward to an interesting week.
The stock market meandered much of the week in a rather uninspired way as volume declined (again) net number of advancing stocks narrowed and new highs remain below the prior week, while new lows expand. Could this be a market redo of 1987? An August sell-off was followed by a minor September gain before falling off the cliff in October. The dollar was declining, however interest rates were rising (not being cut) during that period. What makes today much more interesting is that the Fed is cutting rates with a stock market very close to all-time highs and investor expectations near peak levels. If there is any disappointment in either the economic numbers or the earnings releases due in the weeks ahead, the markets could take a serious tumble. A crash like �87 � unlikely, but even a 5-10% drop back to the August lows could put fear back into investors that only existed for a couple of days in August. We will be watching the volume numbers and net advancing issues over the next couple of weeks to assist us in determining whether we want to hang around the markets or sit out the October dance.
Our bond model is getting whipsawed by short-term rates, rising and falling rapidly over the course of a week, they have pushed to model from positive to negative and back again. Commodity prices continue to rise, tacking on another 1% last week even as oil and gold stocks declined last week. The focus has begun to turn to agricultural commodities, as the heavy corn planting has squeezed out the normal planting sizes of wheat, soybeans and the like. The crowding out of these important global grains have pushed these prices up 50% for wheat just since July 4th and nearly 20% for soybeans over the same period. As these prices make their way through the �food chain� from grains to goods, we would expect to see much higher food inflation this quarter � again putting fears into bond investors that the Fed may have been too hasty in cutting rates as aggressively as they did two weeks ago.
© 2007 Paul J. Nolte, CFA
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.
Paul J. Nolte, CFA