Monday, December 11, 2006

Tuesday is the Big Fed Day

The stock market had a day very similar to Friday and the results were on the positive side.  Not much really happened except right after the opening bell when stocks vaulted higher for the second day in a row.  

Tuesday we hear from the Fed about their decision on interest rates.  We have said that they can not raise rates at this meeting and can hardly raise them any time soon due to the underlying weakness in the economy amid an already inverted yield curve.

In conversations on Monday, there were some forward looking comments by our colleagues who thought that the Fed may be telling the truth that they are really looking at inflation and may actually raise rates.  That thinking process derives from the inherent desire for all of us to believe in the Fed.  True, the all important “core” inflation is running a bit ahead of where the Fed would like it to be.  But, the inverted yield curve hasn’t been able to change that for a year so why do they think that an even more inverted curve could do the job.  

We have said many times that the Fed doesn’t “tighten” when it raises rates.  It only makes the cost of borrowing a little higher.  We would say that going to the bank to ask for a loan 25-35 years ago would have resulted in most of us being turned away due to lack of collateral.  These days, we get checks in the mail with low interest rates and we don’t even have to go to the bank to get them.  How times have changed!

In a related note, we were very impressed with an article in Monday’s WSJ.  If you saw the article or can find the article, we highly recommend it to you.  The article is entitled “The Retirement Lies We Tell Ourselves” with a subtitle of “The biggest—and most risky—assumptions that people make when planning for the future.”  The first one is that “I’m going to work in retirement.”  We urge you to pick up and read this article.

We’ll see you back here tomorrow after the big Fed news.  We expect that some relief will be given by the lack of action but we are wondering what the statement will be.  Could it be that it will be strong enough to change the mindset of the market?  Probably not but we can always hope.

Dow Industrials:  12,328.48  +20.99
VIX: 10.71  (big drop)
QQQQ:  44.06
RYVNX:   17.09
RYAIX:  21.57
RYCWX:  36.12
TLT:  90.63
BEGBX:  14.26

1 comment:

Eric Bergen said...

In 1996, authors Estrella and Mishkin released a famous Fed study that developed a probability table about how likely a recession would be 4 quarters later, given a particular level of the yield curve spread. Their study accurately predicted the stock market crash in 2001 when the yield curve was inverted one year earlier.

The last few months, the spread between the 3-month & 10-year bonds has been -0.40% indicating a ~40% chance of a recession.

Every time a bearish set of economic data was released in late 2006, the stock market shrugged it off since it heightened expectations of a Fed rate cut in 2007 (which stimulates growth). On the other hand, when positive data was released, the market still rallied. Thus, the stock market was going to rally no matter what the news!!!

This year should be different due to (a dirty word for investors) STAGFLATION. Yesterday’s Fed minutes indicated the presence of this double whammy: slowing growth AND rising inflation. These 2 phenomena rarely work in opposition. What this means is that the economy is slowing, but the Fed is unlikely to cut rates as long as inflation is an issue. This is very bad for the stock market and, to a lesser extent, the bond market.