Daily Insight

U.S. stocks, after beginning the session lower, trended higher for much of the day but lost momentum shortly after lunch, which may have increased redemption calls and thus the need to sell additional shares.

The S&P 500 lost 3.3% in the final 30 minutes of trading – ending down 5% from the session’s peak. The same was true for the Dow average and NASDAQ Composite.

Energy, basic material and financial shares took the brunt of the sell-off on concerns that global growth will show substantial damage from the credit-market lock up and the increased caution from the business community, even for those that have not been directly affected by the event.

There continues to be distressed sellers that look for any upside as an opportunity to get out at a slightly higher level and that appears to be what occurred yesterday. Although volume certainly wasn’t heavy, with 1.2 billion shares trading on the NYSE Composite, so it’s tough to be sure.

Market Activity for October 27, 2008
Last week you got a sense of my pessimism – largely driven by the direction it appears policy will go (especially regarding the possibility of a filibuster-proof Senate). Increasing capital gains, dividends, payroll and top income-tax rates (75% of which is small business) as some propose would be very bad for stocks and is likely in the process of being priced in. Remember, stocks move based on future after-tax return expectations, and higher tax rates would obviously lower those expectations.

This week though it’s back to optimism, and there are reasons to be optimistic. Yesterday we touched on how the broad market trades 35% below the 200-day moving average, which has not occurred to this extent since the 1974 bear market – a tremendously powerful long-term buying opportunity. We also touched on cash levels; there’s enough money sitting in money-market funds to buy 45% of the S&P 500 and 30% of the NYSE Composite.

Yes, cash hoarding is all-around right now, not just within the financial sector but economy-wide as investors and firms delay plans to deploy this capital until mass uncertainty subsides. But the system has trillions in cash available and we do not believe it will take much improvement in sentiment to get this train rolling again.

From there, specifically the duration and sustainability of a rally will be determined by economic policy (tax rates, trade pacts and the regulatory regime.) But even assuming just about the worst-case scenario it’s quite likely we’ll engage in a powerful rally from these levels. In terms of the election, if we can simply get a filibuster-capable Senate, stocks could really take off. I’ll repeat, the duration of an upswing will depend on the direction of policy.

Commodity Prices and the Dollar

Nearly all commodity prices have plunged, as measured by the Commodity Research Bureau. As the chart below illustrates, the decline has been massive as de-leveraging and global-growth fears drive commodities down from the fed-induced peak.


Crude-oil continues its precipitous fall, and may move back to the $40 handle, for the immediate future at least – the past economic downturns/recessions do show crude declines by a divisor that ranges 2.5 to 3.0.


In the meantime, the greenback is on fire.


That said one ought not to expect commodity prices to remain depressed – which is a minority view at this point, so if you repeat this claim to most economists they’ll call you crazy; just a warning – as the Fed pumps liquidity like there is no tomorrow, which may be the case (just kidding).

The way the Fed is going (and they’ll cut again tomorrow when their latest meeting adjourns), if inflation rates do not fall abruptly, real fed funds will become even more negative (inflation rate is running above the rate of fed funds). Real fed funds is currently -3.4%. This means inflation may rage once the current problems run their course – for now the Fed has an immediate issues on its hands (the credit disturbance, so inflation takes a backseat), but the irony is the decisions to keep their target rate below the rate of inflation 2003-2005 meant they subsidized debt and is what got us into this situation in the first place (no surprise we’re dealing with so much leverage today and a housing bubble gone bust).

The chart below shows the spread, or real fed funds, sits at -2.90%. This is because we haven’t received the October CPI yet, which means the graph below is not factoring in the October 8 inter-meeting cut (notice how the top chart, which shows the two pieces of data – CPI and fed funds – has fed funds at 2.00%; the orange number). That figure is currently at 1.50%, which give us the negative 3.4% real fed funds rate – 1.50% fed funds target rate minus the 4.90% CPI rate.

When the Fed is able to raise rates again to take away this massive easing campaign, it must be accompanied by reductions in tax rates. To tighten monetary policy, while at the same time raising tax rates means economic death; it is the opposite strategy of what Reagan and Volcker engaged in during the early 1980s. But that’s a year away or so, and there’s just too much going on to look out that far right now on the policy front.

New Homes Sales

On the economic front, the Commerce Department reported new home sales rose 2.7% in September to 464,000 units at an annual rate from 452,000 in August – the reading was expected to decline 2.2%. The jump follows a 12.6% decline for August – new home sales remain 33% below year-ago levels.

New home sales are counted when a contract is signed, as opposed to when it is closed (which could take a month or so) for the existing home sales figures. As a result, new home sales data give us a better look at current conditions – such as the credit-market disturbance. So with that in mind, it was very good news to see sales increase.

However, one has to view this series with some caution as it is subject to contract cancellations if the buyer has trouble obtaining a mortgage. We’ll have to wait for the October figures to get a true indication of how the credit-market issues have affected the housing market. For now, though, things look relatively unscathed.

The median price of a new home fell roughly 1% in September to $218,400, which is down 9.1% over the past 12 months.


The number of new homes available for sale continues to decline, falling 7.3% in September to 394,000 units -- the 17th straight monthly decline, and sits at the lowest level since June 2004. This development, while harsh for now as it shows housing will continue to be a drag on GDP, is important. While the supply of new homes as a percentage of sales (effectively the inventory-to-sales ratio for new homes – two charts down) remains very elevated, the massive decline of homes available for sale (not adjusted to sales) will allow the inventory-to-sales ratio to come down very quickly once sales bounce back in a sustained way.



Have a great day!



Brent Vondera, Senior Analyst