U.S. stocks rallied big on Friday, led by financial and consumer discretionary shares, as oil plunged $6.59 per barrel, or 5.44%. That decline erased the prior day’s increase, sending crude back to $115 per barrel.
For the week, the S&P 500 and Dow average slipped 0.46% and 0.27%, respectively. A rally in the back-half of the week nearly erased an ugly start – the broad market lost 2.45% during the first two trading sessions. The NASDAQ Composite was a different story as tech stocks failed to participate in the Wednesday/Thursday upswing – the index fell 1.54% for the week.
Market Activity for August 22, 2008
On Friday, while financial and consumer discretionary shares led the market higher – a trend that broke down the previous three days – there were other bright spots as industrial, information technology and consumer staple shares all rose more than 1.10%.
For the year, the broad market, as measured by the S&P 500, is down 12.00% and we have moved to a lower trading range as uncertainties over future tax rates (and the direct effect this has on after-tax return expectations), inflation, oil/dollar (although this worry has eased), the housing and credit markets and geopolitical risks all put pressure on stocks. We have rebounded more than 6% from the new low set on July 15, but credit spreads remain wide in most cases and until these narrow it will be tough for the market to sustain a rally in the near term. (Thankfully mid cap stocks are down just 5% and smalls are off by just 3.7% -- as measured by the Russell 2000 -- year-to-date)
The November election will also likely keep us in a trading range.
However, the election is just 70 days away, and if the outcome shows tax rates will not change for the worse this market will very likely rally in a significant way. From there it will take an end of the housing correction to get us back to all-time highs. For this all to play out it will take some time, but for now the market is expecting the worse and if that scenario doesn’t play out then things will be looking upbeat for stocks.
From a longer-term perspective, these tough markets create opportunities. Too, if some bad policy initiatives get implemented, it sets the stage for a pro-growth agenda – don’t forget House elections take place every two years. Patience is really the best prescription right now – without it, I think it is easy for people to make some poor decisions regarding longer-term portfolio performance.
We were without an economic release on Friday, so Bernanke’s speech was the big economic-related news of the day (you may remember we mentioned on Friday that the Fed Chairman would be speaking). Below are some key remarks from the speech and my analysis on each.
“In view of the weakening outlook and the downside risks to growth, the Federal Open Market Committee (FOMC) has maintained a relatively low target for the federal funds rate despite an increase in inflationary pressures.”
Comment:
This is a negative with regard to Fed credibility in the future – keeping fed funds this low even though inflationary pressures have increased?
“This strategy has been conditioned on our expectation that the prices of oil and other commodities would ultimately stabilize, in part as the result of slowing global growth, and that this outcome, together with well-anchored inflation expectations and increased slack in resource utilization, would foster a return to price stability in the medium run.”
Comment:
This is a full-fledged Keynesian view and one that history has proven is hardly a foregone conclusion. Further, inflation expectations are not well-anchored as a 20% year-over-year rise in import prices, a 10% year-over-year rise in producer prices, both large and small business surveys show price increases and plans to raise prices are at historic highs, core (ex-food and energy) intermediate goods have jumped 10.2% year-over-year and consumers believe prices will rise at 5-6% over the next year. (I don’t put a lot of faith in this consumer reading, but use it for purposes of illustration nonetheless.)
In addition, while the bond market has not priced in harmful levels of inflation – which is probably what the Fed is referring too when they state “inflation expectation are well-anchored” – we shouldn’t discount the fact that geopolitical and financial-sector risks have the market flooding to this safe-have, which has pushed yields lower. What’s more, there have been periods in the past when the bond market took some time to price in bouts with inflation, such as the mid 1970s even though CPI was hitting double-digit rates. If they are wrong, these yields will reflect the inflation problem soon enough.
That said, I do hope Bernanke and Co. are correct, it’s just that it doesn’t jibe with my study of the historic data. We shall see.
“In this regard, the recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year. Nevertheless, the inflation outlook remains highly uncertain, not least because of the difficulty of predicting the future course of commodity prices, and we will continue to monitor inflation and inflation expectations closely. The FOMC is committed to achieving medium-term price stability and will act as necessary to attain that objective.”
Comment:
Recall the chart we posted in Friday’s letter illustrating MZM money supply growth. Commodity prices could come down from these levels, but it is not clear to me that overall prices will fall to a level that comes even close to the Fed’s stated comfort zone. Money supply has grown at a rate that has surpassed nominal GDP growth by a long shot over the past 12 months. As Brian Wesbury laid out in a WSJ Op/Ed last week, this excess money creation has been absorbed to some degree by higher energy prices. If those prices fall, that money is still out there – without the necessary production of goods to mop it up. Therefore, demand for other goods may increase and push those prices higher.
Unfortunately, there is nothing in the Fed’s remarks that recognizes their easy money stance has contributed to the rise in commodity prices, nor is there a mention that this type of policy got us into the housing mess in the first place. (I’m not even going to expound on how this policy and the higher commodity prices that have resulted have contributed to Russia’s and Iran’s (oil-exporters) newfound chutzpah)
In the end, the Fed and government policy will choose the correct course – although possibly not before further mistakes are made. But for now things are quite uncertain; I’ll repeat, however, these types of environments do make for great opportunities. On interest rates, if longer-term rates shoot up (to reflect higher inflation expectations) it presents and opportunity to lock in at those higher rates (ala, those that still own 30-year T-bonds from say 1982 that yield 14% -- not saying things will get to that level, but you see the point). Further, stocks behave undesirably during these situations, as we have all seen. But valuations, even if uncertainty over inflation makes valuing equities more difficult, are set up for strong long-term performance and we believe this will pay off in a very nice way for those with patience over the next several years.
Have a great day!
Brent Vondera, Senior Analyst
For the week, the S&P 500 and Dow average slipped 0.46% and 0.27%, respectively. A rally in the back-half of the week nearly erased an ugly start – the broad market lost 2.45% during the first two trading sessions. The NASDAQ Composite was a different story as tech stocks failed to participate in the Wednesday/Thursday upswing – the index fell 1.54% for the week.
Market Activity for August 22, 2008
On Friday, while financial and consumer discretionary shares led the market higher – a trend that broke down the previous three days – there were other bright spots as industrial, information technology and consumer staple shares all rose more than 1.10%.For the year, the broad market, as measured by the S&P 500, is down 12.00% and we have moved to a lower trading range as uncertainties over future tax rates (and the direct effect this has on after-tax return expectations), inflation, oil/dollar (although this worry has eased), the housing and credit markets and geopolitical risks all put pressure on stocks. We have rebounded more than 6% from the new low set on July 15, but credit spreads remain wide in most cases and until these narrow it will be tough for the market to sustain a rally in the near term. (Thankfully mid cap stocks are down just 5% and smalls are off by just 3.7% -- as measured by the Russell 2000 -- year-to-date)
The November election will also likely keep us in a trading range.
However, the election is just 70 days away, and if the outcome shows tax rates will not change for the worse this market will very likely rally in a significant way. From there it will take an end of the housing correction to get us back to all-time highs. For this all to play out it will take some time, but for now the market is expecting the worse and if that scenario doesn’t play out then things will be looking upbeat for stocks.
From a longer-term perspective, these tough markets create opportunities. Too, if some bad policy initiatives get implemented, it sets the stage for a pro-growth agenda – don’t forget House elections take place every two years. Patience is really the best prescription right now – without it, I think it is easy for people to make some poor decisions regarding longer-term portfolio performance.
We were without an economic release on Friday, so Bernanke’s speech was the big economic-related news of the day (you may remember we mentioned on Friday that the Fed Chairman would be speaking). Below are some key remarks from the speech and my analysis on each.
“In view of the weakening outlook and the downside risks to growth, the Federal Open Market Committee (FOMC) has maintained a relatively low target for the federal funds rate despite an increase in inflationary pressures.”
Comment:
This is a negative with regard to Fed credibility in the future – keeping fed funds this low even though inflationary pressures have increased?
“This strategy has been conditioned on our expectation that the prices of oil and other commodities would ultimately stabilize, in part as the result of slowing global growth, and that this outcome, together with well-anchored inflation expectations and increased slack in resource utilization, would foster a return to price stability in the medium run.”
Comment:
This is a full-fledged Keynesian view and one that history has proven is hardly a foregone conclusion. Further, inflation expectations are not well-anchored as a 20% year-over-year rise in import prices, a 10% year-over-year rise in producer prices, both large and small business surveys show price increases and plans to raise prices are at historic highs, core (ex-food and energy) intermediate goods have jumped 10.2% year-over-year and consumers believe prices will rise at 5-6% over the next year. (I don’t put a lot of faith in this consumer reading, but use it for purposes of illustration nonetheless.)
In addition, while the bond market has not priced in harmful levels of inflation – which is probably what the Fed is referring too when they state “inflation expectation are well-anchored” – we shouldn’t discount the fact that geopolitical and financial-sector risks have the market flooding to this safe-have, which has pushed yields lower. What’s more, there have been periods in the past when the bond market took some time to price in bouts with inflation, such as the mid 1970s even though CPI was hitting double-digit rates. If they are wrong, these yields will reflect the inflation problem soon enough.
That said, I do hope Bernanke and Co. are correct, it’s just that it doesn’t jibe with my study of the historic data. We shall see.
“In this regard, the recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year. Nevertheless, the inflation outlook remains highly uncertain, not least because of the difficulty of predicting the future course of commodity prices, and we will continue to monitor inflation and inflation expectations closely. The FOMC is committed to achieving medium-term price stability and will act as necessary to attain that objective.”
Comment:
Recall the chart we posted in Friday’s letter illustrating MZM money supply growth. Commodity prices could come down from these levels, but it is not clear to me that overall prices will fall to a level that comes even close to the Fed’s stated comfort zone. Money supply has grown at a rate that has surpassed nominal GDP growth by a long shot over the past 12 months. As Brian Wesbury laid out in a WSJ Op/Ed last week, this excess money creation has been absorbed to some degree by higher energy prices. If those prices fall, that money is still out there – without the necessary production of goods to mop it up. Therefore, demand for other goods may increase and push those prices higher.
Unfortunately, there is nothing in the Fed’s remarks that recognizes their easy money stance has contributed to the rise in commodity prices, nor is there a mention that this type of policy got us into the housing mess in the first place. (I’m not even going to expound on how this policy and the higher commodity prices that have resulted have contributed to Russia’s and Iran’s (oil-exporters) newfound chutzpah)
In the end, the Fed and government policy will choose the correct course – although possibly not before further mistakes are made. But for now things are quite uncertain; I’ll repeat, however, these types of environments do make for great opportunities. On interest rates, if longer-term rates shoot up (to reflect higher inflation expectations) it presents and opportunity to lock in at those higher rates (ala, those that still own 30-year T-bonds from say 1982 that yield 14% -- not saying things will get to that level, but you see the point). Further, stocks behave undesirably during these situations, as we have all seen. But valuations, even if uncertainty over inflation makes valuing equities more difficult, are set up for strong long-term performance and we believe this will pay off in a very nice way for those with patience over the next several years.
Have a great day!
Brent Vondera, Senior Analyst
No comments:
Post a Comment