When the rally first got started, the gains were attributed to better than expected earnings from Macy’s. It’s hard to see how this could really push the market, though, since this is a distressed mid-cap stock, the source of improvements were related to cost cutting in spite of weak sales, and it still lost money for the quarter.
In my opinion, a strong rally from a weak data point indicates that markets are not trading on fundamental values at the moment. Just as markets were unjustified in their 25 percent drop earlier this year, the 50 percent rally from the low in March seems to have allowed optimistic euphoria to carry a day like yesterday even when it doesn’t seem well founded.
Market Activity for August 12, 2009
Even though the Fed announcement didn’t end up carrying much weight in the stock or bond market yesterday, the news was good. (There was a rally after the announcement, but it faded back to pre-announcement levels before the end of the day.)
First, it was reassuring to hear the Fed say that “economic activity is leveling out,” which fits with the conventional wisdom that the recession is ending. The bigger news, though, is that the Fed is removing one of the lifelines by announcing that it would not purchase more Treasury bonds after October.
To keep interest rates low across the board, the Fed engaged in a massive buying spree in the mortgage, treasury and agency bond markets. This is known as quantitative easing because it injects liquidity into the economy. They couldn’t push interest rates below zero and this was a strategy that the U.S. had not engaged in before but had it been done in other parts of the world, most notably Japan.
By announcing the end of the Treasury program, the Fed is signaling that they are beginning to withdraw the support that they had put in place during the crisis. This isn’t to say that everything is fine and dandy, though, because many of the lifelines are still in place and the Fed will still own all of the Treasury bonds that they bought, they just won’t be buying any more.
In addition to saying that the economy seems to be stabilizing and that the Treasury purchase program will end in October, the Fed was clear that they do not view inflation as an immediate threat. Their exact language remained unchanged - that inflation will be ‘subdued for some time.’
Markets are set to open higher this morning, though some early enthusiasm has been reduced with the retail sales data from the Commerce Department. Earlier, markets showed a triple-digit rise for the Dow based on earnings news from Wal-Mart.
Retail sales fell 0.1 percent in July, despite the ‘cash for clunkers’ program that was so successful it ran out of money in the first week. Retail sales ex-autos fell by -0.6 percent, well below expectations. Retail sales are an important measure of broad consumer spending patterns, so this may put more of dent on the markets as the bell rings.
Have a great day!
David Ott, Partner
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