On zero economic news, just a Presidential speech from New York on how irresponsible everyone has been and the need for more regulations, the market found reason to extend its amazing rally as utilities, basic material and financials led the move higher. Financials had been lower by 1.3% on the session, but nearly 3% from the day’s low point. (Today we get the August retail sales figure, which is likely to show an increase driven by big auto sales, so maybe traders were looking to get ahead of this news.)
Volume remained pretty subdued with less than 1.2 billion shares traded, roughly 20% below normal; this does not suggest much conviction, but we continue to head higher nonetheless.
Market Activity for September 14, 2009
Again, we were without an economic release yesterday, but this gives us a chance to touch on a couple of topics – the first has been something I’ve wanted to mention for about a week now but haven’t had the space.The Dollar and Foreign Investing
The Federal Reserve doesn’t seem to factor the dollar’s direction in their policy decision-making process, but they better start thinking about it soon. Bernanke rarely (and that’s an understatement) mentions the dollar in any of his testimonies to Congress – only when prompted. He generally defers to the Treasury Department, but I wouldn’t count on Tim Geithner and Co. to take good care of the greenback’s value – similar to the previous administration, they see no problem with a declining dollar. In fact, I would say they see it as desirable.
Too often policymakers make the mistake of thinking about export activity (a lower dollar value does help our exports as they become cheaper to the rest of the world), while forgetting about the capital inflow side of the economy.
The dollar has plunged in value, against a basket of other currencies, over the past decade. Some of this decline was needed, as the greenback was quite over-valued as result of the world’s rush into the tech bubble in the late 1990s and the ultra safe-haven trade following the 9/11 attacks – both of which drove demand for dollar-denominated U.S. assets, the former drove stock prices and the latter bond prices. However, from say 90 on the Dollar Index the greenback’s decline has not been a good thing in my view and one has to be somewhat concerned about this direction as a falling dollar drives commodity prices higher and can foster harmful levels of inflation – even if that seems to be no concern right now.
In addition, a falling dollar, and especially the perception that it will fall further (driven by the massive fiscal deficits we have now begun to run and very easy Fed policy that keeps interest rates ultra-low), is not conducive to the capital inflows that our economy needs. Further, there’s concern the adverse effect higher tax rates (lowering after-tax return expectations) will have on foreign investments to the U.S. These inflows are necessary to fund capital formation – a pretty important factor with regard to technological innovation (it’s the seed money for that innovation) and the future direction of productivity.To this point, we all know that the stock market has gone no where over the past decade – virtually flat since September 1998 even including dividends. But in terms of other currencies, due to the dollar’s decline, it is even worse. Since the summer of 2002, when the greenback really began to slide, while the broad market is up 10.33% (or 1.36% at an annual rate) in U.S. dollar terms it has fallen 28.42% in Euros, is down 25.90% in Aussie dollars, off by 20.79% in Canadian dollars and has even declined 17.65% in Yen.
What’s more, keeping interest rates very low will keep the dollar down as it is currently profitable to borrow in dollars, and then turn and sell those dollars to invest in other currencies that offer, or at least perceived to offer, more upside potential and higher interest rates attached. It seems about time we should begin to think about the U.S. dollar again and that begins with the Fed, since we won’t get it from fiscal policy.
One Year Anni
And speaking of Federal Reserve policy:
The financial press, naturally, is focusing on the one-year anniversary of the Lehman collapse – and well they should based on the magnitude and economic reverberations of the event. But we should understand that the demise of Lehman was not the origin that caused the financial system to nearly fail, it was the over-leveraged nature of the system. That over-levered situation was very much encouraged by Federal Reserve policy mistakes that kept rates way too low for way too long.
If the Fed would not have kept real fed funds negative (their benchmark interest rate below the rate of inflation) for nearly three years that over-leveraged state would not have occurred –this was the oxygen for the leverage. Those monetary policy mistakes were driven by too much dependence on flawed Keynesian models, models that put a heavy focus on wage-driven inflation (this led to the Fed’s refusal to move rates higher even when the unemployment rate had moved below 6% in late 2003 – they kept fed funds at 1% until June 2004 and didn’t get back to 3.00% until mid 2005, at which point real fed funds finally went positive for the first time since September 20020.
Will they make the same mistakes this time? We’ll just have to wait to find out, but it seems pretty clear that they will find it difficult to reverse their aggressively easy stance this go around when even an improved labor market will keep the jobless rate well above what is normal.
The Fed has had no choice but to engage in very aggressive easy-money policy over the past 18 months, but that does not mean we shouldn’t learn from the past mistakes that played a major role in the troubles we still face.
Current policy will cause its own problems, problems we can’t possibly know as we sit here today, but we should understand this aggressive easy money policy will make things difficult over the next couple of years, particularly when it is removed. The longer they wait, the tougher it will become for the economy to withstand that reversal and when it is accompanied by higher tax rates…well, that’s something, unfortunately, the stock market will have to begin thinking about.
Have a great day!
Brent Vondera, Senior Analyst
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