Blog

Currently, the Dow Jones Industrial Index is up 6.4% from its August 16th intra-day low. The Nasdaq is up 7.25%. More to the point, credit markets are showing signs of improving. The four large banks in a show of support for the Fed’s reduction of the lending rate last week each borrowed $500 million at the Fed discount window. Though they paid the money back a short while later, it was an important symbolic show of support. It also indicates that banks have better options than borrowing at 5.75% from the discount window. But there is still not enough data to show whether non-bank mortgage lenders are gaining access to the recently risk-frozen credit markets.

Today’s news from the Fed provides good reason for why I don’t write the Brief in advance. We collect data all week and I assemble thoughts along the way, but economic winds can occasionally shift so fast that yesterday’s news literally becomes antiquated. A large portion of today’s topic would have been devoted to speculation of the Fed’s next action. Well, this morning they answered the question without ambiguity.

Before getting involved with the numbers, the whys, and the wherefores of the latest global market volatility, let me reassure you, our clients, that your portfolios are conservatively allocated and diversified with higher than usual levels of cash. We do not try to time the markets, but during times of high volatility and uncertainty we err of the side of caution, particularly in the more risk-averse models. This global sell-off is all about the question of whether the growth outside of the US sustains itself in the face of a US slowdown or recession. Because it is unprecedented, investors are re-assessing their earlier rosy assumptions.

The economy’s growth is slowing across the board; jobs, consumer spending, retail sales, inflation, and manufacturing. Today’s jobs report shows that employers added 92,000 workers to payrolls in July, which was fewer than expected and fewer than June’s 126,000 gain. The slowdown reflects the first decline since January 2006. The jobless rate rose to 4.6% also for the first time since January 2006. Workers' average hourly earnings rose 6 cents, or 0.3%, in line with forecasts, after a 0.4 % increase in each of the previous two months.

Banks and other credit issuers took it on the chin this week with growing uncertainty in the credit markets. Citibank is down over 4% for the week while the S&P Global Financials Sector Index is down 4% over the past two weeks. The news of continuing declines in housing fueled worries that the broader credit markets would be damaged by a growing rate of sub-prime mortgage defaults and foreclosures. Wednesday, the National Association of Realtors reported that existing home sales fell more than expected by 3.8% in June to a seasonally adjusted annual rate of 5.75 million units, the lowest level since November 2002. Yesterday the Commerce Department reported that new-home purchases in June fell by 6.6%, the most since January.

With one day remaining, it’s safe to say that the second quarter was a good one for equity investors. The S&P 500 is up just a smidge under 6% and the NASDAQ increased by 7.7%. Much of the increases in both indices came in April as mega-corporate buyouts and mergers out did the former on a daily basis. Corporate earnings were surprisingly good as they climbed 11.6% on average during the second quarter, more than three times analysts' estimates in March. And the economy showed signs of improving growth without significant inflation pressures.

Once again the big unregulated hedge funds are roiling the markets. Stocks and bonds have been down over the last couple of days on concern that hedge fund losses at Bear Stearns may signal wider problems in credit markets, particularly the sub-prime mortgage markets. The two hedge funds’ speculation in sub-prime collateralized debt obligations has threatened collapse as creditors including Merrill Lynch, Bank of America, and Citigroup moved to sell some of their collateral at fire sale prices.

Today’s buying strength brings stock indices close to their all-time highs. The S&P and Dow are pennies away while the NASDAQ has blow considerably past its seven year high. In all the indices dropped between 3 ½% and 4% starting on June 5th. On that day inflation fears rocketed long term interest rates to three-year highs. The good news today is that an important measure of consumer price inflation increased less than predicted. The index which excludes food and fuel rose only 0.1% last month following a 0.2% rise in April. The measure which includes gasoline was up .7% for the month. The good news so far is that rising energy prices have not been passed along by producers to consumers.

Sailing downwind can be very tricky; certainly not as easy as it looks. A slight shift in the wind can send the mainsail boom sweeping across the boat with terrific speed and force. An alert skipper or crewmember who sees the sail flatten abruptly yells the warning  jibe which means to duck or find yourself in the drink with a knot on your head.

Have they executed a perfect landing by slowing the economy just long enough to wring out inflation while keeping growth alive? After slowing steadily for the last four quarters, the economy is giving strong signs that it may be back on a growth track. Today’s report from the Labor Department shows that employers added 157,000 jobs in May. It demonstrates that employers are optimistic about their businesses and it makes consumers feel better about their own jobs. Another report showed that personal spending rose in April by .5% following a .4% increase in March. Corporate earnings from S&P 500 companies gained 11.6% in the first quarter, which is three times more than analysts' estimates at the start of the reporting season. As the data shows an economy resuming healthy growth, inflation remains tame.