13 Oct 2006 Is This Market For Real?
If you had been given a glance into the future by reading a few of this week’s headlines, would you not guess that stocks would be fall rather than chase new highs? North Korea claims that it detonated a nuclear device, Fed governors threaten further rate hikes, housing continues its retreat, a plane crashes into a Manhattan high-rise, and option scandals at major corporations abound. And aren’t we in the midst of the historically weakest time of the year for stocks – September and October? We have to marvel at the new highs being made.
Fed governors in the last week have been out in force talking down market enthusiasm that rates may soon be coming down. Yesterday, Federal Reserve Bank of Chicago President Michael Moskow became the fifth Fed official since Oct. 4th to play down a possible rate cut. At the Fed’s next meeting scheduled for Oct. 24-25 it is widely expected that they will leave its short-term interest-rate target at 5.25% while they wait for inflation to moderate. But signals continue to be mixed as the economy continues to prove that it is not slowing as fast as was earlier feared.
Retail Sales numbers released by the government today showed that purchases excluding gasoline increased. Strong consumer spending combined with job and wage growth continues to boost sales and prevent a economic hard landing. But, increased consumer spending, which accounts for two-thirds of economic growth, also reduces the odds that the Federal Reserve will reduce interest rates in coming months. The retail sales report highlighted the biggest decline in gasoline service station receipts ever recorded which produced an overall drop in retail sales last month, but it masked huge spending gains elsewhere.
The University of Michigan’s preliminary index of consumer sentiment released today showed stronger than anticipated consumer confidence – a good sign for retailers ahead of the holiday shopping season. The index rocketed to 92.3 from 85.4 in September, the highest since July 2005 according to Bloomberg. Further, the drop in gasoline prices to almost eight-month lows is giving Americans extra cash to spend.
The market ramifications of sanctions agains tNorth Korea are uncertain at this time, but will likely be muted at best. The announcement of the actual blast had little impact on markets.China and South Korea have insisted that the sanctions not be allowed to destabilize the North to the extent they would be overrun with refugees, so they will likely be significantly watered down.
So why have the Dow, S&P 500, and NASDAQ all been on such a recent tear? Maybe things aren’t so bad after all. Productivity continues to grow, keeping inflation under control. Consumers remain as resilient as ever despite falling housing demand and prices. And corporate earnings reports haven’t revealed any significant reasons for pessimism, though the season is young.
Almost everyone expects a pullback somewhere in here as markets are short-term overbought. It may be sparked by global surprise or a major corporate earnings shortfall. As we have shifted from a value bias in our portfolio weightings to growth, we have held some cash on the sidelines in anticipation of a pullback. Otherwise, we remain bullish on bonds and expect yields to gradually fall in the coming months and quarters. The trend may be interrupted occasionally by reports of economic strength, such as this week, but we think that in large part rates will be coming down.
Internationally, we continue like Europe and the Pacific Rim countries as core holdings. Risks have increased somewhat in our emerging market holdings due to price appreciation. But continued strong commodities demand from a growing global economy continue mitigate these risks at present.