Market Commentary

In my view economic cycles are always the same.
February 11, 2010

In my view economic cycles are always the same.  For some reason sales slow, inventories build to excessive levels, production is trimmed, employment is cut, monetary and fiscal stimulus is injected.  Recovery begins as the stimuli generate sales, inventories decline, production is increased, people are hired and interest rates rise.

What is different is what triggers the cycle.  Credit controls was the catalyst in 1969-70.  The oil embargo was the reason in 1973-75.  High oil prices in 1980-1982.  Inflationary pressures in 1990.  The bursting of the technology bubble in 2000.  And today the catalyst is/was the bursting of the housing bubble and the ensuing collapse of financial institutions.

Can a case be made that we are now about to embark upon the last part of this cycle?  As noted several days ago I believe the economy is on the verge of sustainable job creation.  Yesterday FRB Chairman Bernanke stated the Federal Reserve may raise the discount rate “before long” as part of the “normalization” of Fed lending. 

In prepared remarks Bernanke wrote “before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate.”  Bernanke further elaborated that such changes “are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for momentary policy which remains about as it was at the time of January meeting of the FOMC.”

Currently the spread between fed funds and the discount rate is 0.25%, a level set in March 2008 when Bear Stearns imploded.  Before August 2007 it was one percent, reduced to 0.50% 10 days following the August FOMC meeting where the Committee stated inflation was the greatest threat to the economy.

Can a case be made this crisis will be bookended by an adjustment in the symbolic discount rate, or the rate that member banks borrow from the Federal Reserve?

For some time I have held the view monetary policy will be changed sooner than expected, suggesting a possible January/February time frame.  Will this become a prophetic statement?

Will such action be regarded as the “All clear sign?” 

Again referring back to my previous outlook, I hypothesized equities would come under some “rough sledding” perhaps declining by 7%-10% sometime after fourth quarter earnings season predicated by the impending  and inevitable change in monetary policy.  I got the decline correct, the catalyst and timing wrong. 

Yesterday as Bernanke’s prepared remarks were released, stocks declined about one percent only to end nominally unchanged.  Will equities rally into the proverbial “All Clear Sign?”  I wrote earlier in the year once equities become convinced this is a bona fide recovery and rising rates are indicator of strength, averages could potentially end the year 10%-12% higher as was the case during the two previous tightening campaigns of 1993 and 2003. 

As penned a gazillion times, the consistency of this crisis is the velocity of change.  Perhaps my timing is again wrong but catalyst for the advance correct.

What will happen today?  Sovereign debt issues had little impact upon yesterday’s trading.

Last night the foreign markets were up. London was up 0.70%, Paris up 0.12% and Frankfurt up 0.09%.  Japan was up 0.31% and Hang Sang up 1.85%.

The Dow should open moderately higher on the apparent Greek debt accord.  The 10-year is off 3/32 to yield 3.71%.