WEEKLY UPDATE
February 18, 2010
The FED Raises the Discount Rate
The Federal Reserve Bank surprised everyone by raising the rate it charges banks for emergency loans, also known as the Discount Rate. The Discount Rate is normally 1% higher than the Federal Funds Rate but lately the rate has been just ½% higher to give banks access to cheap money from the FED. Today's action by the FED brings the relationship between the Discount Rate and the Federal Funds Rate back to a normal relationship.
What does this mean? It means that banks will have to pay more to the FED to borrow money. It also means that banks will be less profitable than before, which will put downside pressure on their stock valuations. Additionally, prices for shorter maturity Treasury bonds will be weaker in the days ahead.
Today's announcement came after the markets closed and we are already seeing a decline in the prices of bank stocks, stock index futures and treasury prices. Tomorrow is options expiration Friday which may hold up stocks for a bit, but this is generally seen as bearish for stocks. This falls perfectly into our outlook for stocks but it may accelerate the timeframe for changing our outlook on bonds. We will keep you posted as the marketplace reacts to this surprise move by the FED.
Take care,
Greg
February 17, 2010
Stocks Bounce as Greece Default Appears "Contained"
U.S. stocks have rallied off of last Friday's low following speculation that the European Union will help Greece with their debt problems. Leaders across the EU have expressed willingness to step in, but with the condition that Greece makes clear progress towards its goal of cutting its budget gap by 4% of GDP this year (Greece's 2009 budget deficit was 13% of GDP, well above the EU limit: 3% of GDP). This news was good enough to boost the Euro which has been falling for weeks against the greenback, and that in turn fueled a rally in stock prices (see the chart below for the link between the recent bounce in the Euro on bottom and the stock market's action on top). The rally lost steam today when the dollar showed renewed strength against the Euro. The trend for a strengthening dollar continues, which has recently been translating into weaker stock prices.
The Fed Releases their Beige Book
The Federal Reserve Bank released the minutes of their latest FOMC meeting (January 26 and 27). The minutes show that the Fed officials are slightly more optimistic about a U.S. recovery. They project that our economy will grow at a 3.2% rate for this year, and they continue to plan on pulling back monetary stimulus as the economy stabilizes. Below are the latest projections out of the Fed:
Are mortgage rates likely to rise?
The answer appears to be "yes". The reason is that a key program to keep mortgage rates low is ending in March. The program run by the Fed has been injecting cash into the mortgage market by buying $ 1.3 trillion of mortgage-backed securities to keep mortgage rates low. That program is ending in March and as it ends, many expect interest rates to rise around 1% for a 30 year mortgage.
Congressional Oversight Panel Worries about Commercial Real Estate
The panel, chaired by Harvard Professor Elizabeth Warren, is deeply concerned about a wave of commercial real estate loan failures and how it might impact our economy.
The largest loan losses are expected to hit in 2011 with losses as high as $300 billion. The panel is concerned on how these losses will impact community and regional banks who have traditionally been the primary lenders to the commercial real estate market. A collapse of commercial real estate loans will likely translate to further bank closures and even tighter lending practices at the banks that will survive the implosion.
The panel notes that small community banks are already hording cash for fear of what is down the road thus making credit conditions worse for small businesses across the country.
Members of the oversight panel are looking into the possibility of extending assistance to smaller community banks with TARP (Troubled Asset Relief Program) funds that were once held for the "too big to fail" banks.
Take care,
Greg
February 4, 2010
The counter-trend bounce in U.S. stocks ended today. Concerns about the debt status of Greece, Spain, and Portugal as well as disappointing weekly unemployment figures triggered a sharp reversal to the downside for U.S. stocks today. Heavy volume with an overwhelming breadth of decline showed that selling pressure remains in the current leg of the market.
U.S. Treasury debt blossoms as concerns over international bonds grows. The price of short-term treasury and government backed bonds rose strongly today on the combination of disappointing unemployment news and sovereign debt concerns.
Liquidity matters. The chart below shows how the stock market tends to go higher when money supply is increasing and how it tends to fall when cash dries up. If you look at the linked charts closely you can see that once liquidity started falling (5) the stock market headed lower. Liquidity is currently drying up as the FED continues to drain liquidity from the system, causing the stock market to remain weak.
We made several adjustments to our allocations today that focused mainly on our bond funds. We have already positioned ourselves for this leg in the stock market.
Take care,
Greg
*image source www.safehaven.com
February 1, 2010
Our stock market today found the strength that has eluded it the past few weeks with a 118 point gain for the Dow and a 15 point gain for the S&P 500 stock index. This is a counter-trend bounce that follows a break below trend-line support that occurred two weeks ago. Today's rally was on good volume and breadth so it appears that this bounce has more to go. Our folks at Elliott Wave believe that the Dow could climb to somewhere within the range of 10,285 to as high as 10,389 before losing steam. Still, until and unless the market can recover all that it has lost the past two weeks the trend is still toward lower prices ahead for stocks.
The same holds true for the Euro as the Dollar continues to climb higher. This puts a lid on near-term growth for foreign investments but bolsters the Dollar and U.S. government securities did very well in January.
Take care,
Greg
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