Market Update
Dwight Johnston
Vice President, Economic & Market Research
Stop Trading!
In last month’s Words from WesCorp edition, I wrote that Wall Street was setting the stage for another patented rally from “oversold conditions.” The Dow rallied 1300 points from March to May as expectations of bad news on financials had already been priced in at the lows. The renewed collapse in the prices of financials in June brought financial stocks back down to new lows, and the Street expected a big rally from those newer “cheap” levels. This seemed to be working very well. Stocks bottomed on July 15 after the Fannie/Freddie scare and failure of IndyMac. The Dow rallied 600 points in just eight days, and Wall Street’s bulls came out in full force. But unlike the March-May rally, this rally stalled very quickly.
While the earnings of financials were mostly only as bad as expected, not worse, some ugly news on Merrill and a few others shook confidence. But the financial stocks took a back seat to other sectors. There were disappointing earnings in many sectors that had been performing well. Almost every consumer related stock sector failed to deliver. A lot of you might wonder why I have been spending so much time talking about stocks over the past few months when our primary focus is usually interest rates. The reason is that Ben Bernanke’s opinion on the outlook for the economy and interest rates seems to shift with the equity markets. His switch in June to lessened concerns about the economy only lasted until the lows in the stock market in July. In his July testimony to Congress, he again elevated concerns about the economy. Nothing dramatically had changed in the economy, and the only explanation had to be the stock market was bothering him.
If stocks do continue to improve, it may well be that Bernanke will again lower the estimation of economic risks. This would be a huge mistake. Yes, inflation is big in the headlines today, but we contend this has been a commodity play by big money players that created bubbles in those markets. We are hopeful that recent weakness in commodities will turn out to be a significant new trend as those fast money accounts start realizing the party is over. In the meantime, the economy is weakening rapidly – just ask the automakers that reported the slowest sales in sixteen years. Once you take out the noise in some recent data, it’s becoming clearer that the consumer is in major retreat. The lack of credit availability, the rising price of credit, the deteriorating “wealth effect” as home equity disappears along with stock prices, and the weakening job market are setting us up for a significant economic pullback.
The latest jobs report was considered better than expected. But that was on the surface. Some of the minutiae in that report and in other more recent data paint a much different picture. These lesser-known indicators are painting a much more ominous picture about job prospects. We expect that the next few Unemployment Reports will shock the markets out of any concern about the Fed tightening, regardless of the stock market induced swings back and forth by Bernanke and Co. From late January to May, the Fed was consistent in saying the risks to the economy were great because of the credit problems. Their view on inflation was that it would remain somewhat elevated but retreat as economic weakness reduced demand. Both of those assessments looked good then and are even more accurate now. These days the stock market and the commodity market are reflections of major trading plays by traders, not fundamentals. Let’s hope the Fed realizes this sooner rather than later.
You can follow Dwight’s insightful commentary each business day on Member Center or www.wescorp.org. You can e-mail him here.