Apr 02, 2008 The Bottom?
In the US April 1st is called April Fool’s Day, a day when practical jokes are the norm. I normally write on the first of the month. Not yesterday!
Was the US equity market’s 3+% increase a fool’s rally? Has the US stock market already bottomed?
Actually, it is impossible to predict market bottoms as it is market tops. Yesterday’s increase was largely caused by short covering. (Those who had sold stocks short, expecting a continued drop in prices, covering those positions when the market increases. Often this causes an exaggerated move on the upside.)
Investors would be prudent to remember that actions taken by central banks take on average 6 months to work themselves through the economy. This is particularly true on interest rate reductions. However, the actions of the Federal Reserve, in particular those which permitted the pledging of mortgage debt to secure loans and the opening of the liquidity window to investment banks, were extremely significant in addressing the woes in the financial sector.
Contrary to the majority of pundit reporting, these ills had more to do with illiquidity of the mortgage backed (CMOs) or collaterized debt obligations (CDOs), than the actual insolvency of any institution. Just as with any asset that has no liquidity, it was difficult (impossible) to price securities which had no buyers. As the prices dropped due to lack of demand, those same price decreases caused additional price declines – and there was no bottom, because of lack of buyers.
I expect that the recent Fed actions have stemmed the tide and the market will recover from these levels. I do not expect the recovery to be smooth by any means and we might test the lows in the stock markets.
What is more important in my view is the inflationary effects of the actions. The high commodity prices, expecially petroleum and the food components, are working their way through the world economy and it is inevitable that the basic levels of inflation have increased. In the US economy the problem is even more acute because money supply has increased because of the Fed’s injections of liquidity into the financial sector and the falling US dollar means more inflation is being imported (import prices have been rising in US Dollar terms).
Speaking of the US Dollar, in the short term, foreign exchange rates are principally affected by the differential in short term interest rates between two currencies and the prospect for interest rate increases/decreases. The US Dollar has been battered because of the lower and expected lower short term interest rates particularly in comparison to the Euro. This may have been overdone in the short term, but based on fundamentals, it is difficult to see how the US Dollar can prosper over the medium term.
In these markets, it is best to continue with trusted advisors and to rebalance portfolios so that the portfolios match guidelines. It is also worthwhile to review investment guidelines to ensure they are in-line with investor objectives.
by Charles W.K. Haberstroh |
