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Be Careful of what you Wish For
Author: Bob Lang (info)
Website: http://trade-mentor.com
Posted: August 6th, 2007 at 2:09 pm EST
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With the recent sharp decline of the US stock markets and the hyperspeed of the drops, there seems to be a cloud of panic in the air….it’s so thick you can cut it with a knife. Certainly the fear index (VIX) reflects such angst, as volatility has risen to 4+ year highs. Not only that, Friday was the seventh straight day with the VIX closing over 20, again not having been done in 4+ years. Whenever the panic reaches a crescendo, the noise gets louder and louder, and the perceived solutions become even louder (and more ridiculous?). The cries for help also get louder, too. The noise becomes deafening. What’s causing this mess, and what are the solutions to the problem?
Let’s face it…equity markets are positive for the year, even if their big lead has been chopped in the last month. Is it all bad? Hardly so. The Dow Jones Industrials are only a whisker away from an alltime high, while the SPX is about 10% off the mark. GDP for second quarter just came in at a robust 3.4%…hardly and hint of recession, while earnings have still been rather decent. The dollar has seen better days and should be on the mend, but don’t tell that to our multinational businesses who make boatloads overseas. While the mortgage and homebuilder situation is troubling, it likely only touches a small part of our population (but sells alot of advertising and makes great front page news). Brokers had made a bundle in these products via hedge funds, and now they aren’t looking so smart. Sure some people got greedy…who wouldn’t when standards are so relaxed. But when the bubble music stops, you better have a chair to sit down in…or it’s game over. In this case, time heals all wounds…a lot of time.
As for a solution, I’ve heard some crowing about a ’surprise’ rate cut by the Fed, as soon as their meeting this week. While highly unlikely, it would not be unprecedented. But before you start backing into this camp, understand what the consequences could be of such a move. I remember back on April 18, 2001 when the Greenspan Fed came in with a surprise 1/2 percent rate cut intrameeting. It was the second such surprise cut in the series but at the time the worry was not about inflation, rather the potentially anemic expected growth coming after such a protracted economic boom. This was well before 9/11, an event that brought even more doubt to rebounding economy. In April 2001, the market naturally reacted with enthusiasm as the cut was announced early in the am (the SPX rose 4% after having rallied 7.9% the prior 8 days). But the bloom would soon fall off the rose, even in a rate cut cycle…as by the end of August the market slipped 8.4% from that April day. Why did the market fall? Because the Fed may have been behind the curve, but moreso the affect of rate cuts are not felt for several months on the economy. Of course, the events that occurred just days later would only continue the slide that started that summer. So, maybe a rate cut would provide some short term relief now, and perhaps relieve some tension and anxiety, but the Fed risks credibility issues as an inflation fighter, where certainly more dollars into the system tilts the balance toward higher inflation in the future. Perhaps a surprise rate cut says the Fed knows MORE about the potential damage to the economy than even we know.
Bottom line is, the Fed will continue to talk tough on inflation and may acknowledge some of the more recent events as concerns…but nothing like this merits a surprise rate cut, unless the Fed is listening to the static.
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Bob Lang, Indexes
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