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Will Cheap Money Help?
Author: Ravi Prakash (info)
Website: http://www.optionstradinglessons.com/
Posted: February 11th, 2008 at 9:46 am EST
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An economic slowdown this year is starting to be baked into the plan. The question on many minds is whether the recent steep drop in interest rates and the $168 billion fiscal stimulus package will help take the sting out of the economic beating that has just started. It may seem like a good idea now, but I don’t believe it will solve the root of our economic problems. The two major sources of grief right now are the weak and declining real estate market and a tight credit market.
Let us look at real estate first. People who are refinancing ARMS might benefit. However, real estate prices are still quite expensive for most in America. Conventional wisdom dictates that homes should not cost more than 2.8 to 3.0 times annual household income. The median home prices are around $280,000 (average between West Coast and Northeast), that would mean that median household income should be around the $100,000 mark. According to the US Census Bureau the median household income for 2006 was around $48,000. This indicates that there is still a large gap to close and it is likelier that we will see home values continue to decline (rather than a rapid rise in income) in order to bring the relationship back into balance. The government stimulus package which will put a one-time payout of $1,200 into the hands of a family of four, is unlikely to do much to correct this annual $50,000 gap.
Next we have the credit markets where things are still tight. When short term interest rates are low the only group of people who really benefit are those who borrow short term and lend long term. We know that group very well — banks and investment houses. Investment houses borrow short term but finance long term deals at much higher rates. They also tend to leverage their money to invest in long term securities. Banks and lenders on the other hand borrow at really low rates but lend to consumers and businesses based upon higher LIBOR or Prime rates. The credit crunch was hurting the banks ability to borrow to cover the sinking value of their portfolios. Because the banks couldn’t borrow, they were also less willing to lend, regardless of the credit profile of the borrower. While lowering the short term rates for banks, may make banks slightly more willing to lend out, it primarily helps the banks, not the consumers since longer term rates have changed little during this entire crisis.
The recent numbers showed a slow down in the service sector, which has been a critical element of the last five years of economic growth. That news sent the DOW down 370 point mid-week. The Market cannot seem to hold onto any gains. It almost feels as though everyone is waiting for the other shoe to drop. I find looking at short term charts not as helpful since it is hard to say what the indices are going to do from week to week. I have longer term charts below to get an idea of where things might be heading. In a nut shell it seems that the major indices will trend slightly lower but soon find support. After that a bounce up looks certain. But there is no guarantee that the bounce will be big or last long.
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Authors, Economics, Investing, Options, Ravi Prakash, Stock Market
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