A Distilled Markets and Macroeconomic Letter
Stocks - Short Term - High Risk
The large commercial investors seem to still be positive on this market, which may push prices higher. The VIX (fear gauge) has been moving lower. The fundamental picture is bleak in my opinion. The credit crisis does not seem to be solved. Despite the current crisis I would not be surprised to see the markets move back towards their recent highs.
Stocks - Medium Term - Elevated Risk
I believe that the risk is the market averages may have quite low returns for some time or potentially flat/negative returns when inflation is taken into account.
Bonds - Yields Increasing
There has been a lot of volatility in short term treasuries. Even if the Fed ends up cutting rates, the bond yields of longer dated bonds could move higher.
Gold one month futures are at $692.50 (9/4/07). Gold has moved to the high end of the recent range.
Oil - Staying High
Oil is at $75.08 (9/4/07). Factors for increased price near-term: high demand, terrorism, war, or other supply disruptions. Factors for a reduced price near-term: an economic slowdown, less terrorism, Middle East Peace.
The housing crisis continues to worsen and there are plenty of Adjustable Rate Mortgages that could still reset to higher payments. New car sales are still off. Consumers seem to be loaded with debt.
The USD is at 80.88 (9/4/07) (stockcharts.com ticker: $USD). I feel that dollar based assets may be at risk in general, both near and longer term. The USD seems to be range-bound between 80 and 82..
Fed Funds still at 5.25%. The market is pricing in a .25% or a .50% rate cut at the September meeting. If the Fed does not cut rates this could have an interesting effect on the markets. To me, a Fed cut would mean that there are serious issues facing the US Economy.
Fed Cut Coming? Other Solutions?
Many market participants are calling for a cut in the Fed Funds Rate. While a cut in the short term rate may be a good thing psychologically, it might not have much impact on the markets or on the housing crisis. Nouriel Roubini has been saying that the crisis is more of a situation of insolvency than one of liquidity (http://www.rgemonitor.com/blog/roubini/212919). The idea is that if some market participants are insolvent because of their investments, a rate cut or other measures to provide liquidity might not help much.
Other solutions being proposed are various “bailouts” for mortgage holders and/or lenders. The bailouts that I have read about all seem very small when compared to the problems. These bailout plans have been getting a lot of major media coverage and, to me, convey an appearance that the problems will be solved without much more pain. I feel that there is a very high risk that the credit/liquidity/insolvency problems will persist and worsen.
Robert Shiller has a new paper out on the housing boom which you can find here.
So despite the calls for a cut and the continued pain in housing/credit/derivatives the Fed might not cut unless they see a more general economic pain. Of course a lot could happen between now and the September 18th meeting. Once a cut/cuts occur, it might not help much.
Fundamentals: You might want to read John Hussman’s commentary on market valuations here. In short, the market is overvalued on an historical basis and many people seem to not believe that this is the case. I agree with Hussman.
Technical: On a very short term basis we may well see more upside in the markets. There is hope in the bullish camp that the general public will start buying more stocks and help to push the market higher. I feel that this may be tempered by consumer distress.
Fear may have caused investors to purchase treasuries causing the corresponding yields to fall. There is risk that, if the economy slows prompting the Fed to cut, bond yields could rise in a painful manner. If you are holding bonds that mature more than a couple of years from now, you might want to review your strategy at this time.
Gold has moved back up to the top of the recent range. If gold now moves below the recent range, I will be concerned that it is pricing in a recession. Gold might move higher if the Fed decides they need to cut rates.
Reminder: fiat currencies are not tied to anything of tangible value. They are only worth whatever the market, and the public, feels they are worth. As more fiat money is created the value of this paper money should go down. In my opinion, the U.S. is creating too much money and so are China, Japan, and Europe.
Dollar | Currencies
The Dollar has gained a bit but is still range bound between 80 and 82. Long-term I’m still negative on the Dollar. The real story is the Dollar against gold, where the Dollar has lost a huge amount of value and may lose much more.
Oil is at $75.08 (9/4/07). The risk is that oil stays high. If oil prices move downward substantially, they may be pricing in a recession. A major concern with oil is the potential for a wider conflict in the Middle East, which could crimp supply. There are many other potential geopolitical risks to oil as well.
~ $1 Trillion in mortgages may reset in 2007.
The key chart to reference on housing via the New York Times:
I believe that many consumers have less home equity now than before because they have taken money out of their homes and spent those funds. Consumer savings rates are very low or negative. I believe that consumers are being gradually squeezed by high oil prices on one side and rising interest rates on another.
My concept is to bring you a the most transparent look possible on the economy/markets via a quick read with plain language. This letter is geared toward the busy executive/business owner. If you are really short on time just look at the Snapshot section where I keep everything as brief as possible. In the Detail section I try to give a little more insight into my thinking without delving so deep that I stifle the reader.
When constructing portfolios, I take the client situation into consideration first and then combine that with the current economic/market factors presented in this letter along with well researched asset allocation strategies.
If you have specific questions on where I see things, or would like to discuss your portfolio, please feel free to contact me.
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