Daily Investment Interpretations

October 28, 2011

2011-10-28: (Friday Night): U. S. stock market indices closed this afternoon about where they started this morning: Stocks lock in weekly gains, Stocks flatline after huge rallyThe NASDAQ Composite drifted  1.48 points (-0.05%) lower to close at 2,737.15. The Dow wiggled up  22.56 points (0.18%) to 12,231.11; the S&P 500 verniered up 0.5 points (0.04%) to settle at 1,285.09. Oil slipped a little to 93.09; gold fell slightly to 1,744. The VIX dropped 0.93 points to 24.53.
    Today didn't offer a promising buying opportunity. State of the Markets recommends waiting for a pullback to the 1,260-1,265 neighborhood before committing more funds to this market, and that didn't happen today. (The S&P 500's intra-day low was 1,277.)
    Market watch advises that Consumers spending more and Mood improves.
    Howard Gold warns: Howard Gold: Leveraged ETFs are the worst.  His well-taken point: leveraged ETFs are for professional day traders and not for long-term investors. They leak money because of the fact that they are rebalanced daily.
    Al Lewis states that it's Too late to debate Obama’s stimulus plan. And Mark Hulbert notes that Wall of worry gives way to slope of hope... optimism is rapidly replacing fear and pessimism. (State of the Markets mentions this, but only as one factor among several in foretelling market action.)
    Charting U.S.'s recoveries  What I find striking and a source of real concern about this article is the way it compares the current economic recovery with previous post-World War II recoveries. To recap what I've discussed previously, this recession is qualitatively different from all the other recessions we've experienced since World War II. For the first time since WWII, the Fed's monetary machinery for controlling unemployment and inflation has run out of traction. After WWII, the Fed found that it could speed up or slow down the U. S. economy by raising or lowering the discount rate it charged banks for overnight loans. This raised or lowered interest rates on business (and all other) loans, contracting or boosting the money supplies (e. g., M1 and M2), slowing the economy to fight inflation or speeding up the economy to fight unemployment. In 2002, during the dot.com boom-bust, the candle almost blew out. Fed Chairman Alan Greenspan had lowered the discount rate to 1%, and for a time, it appeared as though this nearly-zero interest rate  wouldn't be enough to re-ignite the country's financial fires. It was explained at the time (in 2003) that if this 1% interest rate didn't pull us out of recession, the Fed would have no more bullets to fire against the bear. As they put it at the time: "You can't push on a string." But it worked in 2002-2003, if only barely. The economy rebooted once again... until 2007. Then in 2008, the Fed once again lowered interest rates to essentially zero, and this time, it didn't restart the economy. 
    During the 60-year period from the late 1940's to 2008, two generations grew up with the understanding that if the Fed lowered interest rates to increase the money supply, there would be more money chasing a given amount of goods and services, and the result would be inflationary. (This is what I learned in the late 70's.) This led to the mantra: "When the government prints money (by lowering the discount rate), it causes inflation". But this is only half the story. It's the rate of flow of money--the amount of money multiplied by its "velocity"--that determines the effect of federal money on the economy. From the late '40's to 2008, the Fed could count on the velocity of money being sufficient to move into the economy any money it "printed", stimulating it. If banks had money, they would lend it. But in 2008, this all changed. The Fed lowered the interest rate effectively to zero, but this time (2008) , lowering the discount rate failed to restart the economy. Furthermore, since it was the banks that were at the heart of the bubble, the banks were left with highly questionable collateral. They all-but-quit lending in order to rebuild their cash reserves in case their depositors wanted their money back. 
    The Federal Deposit Insurance Corporation insures individual bank deposits up to $100,000 per account, which probably helped prevent runs on banks. However, at the peak of the crisis, in the fall of 2008, it was mentioned that the Federal Deposit Insurance Corporation would run out of funds in a hurry if wholesale runs on banks occurred. Since the FDIC is backed by the federal government, there was speculation that if necessary, the government would step up to the plate and back up the FDIC. And since the whole problem is that of confidence that the system will protect us, that and other steps taken by the U. S. government (especially by Ben Bernanke and the Fed) were able to calm everyone down and avert massive runs on banks, credit unions, and money market funds.    
    Getting back to the plot, the Federal Reserve has pumped up the U. S. money supply hugely, but there's been no rampant inflation because the economy is too weak to allow employees to demand higher wages and to permit companies to increase prices.  (Consumers financed the past decade by going deeper and deeper into debt. Now it's time to recover. The threat of unemployment is forcing a less lavish, more prudent lifestyle the average consumer.)
    My key point is that this is no garden-variety recession but one that has demanded unprecedented corrective maneuvers. Comparing this to any other post-WWII recession is misleading. Also, it's discomfiting that financial journalists don't make this distinction. You wonder if they're aware that it's really different this time. And it doesn't follow that the future will mirror the past.
    Or so I think.
    Financial stocks slide into red on U.S. data  
    State of the Markets articles include:
    Technical Talk: Will We Get A Pullback In Near-Term?

    Rates Hit Record High At Italian Bond Auction        
    UK Consumer Confidence Falls To Lowest Level Since Feb 2009  
    Unemployment Hits 15-Year High in Spain  
    Personal Incomes and Spending Rise in September  
    EFSF Head Says No Chinese Commitment to SPV (Yet)  
    University of Michigan Sentiment Index Rises in October  
    And that about sums it up for this week.

    Market futures are down about 1/3rd % tonight.