Market Walking a Tightrope

By Jerry Slusiewicz | August 04, 2008 | 3:45 PM | 0 Comments

The Dow has been down six of the last seven weeks.  It's a pretty weak market.  However, since the low set July 15^th we've seen a rotation as money flowed out from the oil and material sectors and into the financials.  Last week was like a tug of war with the Dow down 200 Monday; up 200 Tuesday and Wednesday; followed by down 200 Thursday and finished the week almost where it started.  If the financials really can get its legs underneath we could be in for a better market going forward.  I would like to see broader participation from other sectors before buying in.

Merrill (NYSE: MER) set the price for that toxic mortgage paper when they sold $30 billion of it for 22 cents on the dollar (next can I show you an island the Indians call Manhattan).  In real life, the other financial firms are supposed to mark their similar paper to the market (which is 22 cents); we shall see if they do that and what happens to their stocks.  Most Financial firms have been self pricing this paper to what they call the model (that you learn from grad school - not in real life), which I am sure is higher than the 22 cents Merrill received.  It is possible that these companies have actually re-priced their paper and we are at the bottom for financial companies, however I doubt that happened.  I am watching and hoping for a positive follow through.

The markets are still concerned about whether we are in an inflationary period, a recession, or 1970's styled stagflation.  A lot depends on how you choose to define a recession. It's clear that some industries like housing, manufacturing, banking, and regions like the industrial Midwest, are already in a recession. Families are struggling with flat wages and rising prices.  So we have commodity inflation not accompanied by wage inflation.  The cost of labor has a bigger effect on the economy than the cost of materials.  So I am still not sold that inflation is our biggest problem.  

Friday's jobs data marked the seventh straight month of job losses, bringing the total decline to 463,000 so far this year. Though still relatively low by historical standards, the jobless rate has jumped by more than a percentage point - from a low of 4.4 percent in March, 2007 to the current 5.7 percent. In the past, that kind of move has been accompanied by a recession.  It must be also noted that the Labor Department uses some factor for a births death ratio that if left out could have put the job losses for last month alone at over 150,000.  That would have had a much more negative reception than the 51,000 job loss number.  When the largest asset most Americans own (their house) and the second largest investment (their retirement account) are down in the double digit range, it makes a strong case for deflation, commonly referred to as a recession.

Thursday's report on Gross Domestic Product added to the debate, after the government revised the results for the fourth quarter of last year to show the economy shrank at a 0.2 percent rate. That's the first negative quarter for GDP since the end of the last recession in 2001.  Generally two negative quarters of GDP in a row are associated with a recession.

Consumers, despite high oil prices and lack of confidence in the economy are still spending.  I feel this has something to do with the $150 billion stimulus package.  Once that money is spent we could return to a slowdown in consumer spending.  That money provided an artificial, temporary lift to consumer spending, which accounts for about 70 percent of GDP. Without that infusion, the economy might have slipped into reverse by now.

The Fed and Treasury have taken unprecedented measures to prevent more banks and brokerage firms to fail.  However they continue to struggle and no one can be sure of the outcome yet. No one even knows how much troubled assets they still have on their books.  Meanwhile the U.S. Financial Accounting Standards Board decided last week to delay until 2010 rules requiring banks to move previously hidden (off-balance sheet) assets and investments onto their books where investors (and regulators) can see them. Such rules should have been in place all along, and probably would have gone a long way toward preventing the current crisis. But now, rather than risk further shocks in the banking sector, the abuse has to be allowed to continue until 2010.

The Fed will probably leave interest rates alone when they meet on Tuesday and create much consternation for market participants that want the Fed to act one way or another to fight the inflation / deflation that they fear.  There just is not a clear cut direction for today's market and the economy to take action just yet.  Both the stock and bond markets are walking a tightrope trying not to fall to one side or the other.  Patience is a virtue, sometimes more than others.