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It
has been almost ten full months now since the Fed first lowered interest
rates. If you remember at first there was a lot excitement over the Fed cuts.
The DOW and Nasdaq rallied to new 52-week highs a
few weeks after the first rate cut in September. The rally and promise of
more Fed intervention for the market made many big name commentators
extremely optimistic about the market.
But just a few
weeks later the market turned lower and has been stuck in a bear market ever
since. The banking problems multiplied and inflation skyrocketed with oil
rising almost double in price now from where it was a year ago. The rate cuts
tasted good at first, but are no longer palatable.
When thinking
about the financial markets sometimes it is best to take stock of things before
trying to look ahead and decide if you need to make changes to your portfolio
or figure out where to look for the best investment opportunities. A lot can
be learned about looking at where the market was a year ago and comparing it
to today.
A year ago from
today the DOW, S&P 500, and Nasdaq were all
climbing higher. They had experienced a fast and furious correction that took
the S&P 500 down over seven percent in February of 2007. The financial
media blamed that quick correction on "credit worries," a fast drop
in the dollar versus the yen, and a huge correction in the Chinese stock
market. Rumors also circulated that some billion
dollar Bear Stearns hedge funds were in trouble.
Over the next
few months as the market went higher everyone thought that all of these
problems were gone. Then the financial press started to focus on oil prices
that were making new highs and the threat to inflation that they posed. In
July the market peaked as talk intensified that the Fed might actually start
to raise interest rates by the end of the year. Indeed Fed fund futures a
year ago were pricing in rates hikes by the end of 2007.
Fed officials
gave repeated speeches and statements that sounded hawkish on interest rates.
At the same time though the drop in real estate prices started to pick up and
the value in "subprime" mortgage
securities went into collapse. Rumors abounded that
several large hedge funds were in trouble.
The Fed publicly
ignored all of this. At its August FOMC meeting they released a more hawkish
statement on inflation to prepare the way to raise rates. The market dropped
hard that day and James Cramer blasted the Federal Reserve and Ben Bernanke on TV for knowing "nothing." His
statement was one of the most watched moments in financial TV reporting as
people watched it millions of times on the Internet.
At that moment
he was right. Within two weeks the market went into a mini-crash and the
Federal Reserve lowered the discount rate in what looked like a panic move. The
value of "subprime" securities went to
zero. They are still being counted as "level three" assets on the
balance sheets of some of the world's largest banks but in reality they are
worthless and have been worthless since last August.
The Fed changed
course 180% degrees in August and began to slash rates in September. It
continued its rate cutting campaign and has lowered rates in the past ten
months at the fastest rate than it ever has before in history - faster than
it did even during the Great Depression.
Since then we
have seen the "credit crisis" worsen. We have seen the economy slow
down, real estate prices continue to drop, inflation explode, and the Fed
print about 30 billion dollars and hand that money to JP Morgan so that it could
buy Bear Stearns and prevent a potential systemic bank run.
What a roller
coaster! And it ain't over yet folks. You can
expect to see more volatility and the overall downward bias in the financial
markets to continue the rest of the year.
What I want you
to do right now though is think about the situation last year and how it
compares with today. Just like in June of 2007, right now we can look back on
this year and see a big correction behind us. Just like the correction in
February of 2007, this one we saw in the first quarter was linked to credit
problems and the unwinding of the real estate bubble. And just like then we
have seen the market rally after that correction and lots of big name experts
come out and declare the worst behind us. For instance Abby Cohen of Goldman
Sachs claims that there is going to be a second half economic boom that will
make the stock market rise much higher than it is now into the end of the
year.
Things are
certainly different right now than they were last year. The US is in a
bear market right now whereas last year it was approaching the tail end of a
cyclical bull market. That is a huge difference. But there is one important
similarity that you need to focus on right now. At this time last year most
people were worried about inflation and were expecting the Fed to raise rates
by the end of 2007. Right now everyone is worried about inflation and the Fed
has talked very hawkish about inflation over the past few weeks. Most of the
talking heads are looking for the Fed to raise rates by the end of the year. This
is exactly the same spot we were in this time last year!
But what if the
economy doesn't pick up steam in the second half of the year and the stock
market continues lower? What if more banking problems materialize? Bank
stocks are making new 52-week lows and have been falling fast this month. They
do not seem to be forecasting an end to the credit crunch. And really they
shouldn't, because there is no sign of a bottom in real estate and all
indicators I follow suggest that we won't see one into at least the second
half of 2009.
I think we are
likely to see a Fall shock hit the market. Last year we saw the Fed do a 180
degree turn from talking about inflation to cutting rates like a mad hatter. This
year I believe we will see the Fed abandon its talk of fighting inflation to
once again intervening to bail out some bank, patch up the leaky economy, or
in response to a stock market mini-crash. I think the situation right now is
like it was a year ago - everyone is worried about inflation, but the bigger
problems lurk in the cooked books the banks are carrying. In fact we are more
likely to see more problems emerge and the stock market go lower as that is
the primary trend right now.
In essence the
Fed is playing a game of poker. It is bluffing when it says it is fighting
inflation. It has no chips left and has bet everything on the slim chance
that the economy has already bottomed. If something happens to make the Fed
intervene again then it will be faced with a choice of fighting inflation by
raising rates, which would have the effect of blowing up the banking system,
or intervening to save the banking system, the economy, and the stock market,
which of course would mean more inflation, a falling dollar, and falling bond
prices. The Fed has proven that if it gets trapped into such a corner it will
side to help the banks and the stock market a stable currency be damned.
If this is what
we see happen in the Fall then the Fed will lose all of its credibility when
it comes to maintaining a stable currency.
What do you need
to do? You need to do what you should always be doing - keeping your pulse on
market trends to figure out the best way to position yourself to make money
is. You can profit from any situation. Right now we have a bear market and
that means using bear market strategies.
I will leave you
with one last thought for today. In the past ten years every time the Fed has
gone on a campaign of lowering interest rates it has create
a "bubble". In 1998 the Fed lowered rates to bailout the Long-Term
Capital Management Fund. When it did so it put excess money into the banking
system. There was a lack of good investments for that money to go into so it
flowed into Internet and tech stocks and formed a bubble. When that bubble
burst the Fed lowered rates again to try to make the stock market go back up.
As a result they dropped interest rates to an artificially low point, which
created a housing bubble.
We are now
suffering through the fallout of the housing bubble - the direct result is a
recession, bear stock market, and "credit crisis" from banks who went nuts during the bubble.
Now remember -
every time the Fed cuts rates it creates a bubble, because it puts excess
money into the economy.
Well, the bubble
now is now in commodities and oil. A direct result is inflation, a falling
dollar, and eventually a bear market in bonds. There are opportunities to
profit from this and I believe gold and precious metal stocks along with
tactical short selling against he broad market and
bonds will be the best way to go. If the Fed abandons this current inflation
fighting talk this Fall I expect we'll see gold prices skyrocket into the end
of the year.
Of course this
is looking ahead and that isn't always an easy thing to do when it comes to
the stock market. I can't say with certainty that this is going to happen. But
I do know the technical signs in the market that will appear over the next
two months if this is indeed what is going to happen and I know how I will
position myself. The next eight weeks are going to be some of the most
important we've ever seen in the financial markets. Not because of what will
happen during these weeks, but to see how the markets are positioned once
they are over. As any technical signs appear to point us the way I will draw
your attention to them and explain to you exactly what they mean so that you
can take advantage of anything that may happen too. From chaos comes
opportunity and opportunity is another way to spell profits.
This article is an except from a WallStreetWindow
subscription article. The full article contains more price projections of
what I see happening for the S&P 500 and gold for the rest of the year. You
need to subscribe to my free weekly newsletter to get all future articles. Just click here.
Mike
Swanson
Editor, Wall
Street Window
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