FYI | Nov 28 2007
On Sunday I attended a workshop by the Tech Wizard in the Sydney CBD – early in the morning, the day after what turned out to be an historic election result for Australia.
Prior to the event it had been my understanding I would be one of a few special guests. It turned out I was the only special guest for the day.
At the end of what had been a pretty busy Sunday, some of the attendants approached me to ask about my view about where financial markets were heading in the short term.
I always emphasise I am not a financial advisor or stockbroker, but I do follow the markets closely and as the editor of a financial news service I do read a lot and come across a wide variety of expert views.
I quoted one of many experts I had recently read and whose view I thought captured the current market situation perfectly: there are no potential catalysts left that can push shares significantly higher in the short term – other than another Fed rate cut.
I added: and the Federal Reserve is doing its best to send out the message it won’t be cutting interest rates anytime soon.
I could tell my answer had instantly captured the attention of at least half the room.
“So you’re saying shares won’t go up in the short term?” asked the lady on my left.
I said: the market is currently indicating the Federal Reserve will cut interest rates in December, whether Bernanke and Co like it or not. And that also seems to be the view of quite a number of reputable market experts.
One of such experts is Dr. Jeremy J. Siegel, the Russell E. Palmer Professor of Finance at The Wharton School of the University of Pennsylvania. Siegel is the proud author of a handful of good selling investment books in the US and is a regular commentator on financial matters for CNN and CNBC, and various other media.
Siegel believes economic data and specifically any data that relate to economic growth in the US over the next two weeks will be crucial in the Fed’s decision on interest rates. He even suggests that if interest rates will not be lowered at the upcoming December 11 meeting, there is still “a strong possibility” for an intra-meeting action between December and late January, if data would indicate the US economy is declining markedly.
As he believes US shares are priced relatively inexpensively at current levels (a view shared by many other experts), such an interest rate cut, even if it were only by 25 basis points, would likely put some fireworks under the market in the final weeks of the year.
That way investors might still have their annual Christmas rally to finish off the year.
This, obviously, brings us to the question whether the Federal Reserve will cut interest rates or not, despite Fed officials sending out signals they are unlikely to do so.
One of the sharpest knifes in the trade, albeit with a bearish slant at the moment, is Merrill Lynch North American Economist, David A Rosenberg.
This week two of his remarks caught my attention. Both add to the odds for more rate cuts by the Federal Reserve.
Rosenberg’s first remark (that caught my attention, he has made many more this week) refers to an analysis conducted by Merrill Lynch Chief Investment Strategist Richard Bernstein.
According to this analysis, negative earnings surprises from US companies reached their highest proportion in the third quarter since the third quarter of 1998. In fact, reports Rosenberg, despite Financials and Consumer Discretionary attracting all the attention these days the largest increases in negative earnings surprises actually came from companies in the Energy and Materials sectors.
Conclusion? The earnings quality of US companies is trending down.
(As it happens one of Rosenberg’s favourite media stories this week was an analysis by the Wall Street Journal concluding that US profit margins could well be the next casualty).
But it is Rosenberg’s comments post the recent release of the monthly Chicago Fed National Activity Index that should catch everyone’s attention. In the opinion of Rosenberg, this is one of the most reliable real time indicators of economic activity in the US.
The October index came awfully close to indicating a recession was knocking on America’s door. But probably of equal importance is the fact that this index has now fallen three months in a row, and five months out of the past six.
The October index reading was the lowest since April 2003.
Rosenberg adds despite the crash of 1987, the Chicago indicator never once moved into negative terrain that year, but when it fell through minus 0.50 in the opening months of 1990 and again at the end of 2000 “recession followed suit no more than one quarter later”.
As at October the Chicago index stood at minus 0.56 on a three-month basis (this is the Fed preferred way of measuring this indicator). While this is still 14 basis points from the minus 70 level which would indicate a recession has become inescapable, Rosenberg notes there have only been two other times when this index fell as low as it did in October without subsequently sinking deeper past the minus 70 level.
Those two precedents were January 1996 when the whole eastern seaboard shut down due to severe weather circumstances, and in early 2003 when the US went to war with Iraq and the country was still reeling from all the previous accounting scandals.
If you agree all this makes for a rather convincing argument in favour of more interest rate cuts, you can now start hoping for a late Christmas rally this year.
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Fabulous Team of Greg, Chris, Sophia, Paula, Joyce, Pat, George and Grahame)
