Positive Negativity

Good news: Everyone thinks the economy is only going to keep getting worse! It seems that when "everyone" knows something bad is going to happen the worst is often behind us. I was thinking yesterday, as some of the stock market indexes reached new lows in this bear market, about the price of oil just a few months ago. The price had reached about $140 per barrel and the talk was that it was bound to rise to $200 or $250. Very, very few "knowledgeable" people thought it would go down. Where is the price of oil now! Would you believe it has fallen about $100 per barrel to roughly $40. Bear markets generally begin to wane when "everyone" is sure there is no hope! In listening to what has been going on lately it would seem we may be close to that point. Yesterday, when the S&P 500 and the NYSE indexes reached new lows for this market downturn, I found that not many stocks were reaching new lows. This too may indicate that the market is getting to an oversold place and is only waiting for the time when the signal to buy emerges. I have read reports by some that the Dow will drop to 5500. This is possible. I have not been reading much from people who are saying the market could go to 10,000. I think that this, too, can happen. This may not be the bottom, but the sentiment is so bad, and so much negativity has already been built into the price of stocks that we may well be approaching the bottom. After a year and a half of being pessimistic about what is going on, I now feel optimistic! I don't think the ship is going to sink! Ed

Interest Rates are Coming Down!

For some time I have indicated that I did not believe a strong market upturn could happen until corporate bond interest rates came down from their high. When interest rates go down the value of bonds rises! I wanted to see the value of our bonds rise! Back in November of 2007, the corporate interest rate on core bonds was about 4.75%. In March, rates had risen to about 6%, which I thought was a good buy. From March until mid-June, interest rates declined to about 5.5%, but then we heard about Freddie Mac and Fannie Mae and their problems. In a matter of days, the interest rates shot up to almost 9.5% on core corporate bonds as many investors left corporate bonds and turned to the safety of short-term U.S. government bonds. Fear was running the markets! It has been my belief that we needed to see the core corporate interest rates decrease to below 7% before we would see relief from the fear that has driven this market all year long. Interest rates last month did finally get down to a range of 7.5% to 7.65% and stalled at that point . . . until this week! I mentioned to some clients that we might see the core corporate interest rates, when they did decrease, look something like the drop in the price of oil, with a rapid drop in rates and a corresponding increase in the value of bonds. Well, it happened! On Monday the interest rates on these bonds dropped to 7.35%. On Tuesday the rate dropped to 7.22%, still higher than my target of under 7% but looking better than we have seen in a long time. On Wednesday they went to 6.91% and I wondered: is this for real? Thursday confirmed the trend with the rate dropping to 6.71%. This is a major change in a very short period of time. Until yesterday there had been no real drop in the interest rates on high yield bonds that had risen from about 11% in March to 23%. Yesterday we saw the first meaningful drop as the rates went down to about 21.65%. The drop in interest rates seems to be the first signal since last June that the fear that has swept the market seems to be receding. I believe this is a good trend and I am optimistic about where we might go from here. Ed Mallon

FED changes

Yesterday, June 25th the Federal Reserve Board (FED) made a change. The change was that there was no change. They kept a key Federal Funds lending rate (the interest rate) at 2.00%! This was an expected decision by the investment markets around the world. It did confirm however that the FED is concerned with “REAL” inflation and is not talking about the “Core Inflation Rate” as they did at prior sessions. Since the Clinton administration decided to mess around with how the inflation rate is calculated (as well as the calculation of unemployment) reality has taken a holiday! When you hear about the inflation rate you are usually hearing about the “Core Inflation Rate.” What is the “Core Inflation Rate?” Let me put it this way: someone asks me what I had for dinner last night and I tell them “A plate, a knife, fork, spoon and napkin.” No food? Food doesn’t count in the “Core Inflation Rate”. How did you get to work today? By car. How did the car move you from home to work? On wheels. Energy doesn’t count in the “Core Inflation Rate.” How are cost of living adjustments that are made by the US Government on things such as Social Security determined? Of course, using the “Core Inflation Rate.” Food and energy costs have gone up substantially in the past six months. In addition, the increased cost of food and energy are rippling through other products we buy and services we use, such as plastic products and restaurant price increases. The FED is in a dilemma! On one hand the economy appears to be in a recession while on the other hand inflation is a problem. To curb inflation you raise the interest rate. To help the economy you lower the interest rate. The current answer by the FED was to do nothing! In March of this year we moved some investment money into investment grade bonds and into high yield bonds. At the time we had seen the investment grade bond interest rates go from about 4.75% in October to 6% at the beginning of March. A bigger change had occurred with the high yield interest rates going from about 7.25% to 12%. Since that time the investment grade rates and high yield rates had been going down to 5.8% and 10.5% respectively. I told some of you that I was very cautious about how much money we should place into these investments because I was worried about inflation. I am very glad I was cautious. As of today the investment grade interest rate is over 6.20% and the high yield rate is now up over 11.40%. High interest rates are not good for business and therefore not good for stocks. Based on the above I believe that stocks will go down more and longer term interest rates will continue upward until the FED begins to raise their Federal Fund interest rate and show that they are serious about fighting inflation. At some point, when the interest rates get high enough, longer term interest rates will be a real buy!