Introduction
My forecast: the FOMC hikes the Federal Funds Rate a quarter point today, in a somewhat paradoxical effort to avoid spooking the stock market. But no matter what the Fed does today, or in what terms it couches its action, the equity market's recent slide is not over. Moreover, I'm looking for the slide's unmistakable resumption very soon. Something that is over, however, is the cyclical bull market that has been embedded in the secular bear trend.
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Today's FOMC Meeting
Later today (about 2:15 PM ET), the Federal Open Market Committee will announce the interest-rate decision it reaches at today's policy-setting meeting. Up until last Friday's employment report, virtually everyone assumed the decision would be to hike the target on federal funds by 25 basis points, to 1.50%.
Friday's weak employment data have caused many analysts to modify their positions on the level of aggressiveness the Fed will show in coming months in raising rates. And since the FOMC's last meeting, a two day affair held 6/29-30, the fed funds futures market certainly has reflected expectations of reduced aggressiveness.
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FEDERAL FUNDS FUTURES -- 08/09 VS. 08/06 AND 06/28*
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BP Change
To 08/09
From Scheduled
08/09 08/06 06/28 ----------- FOMC
Contract Close Close Close* 08/06 06/28 Meetings
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Aug. '04 1.42% 1.42% 1.51% 0 -9 Aug. 10
Sep. '04 1.54% 1.53% 1.72% 1 -18 Sep. 21
Oct. '04 1.64% 1.63% 1.90% 1 -26 No Meeting
Nov. '04 1.78% 1.78% 2.10% 0 -32 Nov. 10
Dec. '04 1.90% 1.89% 2.30% 1 -40 Dec. 14
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*Day before June FOMC meeting.
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* Although there are some who believe the FOMC will take a pass on rates today, leaving the funds rate unchanged, I am not among them. I look for a quarter-point hike, to 1.50%.
At the moment, you can be sure the Fed -- Greenspan in particular -- is very concerned about the stock market's recent behavior. (As an aside, it is Greenspan's incessant attempts at manipulating stock prices that have contributed inordinately to the market's current trouble. But this is a story for another time.) Thus, although it may appear paradoxical, I think the Fed will raise rates today to try to protect the equity market.
If the central bank were to leave the funds rate alone, there would likely be an immediate positive stock-market reaction. But not long afterwards, I suspect prices would slump, perhaps badly, as participants pondered how negatively the Fed must be viewing the current environment to change course. In other words, what does the Fed know that we don't know?
In this regard, remember that the rate-raising process has been laid out by Greenspan and his surrogates over many, many months. Consequently, were one statistic to alter its course, I believe it would quickly be taken by the stock market as a seriously negative portent.
* In addition, the Treasury is in the midst of a $51 billion refunding operation. Government bond dealers may already be in trouble on this one, because of the sharp decline in open-market Treasury yields resulting from last week's employment report. Although I suspect Greenspan finds a way or two of getting critical information to the dealer community, a head fake in monetary policy at the moment could prove disruptive.
* Moreover, the Fed already is probably behind the curve, maybe well behind it. In my opinion, the US economy is now encountering a bout of stagflation, and stagflation, put bluntly, is a bitch! If the Fed favors stagflation's economic component by ignoring the inflationary one, it is likely to lead to increased trouble down the road.
* Another consideration the Fed must confront is the competitive situation persisting between US Treasuries and yields available on the sovereign debt of foreign issuers at the short end of the yield curve. This is particularly so if the Fed has any concern about potential dollar exchange-rate vulnerability in the months immediately ahead.
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APPROXIMATE INTEREST RATES OF SELECTED
COUNTRIES' SOVEREIGN DEBT SECURITIES
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Maturity
Date ----------------------------
Country 2004 1-Year 2-Year 5-year 10-year
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Australia 08/09 5.22% 5.20% 5.46% 5.61%
United Kingdom " 4.77% 4.88% 4.96% 4.96%
Germany " 2.16% 2.46% 3.28% 4.08%
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UNITED STATES " 1.90% 2.42% 3.42% 4.25%
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Japan " 0.04% 0.19% 0.76% 1.63%
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Yield Spreads -- Treasuries Vs. Foreign
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Australia 08/09 -332 -278 -204 -136
United Kingdom " -287 -246 -154 -71
Germany " -26 -4 +14 +17
Japan " +186 +223 +266 +262
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In conclusion, I think we get a 25 basis-point increase in the fed funds rate today, and the FOMC will likely attempt to tone down expectations regarding the pace of future hikes through the wording contained in the post-meeting statement that the committee will issue after the conclusion of today's meeting.
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NOTE: Something worth keeping an eye on is the slowing in the growth of the various monetary aggregates. The table below takes a longer-term look at this by examining year-over-year growth as of June 2004 and June 2003.
In addition, there was a recent plunge in the so-called "M1 Multiplier," which is the ratio of M1 to the St. Louis Fed's monetary base. This value fell to 1.677 for the two weeks ended 7/21, down from 1.718 for the two weeks ended 7/7. There may well be short-term technical factors that contributed to this, but it is still worth keeping close tabs on.
Year-Over-Year
Change As Of:
Monetary --------------
Measure 6/2004 6/2003
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M1 5.1% 6.7%
MZM 4.5% 8.1%
M2 4.4% 8.1%
M3 5.8% 7.3%
St. Louis Fed
Monetary Base 4.8% 6.1%
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Stocks
Not much new to report here that has not been discussed in recent material. I remain of a mind that the technical damage to the market is now of sufficient magnitude that a genuine washout, a real selling climax, will be required to turn things around.
But here's a key thought. I believe that the cyclical bull market commencing off 2002's July through October lows, lows then confirmed by the successful retest occurring in March of 2003, is over! It ended with the downward move off a long distribution top. If forced to date the confirmation of the end of the cyclical bull, I'd use the bellwether measures' most recent highs, occurring around the third week of June. At that juncture, at least to my way of thinking, the equity market reconfirmed its secular bear trend. The next major rally stocks have should serve as an additional confirmation, because I think the maximum levels that will be reached are likely to fall well short of the June levels.
The washout bottom I'm now looking for could come from materially lower than current levels, although there will be rally attempts along the way -- like yesterday's.
Here's something of interest about yesterday's feeble attempt at a turnaround. My seven-measure tracking group rose an average 0.1% on the day, with returns running in a range of +0.3% for the NASDAQ 100, to minus 0.2% for the Russell 2000. This is a pretty tight. However, on average, the group closed 0.5% below respective intraday highs. This is some indication of how a not-so-hot rally to begin with quickly evaporated going into yesterday's close.
The following table breaks out returns for the tracking group from some key dates through last Friday's close.
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SELECTED STOCK-MARKET RETURNS (Excluding
Dividends, Ranked In Order From 06/30)
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To Close on 08/06/04 From:
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2004 12/31
07/30 06/30 High 2003
Close Close Close Close
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NYSE Comp. -2.8% -5.7% -8.2% -3.3%
DJIA -3.2% -5.9% -14.2% -6.2%
S&P 500 -3.4% -6.7% -8.1% -4.3%
Wil. 5000 -3.7% -7.5% -8.9% -4.6%
Value Line -5.2% -11.1% -13.4% -7.5%
Russ. 2000 -5.7% -12.2% -15.4% -10.4%
NASDAQ 100 -6.1% -13.3% -15.4% -10.4%
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Average -4.3% -8.9% -11.0% -6.1%
Median -3.7% -7.5% -8.9% -6.1%
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Politics
For well more than a year now -- actually, going back to May of last year -- I stated rather boldly I thought President Bush definitely could lose this year's election. It was a "bold" statement then, since it fell far outside the prevailing consensus view.
Soon, I should get down to having a more detailed look at the political situation. It is having an impact, a negative one, I think, on the economy and the financial markets. In the meantime, though, I'll go back to one of the key reasons from May of last year that I thought George Bush would be vulnerable to defeat this year. In a word, it was -- Greenspan!
I thought then and really, really think now that promising Mr. G. a fifth term as Fed chairman about 14 months before his fourth term was over would emerge as a huge mistake. I believe it did.
One of the time frames the preceding table breaks out are stock returns for the third quarter to date. Using the tracking group as a proxy, the respective average and median declines are 8.9% and 7.5%. I think they will get worse before they get better. If so and it only takes another couple weeks to unfold, it means lots of proverbial blood flowing in stock market street's about 60 days before the election.
Enough said!
Return of the Model Equity Portfolio
I've now reached what I think is an acceptable method to reconstruct the model equity account and get it back on stream. It will require a detailed memorandum, but to get things moving along immediately, the table below breaks out the account's reconstructed non-money market holdings, shown at their original cost, or in this case, original proceeds, since they are short positions.
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Model Equity Portfolio Short-Sale Summary
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Dow Jones Industrial Average
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Contract Gross Net Net Cum. Net
Date DJIA DJIA Proceeds Proceeds
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2003
07/02 9142.84 9120.00 $ 45,600 $ 45,600
07/07 9239.20 9216.00 $ 55,296 $100,896
07/11 9132.76 9110.00 $ 45,550 $146,446
08/06 9090.67 9068.00 $ 54,408 $200,854
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Average 9129.73
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Standard & Poor's 500 Index
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Contract Gross Net Net Cum. Net
Date S&P S&P Proceeds Proceeds
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2003
07/02 993.75 991.25 $ 54,519 $ 54,519
07/07 1002.86 1000.36 $ 45,016 $ 99,535
07/11 999.17 996.67 $ 54,817 $154,352
08/06 971.10 968.68 $ 48,434 $202,786
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Average 989.20
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Combined Cumulative Net Proceeds $403,640
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