Market Commentary: The market recovery lost some steam this past week, but it hasn’t given up. Even though the rally stalled as the 50% retracement levels were reached, it would be premature to say that the rally has failed. The day-to-day action appears to be news driven and remains highly volatile. Equity traders are putting a large amount of emphasis on the upcoming FOMC meeting, and volume is expected to be light leading up to that event.
During times of commercial paper liquidity problems, the Fed has historically used the Discount Rate as the intervention mechanism. Greenspan bucked tradition by ignoring the Discount Rate during his 18 years at the helm. Bernanke has reinstated the use of the Discount Window in an attempt to separate the dual roles of the Fed: maintaining financial stability and controlling inflation. In the meantime, the bond market appeared to shrug this off, and futures traders are predicting a 74% chance of a 50bps cut to the Fed Funds rate next week. The September 18 FOMC meeting might be a meeting to remember. The Fed is receiving pressure to cut the Fed Funds rate in an effort to help the liquidity problems brought on by the subprime slime. Bernanke has made it known that he believes the Discount Rate is the appropriate mechanism for this particular concern. His resolve will be put to the test next week. He can hold his ground and leave rates unchanged, or he could attempt to appease the masses by cutting the Fed Funds rate. He could also do a little of both: cut the Fed Funds Rate but claim that heading off a recession is now a higher priority than keeping inflation under control, instead of saying that it is to address credit liquidity concerns. Meanwhile, the 10-year Treasury yield dropped as low as +4.30% on Monday (down from 5.3% in June) before moving back up to +4.41 today.
Sectors: We have a wide divergence in sector strength at the present time. There are two strong sectors, two weak sectors, and the rest are in the neutral range. Energy and Technology are the two strong sectors. Oil prices are again at new highs, and the Technology sector has successfully separated itself from the credit crunch. The weak sectors are Financials and Consumer Discretionary, a dubious honor they have held for quite a while. Real estate and the mortgage lending business are at the epicenter of the credit problems, and they are both part of the Financial Sector.
Styles: History does repeat itself, but sometimes the names are changed to protect the guilty. In 1999 it was widely believed that Large Cap Growth was all anyone needed. At that time, Large Cap Growth was the best performing style for the most recent 5-years and almost every other time-period you could imagine. Small Cap Value was at the other end of the spectrum. Last year we found those roles reversed. Investors were chanting the Small Cap Value mantra, as it was the new style king for 5-year performance (along with almost every other time-period you could imagine) while Large Cap Growth was at the other end of the spectrum. Styles rotate. Small Cap Value is now weak and getting weaker. It would not surprise us to see Small Cap Value at the bottom of the 5-year performance charts five years from now. We don’t know who will be on top, but the odds are in favor of Growth being part of its name.
During times of commercial paper liquidity problems, the Fed has historically used the Discount Rate as the intervention mechanism. Greenspan bucked tradition by ignoring the Discount Rate during his 18 years at the helm. Bernanke has reinstated the use of the Discount Window in an attempt to separate the dual roles of the Fed: maintaining financial stability and controlling inflation. In the meantime, the bond market appeared to shrug this off, and futures traders are predicting a 74% chance of a 50bps cut to the Fed Funds rate next week. The September 18 FOMC meeting might be a meeting to remember. The Fed is receiving pressure to cut the Fed Funds rate in an effort to help the liquidity problems brought on by the subprime slime. Bernanke has made it known that he believes the Discount Rate is the appropriate mechanism for this particular concern. His resolve will be put to the test next week. He can hold his ground and leave rates unchanged, or he could attempt to appease the masses by cutting the Fed Funds rate. He could also do a little of both: cut the Fed Funds Rate but claim that heading off a recession is now a higher priority than keeping inflation under control, instead of saying that it is to address credit liquidity concerns. Meanwhile, the 10-year Treasury yield dropped as low as +4.30% on Monday (down from 5.3% in June) before moving back up to +4.41 today.
Sectors: We have a wide divergence in sector strength at the present time. There are two strong sectors, two weak sectors, and the rest are in the neutral range. Energy and Technology are the two strong sectors. Oil prices are again at new highs, and the Technology sector has successfully separated itself from the credit crunch. The weak sectors are Financials and Consumer Discretionary, a dubious honor they have held for quite a while. Real estate and the mortgage lending business are at the epicenter of the credit problems, and they are both part of the Financial Sector.
Styles: History does repeat itself, but sometimes the names are changed to protect the guilty. In 1999 it was widely believed that Large Cap Growth was all anyone needed. At that time, Large Cap Growth was the best performing style for the most recent 5-years and almost every other time-period you could imagine. Small Cap Value was at the other end of the spectrum. Last year we found those roles reversed. Investors were chanting the Small Cap Value mantra, as it was the new style king for 5-year performance (along with almost every other time-period you could imagine) while Large Cap Growth was at the other end of the spectrum. Styles rotate. Small Cap Value is now weak and getting weaker. It would not surprise us to see Small Cap Value at the bottom of the 5-year performance charts five years from now. We don’t know who will be on top, but the odds are in favor of Growth being part of its name.
International: Same song, different verse. China, and the rest of Asia excluding Japan, continue to provide global leadership. The “developed” markets of Japan, the USA, and the European Union are lagging.
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