When I awoke on Tuesday morning, Dow Jones Industrial Average futures were trading down more than 500 points from their close on Friday. (Markets were closed Monday for the Martin Luther King holiday.) On Monday, foreign markets from London to India to China collapsed, pushing many markets into official “bear market” territory with declines of over 20% since their 2007 highs.
In Tuesday’s trading the markets continued a panicky sell-off, with the MSCI Asia Pacific Index falling about 6.5%, that benchmark’s largest decline in almost 18 years. In European morning trading, markets were down another 4%-5% when “Helicopter Ben” Bernanke parachuted in with an emergency 75 basis point (3/4 of a percentage point) cut in the Fed Funds rate, from 4.25% to 3.5%, the largest inter-meeting cut since 1984.
It was a stark expression of the Fed coming to believe that the risks of recession now outweigh the risk of inflation, something which is the source of serious debate among professional economists and traders alike.
A professional Fed Funds futures trader I spoke with put it this way: “Plain and simple: the stock market threw a tantrum, and Bernanke caved.” That trader, however, believes the Fed’s error was in not cutting sooner.
Economist Brian Wesbury, on the other hand, believes that “The Fed is not tight now, and has not been tight”. (In this context, “tight” means keeping interest rates too high.)
Wesbury maintains his view that the US is not likely to have a recession in 2008, that our financial system is not as fragile as the media would like us to believe, and that inflation remains a bigger risk than substantial economic weakness. “Incomes grew more than 3% above inflation last year, even after taking out income taxes as well as monthly obligations such as mortgages, rent, car loans/leases, property taxes and debt service on credit cards.” Wesbury’s target price for the Dow Jones Industrial Average is 15,000 by year-end.
What the trader and the economist have in common is their belief that the Fed is not doing a good job. The trader says “the Fed’s efforts towards ‘transparency’ have done nothing but expose the man behind the curtain.” The economist believes the Fed is responding to stock markets rather than the real economy, thereby exposing us to the type of inflation risk that the Fed is specifically tasked to protect us from. If Wesbury and others think the Fed is too loose now, they would be even more chagrined to know that Fed Funds futures are predicting nearly 100% chance of another 50 basis point cut in that rate, down to 3%, at the Fed’s scheduled meeting next Wednesday, and more cuts later in the year.
The result of Tuesday’s cut was one of the wildest days I have seen in 20 years as a professional trader. The initial market reaction to the rate cut was basically a yawn, given the huge downward pressure on stock prices from overseas. The Dow dropped more than 450 points, about 3.8%, in the first 10 minutes of trading. And then everything changed…
Over the course of the next hour, the Dow rallied 350 points, and ended up meandering on either side of the 12,000 level for most of the rest of the day, ending at 11,971, down 128 points. An ugly day, and the Dow’s first close below 12,000 in more than a year, but nothing like the near-crash it appeared we were in for just hours earlier.
Despite the relief that today was not a bloodbath, the Dow is down more than 5% in five trading days, and the Nasdaq down 7.5% in that time. Since Christmas, the Dow is down over 1500 points, more than 11.5%, and the Nasdaq down almost 16%. There is clearly a message here and the message is that the market expects the health of the US consumer to decline dramatically. (Apple helped further that thought after the close on Tuesday as they warned of weaker sales next quarter, causing their stock to drop more than 10% in extended hours trading.)
There are other messages from the recent market weakness. First, the financial blood-letting around the globe all but destroyed recent wishful thinking by investors in foreign markets that other economies had somewhat “decoupled” from the United States. The thinking was that non-US consumers had enough financial wherewithal to allow their domestic markets to withstand some lessening of the (in)famous US consumption society. Several trillion dollars (yes, I said trillion) in losses in global stock markets have reminded investors that when the US sneezes, the world still catches a cold.
Second, it is probably not an accident that the last “leg down” in the markets, from over 12,300 in the Dow on Friday morning, followed President Bush’s announcement that he wants to work with Congress to put together a “stimulus package”, something which will likely be some form of income tax rebate. One financial web site said “Bush stimulates the bears”.
The message here is that the markets recognize a Keynsian “stimulus package” as the shell game that it is. It might pump more money into the economy in the short term, but no manufacturer will build new factories, buy new capital equipment, or hire more workers to satisfy a demand that everyone knows to be temporary by design. It also is a zero-sum game (at best), simply returning to taxpayers’ right pockets the money the government pilfered from our left pockets…leaving us saddled with the inefficient administrative costs of the transfers which simply add to our deficit and national debt.
Let me be clear: I’ll gladly accept the $800 check. But it isn’t good policy, and we must be very wary of Democrats turning the bipartisan desire to appear to be doing something into another way to redistribute income from taxpayers to non-payers. With some luck, the desire to do something quickly will keep them from following their ordinarily socialist instincts to buy non-payers’ votes with taxpayers’ money.
Third, I believe there is a substantial message in stocks, interest rates, and commodities’ behavior over recent weeks (all down substantially) that a recession is likely (or at least the investors believe that “Bernanke and Bush expect one, so why shouldn’t we?”) and that neither the government nor the Fed has the power to stop it. I’m not optimistic about the markets or the economy, but Wesbury disagrees and I for one hope he’s right.