What Is Wrong With This Picture?
The Fed cut the Fed Funds rate by 25 bps (basis points) to 4.5% this afternoon as expected. It also cut the discount rate by 25 bps to 5%. See the following from CNN.Money:
The Federal Reserve lowered the target for a critical short-term interest rate by a quarter of a point Wednesday, citing continued concerns about weakness in the housing market.
But the Fed indicated that it is also worried about inflation, a sign that the central bank may be reluctant to cut rates again at its next meeting in December. . . . .
. . . . "Housing will continue to be a drag," said Thomas di Galoma, head of U.S. Treasury trading with Jefferies & Co.
"If the Fed sees weaker housing data, they probably will drop rates another quarter point later this year. In the back of everyone's mind, people are wondering how will banks and brokers come out of this. Those fears are not going away overnight," di Galoma added.
So far so good. Right?
As you might expect oil is up to an all time high of $96/barrel, gold is up to $796/oz., and the dollar hits an all time low against the euro of $1.45/euro. All this basically says the dollar is becoming worth less as time goes on.
So why is the stock market up?
By the end of the day the DJIA is up 137 points (+1.00%), the S&P 500 is up 18.36 points (+1.20%) and NASDAQ is up 42.41 points (+1.51%).
Wednesday, October 31, 2007
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7 comments:
Well the market is up because people are more confident that they are not going to lose their money as long as Fed keeps cutting interest rate.
There is always a buoyancy that Fed ( the ultimate warrior ) is available for rescue fir any forseen or unforseen turmoil.
Good thing is that the firms traded on the NASDAQ and NYSE are very much global ( some of them have more than 50% revenue coming from Asia ).Also the cut signifies that the consumer-led US economic growth will keep going and this is supported by the strong economic data.
Overall the picture being painted is infusing hope and diffusing fear.
But my question is "Is Fed's most potent weapon always there to rescue ? ". Isn't there some big cost involved, Isn't something unsustainable happening ?
Looking at the past its difficult to answer this as the emerging market economies are providing good cushion to the overall anticipated recession.
The falling dollar means higher profits in dollars for US-based multinationals. Since all of the Dow 30 Industrials and many, if not most, of the S&P 500 companies have significant international activities, all things being equal a falling dollar means higher dollar profits for these companies and a higher stock price in dollars.
Stocks benefit from gentle inflation because as companies pass price increases through to consumers to maintain profit margins, many of the numbers that go into the earnings figure just scale up with inflation -- thus supporting a higher share price at the same P/E.
In a sense, it is the relativistic effect of shrinking your unit of measure (the dollar). But it does not propagate evenly.
What will hurt is when the inflation expectations lead people to genuinely change their spending habits-- that breaks the cycle of gently rippling inflation. Some are predicting that this will happen during the holiday shopping season this year. Who knows.
It should also be mentioned that a small commodities bubble may be forming as people speculate that this might be the currency crash that permanently drives all dollar-denominated prices through the roof. Time will tell if they are right about that.
Huh? The shares are valued in dollars, correct? So, unless they have risen more than the dollar have fallen, the actual values are down. (or am I missing something obvious here)
No, you're not missing anything. When you look at the DOW vs. gold, or DOW vs. oil, or DOW vs. the US Dollar Index, its down on all fronts (considerably).
If you consider that the US dollar index has gone from 120 to 76... for the sake of math, lets say 1/3rd off, your current (13930) DJIA is 9286-and-change when adjusted for the dollar drop - a far cry from the cheers of 10,000 back in the dot-com boom.
The argument I've heard most often is that it "doesn't matter" the dollar is down, since most Americans don't transact in foreign currency, and "domestic inflation" should be tame. A few seconds of thinking will show this argument to be a logical fallacy, given that large quantities of what they buy (food, clothing, energy, cars, electronics, etc.) come from outside the US. While they may pay in dollars, sooner or later, someone in the chain feels the sting of the currency conversion, and clearly they're not going to eat the loss.
The real "problem" is we're spending more than we have, creating boundless credit, and the world is taking notice.
Sooner or later, the US debt is going to be called. Given the leverage models used, even small calls can cascade in to big problems. How many billions have already evaporated over "subprime" mortgages?
The benefit to all this, of course, is that as the slide continues, and people realize just how little wealth they have, that there is always the final barrier of having nothing left.
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