"The Market" by Sheldon M.
Bell
Volume 2 - Issue 4 - December 31, 1998
The stock market continued its decline in the first week of October. The low that was set on August 31, was tested in the first few days of October. However, in the second week of November the stock market regained its bullishness. It continued its rise almost unabated until November 24. By then it had regained almost all the ground it had lost from the August 31 low set by most of the major averages.
In my last newsletter I didn’t predict a protracted bear market. I guess so far I am right. I am surprised that the recovery has been so fast and aggressive.
But sentiment can change on Wall Street very fast, as I have learned from my experience in the last 30 years. The stock market tends to go from oversold to overbought very fast. This is caused by investors moods changing from fear to hope. I guess human beings haven’t changed very much since mankind has been investing in the stock market.
This year has been a very rocky year for the stock market. Volatility has regained the upper hand, providing the day traders great opportunities. For the conservative investor however, anxiety has increased.
Remember that the stock market is always risky in the short term and as such should not be a vehicle for those investors that are looking to invest for a short time horizon.
The daily price fluctuations of the stock market can never be predicated by any living mortal. Even computer models have failed to predict the short term direction of the financial markets. The best financial minds of this century were principals in First Capital, a hedge fund that has hemorrhaged billions of dollars this year.
A metaphor for the stock market is the tides, waves and ripples of the ocean. The ripples are the day to day price swings of the stock market. The waves are the periodic changes of investor sentiment. The tide is the growth of the economy which is ultimately the strongest force moving the ocean or the financial markets.
Stock market valuations will continue to move higher over time as long as the economy continues its growth. This has certainly been true since the stock market has existed.
You should not invest in the stock market if you do not believe that the economy will continue to grow. If you do not have faith in our economy then you better stay away from the stock market.
Now that I have expressed a thesis on the macro elements of the stock market mechanics of momentum, I will continue to discuss the stock market fundamentals as it exists today.
The catalyst for the rebound of the stock market from the lows tested in early October was certainly the Federal Reserve Board.
The Fed had been very concerned in reference to inflationary pressures building in the economy early in 1998. They based this concern on the fact that the unemployment rate was historically low. They reasoned that this potential labor gridlock could presage wage pressures, and if it wasn’t offset by increased productivity, it could be inflationary.
The Fed changed their stance on September 29, 1998 when they met for their regular meeting by easing interest rates. They lowered the Federal Funds Rate .25% to 5.25%. The discount Rate remained unchanged at 5.%.
The last time that the Fed changed interest rates was on March 25, 1997 when they raised the Federal Funds Rate .25% to 5.5%.
Since that meeting the Fed has been on hold leaving rates unchanged until September 29, 1998. On October 15 the Fed lowered the Federal Funds Rate .25% to 5%. The discount rate was also lowered .25% to 4.75%. This action taken by the Fed was facilitated at an unscheduled meeting, only two weeks from the meeting on September 29. The Fed usually meets every 6 weeks. At their next scheduled meeting on November 17, the Fed again lowered interest rates. They dropped the Federal Funds Rate .25% to 4.75%, and the discount rate .25% to 4.5%.
Why did the Fed change their bias from raising rates to ward off inflation to dropping rates three times in six weeks? The reason is simple "deflation’". That’s right, the Fed finally accepted what I have been writing about for two years, that deflation not inflation is what they have to be concerned with.
The Fed needed to assure the financial markets that it would be willing to lower interest rates to add liquidity to the fragile bond market. The only portion of the U.S. bond market that was performing well was the treasury market. Investors were predicting a Fed easing as long term maturities were lower than short term maturities. This usually predicts a economic slowdown. The Fed certainly didn’t want that to happen. The Fed became concerned that the Asian financial crisis that started in the summer of 1997 was importing deflation and an economic slowdown in the U.S. Liquidity was drying up in the financial markets of corporate investment grade bonds, high yield bonds, and mortgage backed securities. By lowering interest rates the Fed was trying to stabilize markets.
The fourth quarter ended on a bullish upswing. However, the driving force of the stock market remained the "nifty fifty" of the SP-500.
What is ahead for 1999? No one can be sure. I will continue to maintain diversification by sector and asset class in order to increase the safety of my clients portfolios.
I have reduced my clients exposure to the foreign markets as the new "Euro" and the Asian crisis are too unpredictable.
If corporate earnings continue to grow and the Fed doesn’t raise interest rates, the stock and bond markets should perform well in 1999. However, volatility should continue to prevail as many uncertainties about the economy remain.