Bell Financial Management Corporation

In early July the Consumer Price Index (CPI) was released for June. It remained unchanged for a second consecutive month. The CPI is the most widely watched gauge of inflation. On June 30, the last day of the second quarter, the Federal Reserve (Fed) raised the Federal Funds Rate 1/4% as a preemptive strike against any inflationary pressures building in the economy.

The financial markets normally would have been relieved with such a benign CPI report. However, the stock market began to decline in mid July, and hit its low point in early August. Wall Street again exhibited its own logic difficult to understand for most investors. The underlying reason for the stock market decline, when no apparent inflationary pressures exist for the economy, is the comments that the Federal Reserve Chairman Alan Greenspan, continues to release to the public. These comments are in reference to his fears of the tight labor market that exists for the US economy . On August 24, the Fed again raised short term interest rates another 1/4 %, further confusing stock and bond investors as to the Feds next move at their Oct 5 meeting.

The Feds action of raising interest rates seems at odds with the US Treasury. Lawrence Summers, the new Treasury Secretary, released information to the press in early August that the Treasury may buy back some of its bonds to trim debt.

Summers said buying back debt could have many benefits for the US economy and the government, including lowering interest costs and enhancing liquidity.

"Enhancing the liquidity to the Treasury’s benchmark securities should lower the government interest costs over time and promote market liquidity" Summers said at a news conference.

It appears that the Fed is determined to keep interest rates high, while the Treasury is trying to lower interest rates. This dichotomy is not very reassuring to the investment community, that is always seeking some logic and certainty in reference to the actions of the government and its agencies.

Perhaps the actions and desires of both the Fed and the Treasury will align soon, providing the government with a common agenda to help the US economy grow, while at the same time keeping prices stable.

This backdrop of uncertainty has kept the stock market trading in a range since mid May. There has been tremendous daily volatility since then. However, the market by mid September was trading about where it started out in mid May. The summer rally never happened.

To add insult to injury, many internet stocks as well as internet IPO's dropped precipitously in early August.

In the last week of September the stock market tried to regain its composure . Investors however, seemed spooked by the recent rise in gold prices and the weakness in the bond market.

In late September the Federal Reserve released its "Beige- Book" a report on the economy. This "Beige-Book" compiled by the Fed’s dozen district banks, said that every region in the US continued to exhibit "overall strength" while there were "few reports" of accelerating wages and salaries.

Wall Street economists welcome the pairing of rising business activity and flat wages, since the Fed views higher wages as a key part of potential future inflation. The current "Beige-Book" survey, based on data recorded in August and September, is intended as a guide to regional economic conditions ahead for the next Fed meeting on October 5.

This "Beige-Book" revealed a healthy economy, with little if any inflationary pressures building. This reinforces the view that Alan Greenspan’s recent speeches regarding his concern about rising inflationary pressures in the future, may have only been cautionary or simply misplaced.

Wall Street however, does not tolerate uncertainty about the future actions of the Fed and as such, this uncertainty has been a catalyst for the poor performance of the stock market in the third quarter of 1999.

Adding more uncertainty to the financial landscape are two other factors. The first being the decline of the US dollar against the Japanese Yen, and the second being the recent escalation of the price of gold.

In mid 1995 the fear was that the Yen would continue to appreciate against the dollar. The exchange rate of the Yen versus the US dollar was 80 Yen to the dollar. At that time the consensus of the international banking community was hoping for a weakening of the Yen to 100 Yen per dollar, which consequently is where the Yen versus the dollar is today.

In mid 1998 the fear was that the Yen was too weak when it was trading at 150 Yen to the US dollar. Today the fear is the Yen is too strong, even though it is trading at a level sought by economists in 1995.

There are pros and cons of having a strong or weak currency. The financial markets overreacted to the Yen strengthening versus the dollar recently, as the dollar is quite strong against most other foreign currencies. The dollar weakening versus the Yen can actually be beneficial for the US economy, as US exports will be cheaper in Japan, which bolsters the gross domestic product for the US. The strengthening Yen is potentially harmful to the Japanese economy because it raises the price of the goods they export. This might delay the recovery of the Japanese economy which has been languishing for almost ten years.

The recent rise in gold prices should have little if any impact on the US economy. On September 27, fifteen European central banks announced to the news media that they will not be unloading extra gold onto the market for at least five years. Gold prices have been trading between two hundred fifty and three hundred dollars per ounce since early 1998. On September 27, gold rose fourteen dollars per ounce, closing at about $281 per ounce. The next day gold went up an additional $26 per ounce closing over three hundred dollars per ounce.

Gold prices are no longer used as a barometer for inflation, therefore its price has a minimal affect on the overall stock and bond market.