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Stock Market Action & The Fed

Below is an email I received this morning from noted economist Bob Genetski. Yesterday’s big drop in the market caused a few heads to turn, but Bob’s explanation seems to make sense to me. This, coupled with the fact that the week before Labor Day is sparsely populated on Wall Street and you have lesser experienced traders over-reacting to news.

My stand on the equity market still holds: this is a dip that should be used to reposition portfolios into our favored sectors (which we’ve been doing).

Enjoy Bob’s note.

Mark

Yesterday’s stock market response to economic news, particularly the Minutes of the Fed’s Aug. 7th meeting was just plain goofy. Everyone knows, or should know, that the Fed screwed up at its Aug. 7th meeting. Credit markets responded to the screw up two days later. After the credit squeeze, the Fed reversed its decision of two days earlier and allowed the effective fed funds rate to decline by about 50 basis points. Publishing obsolete Minutes without some amended, updated comments apparently left the impression that the Fed remained oblivious to the current credit crunch. That just isn’t the case.

The decline in consumer confidence also should not have been surprising, given the developments with respect to credit problems and the stock market crash earlier this month.

As for the decline in housing prices, the latest Case-Shiller home price index shows prices in June down 4% from the peak reached in June of 2006. The futures market calls for an additional 4.5% decline to the middle of next year for a total decline of 8.5%. Previously, the total decline in the futures market had been forecast to be 7%. From the betting on futures markets, the deterioration in the credit situation for housing over the past month has added an additional 1.5% to the expected drop in home values from the peak. Given that the credit squeeze has been centered on the housing sector, the expectation that housing prices will fall by only an additional 1.5% represents a pretty modest change.

Bottom line–none of this information yesterday added to what we already knew. Perhaps all of it coming on the same day contributed to yesterday’s market’s sharp downward move.
I continue to believe that the stock market is overreacting to old news, that the Fed will continue to restore liquidity to the system and that stock prices will recover.

Robert Genetski