Friday, August 10, 2007

Answering The Bell - Global Turmoil

"A clever person solves a problem. A wise person avoids it."

Albert Einstein


In recent days there has been a lot of talk of the Federal Reserve adding liquidity to the system and/or cutting interest rates. Should the Fed come in and take action to provide a level of protection for what many seem as groups/companies that have been taking advantage of the already increased liquidity and readily available low cost capital? It is hard to know the answer until the depth of the current problems are fully known. Some hedge funds will not have firm numbers on their performance for a couple weeks still. The bigger, and possibly smarter ones, who have problems will probably be the first to confess their sins. Many funds have clauses pertaining to the time frames investors can withdraw capital. A couple mentioned in the news recently stated that August 15th was a deadline for investors to notify them if they wanted to take money out of the fund on September 30th. These redemptions are only adding to the selling as of late. There will probably be more and more to come.

The brokerage companies have transitioned themselves from toll-collectors back in the late 1990s's to very leveraged hedge funds today. A large portion of their earnings growth comes from trading. Another portion of profit comes from the hedge funds they service. This clearing business is profitable, and along with it comes the control of how much leverage they allow these customers to use. Combing through all these levels of risk will not be something that will be accomplished in just a few weeks. This story will play out for some time to come.

With the talk of a rate cut to rescue the market, below is a chart of the S&P 500 Index today and then another chart of the S&P from 1998 when the Fed stepped in to lesson the effects of the Asian Crisis.

Today's market is still above the 200 day moving average and is sitting on the red 2 standard deviation channel line. Does the Fed look at the market to determine when to act? They will say they don't, that it is only fundamental factors that determine their action. But, it does make logical sense that they will only take an action when they know things are at a support level where they have some other forces coming into to the market. In 1998 the market was well below the 200day moving average and was also 20% off its recent high. This was violent move down, and when the Fed acted, the move up was like a rocket. The result was a 33% rally in a matter of 90 days. Fortunes were lost and new ones made in the time of one quarter!

Below is the corresponding chart of the Dow 30. Will this index make it down to its 200day moving average? If it had more financial stocks in it like the S&P 500 it would be there already.

How addicted is the "market" and our economy to low interest rates? People have been hoping/predicting that the Fed will be cutting rates anytime now for over a year. Global inflation is a fact. Other economies in the world are growing at 5x the pace the U.S. economy is growing. If these global signs of inflation start to slow, then maybe there will be a rate cut. But there shouldn't be a rate cut because the S&P 500 touched its 200day moving average. If they cut rates now, what are they going to do when things get really bad. Fear from when they cut rates to 1% has now gone full swing to greed, and we are paying for another self inflicted problem now.

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