Tuesday, March 18, 2008

Dow Jones Industrial Average Up 400 Points. Steroids?

Ben Bernanke's deal with the devil might be working for the short term, but two problems still loom on the horizon. The ever present problem of inflation still exists, but it is a secondary concern currently with the problems in the credit and banking markets. The second problem is what ammunition works best to solve the problems in the banking sector. As much as it seems helpful to always being doing something to promote lending and more liquidity, the only cure for what ails the system right now is time. As long as housing prices are going down, it is very hard for prices for stabilize. All of the prices of mortgage backed securities can not be truly valued until housing prices stop their decline. This is not something that is going to happen in a week or two because the Fed has cut rates. All the rate cuts do it hopefully create more room for banks to lend and create liquidity. This can only happen when fear is not the governing emotion in the lending market. It will take time. Time for fear to be replaced by the desire to grow, and time for prices in the housing market to stabilize.

How many more bullets does the Fed have in its gun to fight more potential problems? The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with its recent decision to become a lender of last resort for the biggest Wall Street dealers. This is essentially the same as the idea a few months back when there was talk of some of the largest banks getting together and creating an off balance sheet fund to deal with these mortgage securities. This plan was scrapped, but now the Fed has stepped in to do the same thing. They have time on their side, and many of these securities will perform the way they were intended. It does however make one think to what point does the Fed willingness to take on these debts stop?

Ben's deal with the devil to reduce rates so low to help unfreeze the credit markets can work in the short term, but inflation is still a force to contend with. Calculating inflation figures minus food and energy is like saying a team would be 30-2 if it wasn't for them getting blown out in the fourth quarter of every game. The demographics of our economy that are living on fixed income and interest payments is very large. This group of retired people take a strong hit in income when the Fed decides to reduce rates to effectively zero to compensate for the actions of irresponsible borrowers and aggressive lenders. Finding investments paying 5% six months ago was not a problem, but today that rate is roughly half of that amount. With food and energy rising in price, it would make sense for rates to go higher to compensate savers for the increase in prices, and possibly in return keeping prices, inflation, down.

Below is a chart of the Dow 30. This is a day chart showing a series of standard deviation lines from a long term linear regression line. The yellow circle shows the last attempt to get to the channel and the kiss goodbye. The market is trying to make a short term bottom. We have had a couple very strong up days in the last month, but they have not had much follow through with strong volume. It is going to take time, and an strong rally back to the 12700 area should be sold into.

Dow Jones Industrials (click to enlarge)

This is a longer term chart of the Dow 30. It is a 3day bar chart which is used to smooth out daily fluctuations.

Dow Jones Industrial Average(click to enlarge)

This is the S&P 500 Index with extensions from the opening range. The 1350.61 area is the next target.

S&P 500 Index(click to enlarge)

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