Will Tuesday be D-Day?

Will Tuesday be D-Day?


Hi, Friends,

All eyes are on “Gentle Ben” and his cohorts at the Federal Reserve as they gather on Tuesday, September 18th to contemplate the future of U.S. interest rates. The market has factored in at least a 25 basis point cut and many players are hoping for a 50 basis point cut. The most likely outcome is a 25 point basis cut with an accompanying announcement pointing to further easing in the months ahead.

If the Fed leaves interest rates unchanged, there will be blood in the streets; a 25 basis point cut will be market neutral to slightly negative for the week and a 50 basis point cut would be a nice surprise. Any cut will be the first rate reduction since 2003.

Our view is that this will be the first of several interest rate cuts extending into next year.


The View from 35,000 Feet

It appears that the current situation leaves the Fed no choice but to cut interest rates even though this could have long term negative effects for the dollar and their inflation fighting efforts. There are simply too many pockets of weakness for them to ignore.

Consider this slew of recent reports:

August non-farm jobs down 4000, the first decline since 2003
August retail sales up .3% but down -.4% excluding autos, the biggest decline in a year
Oil closing Friday near record highs at $79.10/bbl
Home sales down 23% from their peak 2 years ago

And declining home sales is just the tip of that iceberg.

Goldman Sachs predicts that nationwide home prices will decline 7% this year and 7% more next year, and these declines would then be the largest since the Great Depression.

Furthermore, price declines in Florida, California and Arizona are forecast to go drop as much as 25% off their peaks, and most of the sub prime interest rate resets will come in the first and second quarter of next year, adding more downward pressure due to higher supplies of home for sale and more foreclosures.

And what this means for the general economy is that consumers will be spending less.

Fed. Economist James Kennedy estimates that consumers have spent $2.2 Trillion from their home equity since 2001, and with declining prices, this “wealth effect” will now work in reverse as people feel less wealthy and so cut spending. This phenomenon is called Mortgage Equity Extraction and is now already 50% of what it was in 1st Quarter of 2005. And this is leading to rapid revisions downward in economic growth forecasts.

So, when you add up falling home prices, rising energy prices, a flat to declining job market and the political pressures of a Presidential Election year, a series of rate cuts seems almost inevitable because, let’s face it, no politician in this country wants to face re-election with the dreaded “R” word (recession) being discussed during the campaign season.


The Week Ahead

Aside from D-Day on Tuesday, or should we call it B-Day? (Ben Day,) next week is also September Triple Witching when stock options, index options and index futures all expire on Friday. Triple witching typically leads to higher volatility, and in recent years, September Triple Witching is approximately market neutral with 8 years being positive and seven years being negative.


Sector Spotlight

Hot sectors continue to be precious metals, commodities and oil/energy (perhaps forecasting higher inflation ahead?) and international, particularly in emerging markets and the Pacific Rim.

Cold sectors are Home Construction, semi-conductors and Japan as their Prime Minister resigned and then was hospitalized for stress last week.

In an interesting anecdote to the booming Pacific Rim, a close friend of mine was in Beijing earlier this month and told me that while he was getting his $2 haircut, one of the girls working in the shop spent the whole time trading stocks on her desktop computer. Always the sign of an overheated market.

Wishing you the best for a peaceful weekend and week ahead,

John Nyaradi
Publisher
Wall Street Sector Selector