The stock market rebounded this week like a cork popping up after a fish wiggles off the hook. The Dow opened the week below 13,000, declined to 12,725, then railed 647 points to close on Friday at 13,372. The S&P and NASDAQ turned in similar performances. From a 10% correction, fears of a meltdown in the financial sector and recession the preceding week, the market rallied for four consecutive days and closed at its high for the week. What caused this swing? Equity investments in Citicorp and e*Trade demonstrated that capital was available for the financial sector and the financial stocks rallied on the news. Treasury Secretary Paulson proposed a moratorium on rate adjustments for certain subprime mortgages and Fed spokespersons, including Chairman Bernanke, hinted at the possibility of another rate cut in December. And, overshadowed by all the good news in the financial sector, oil closed at $88.70 a barrel, below $90 for the first time in weeks.
Has the economic outlook improved that much to justify an almost 5% move in the stock market? No. The only change was the infusion of capital into the financial sector. That’s good and the financials responded, although I think their lows will be re-tested, but it doesn’t solve their problems. Neither does the government program. The proposed rate freeze for selected mortgages is a band aid which will benefit some homeowners but does not address the underlying problems facing mortgage lenders. The mortgage industry is in for a period of contraction due to the economic slowdown, slowing new home construction, a slowing re-sale market for existing homes and the ability of homeowners to meet their payment obligations, particularly if the employment picture weakens. Interrelated are the tighter lending standards which the major mortgage originators have implemented. Reality will set in when the initial euphoria wears off.
As for oil, who knows how much of the recent movement, in both directions, was due to speculators adding to, or closing out, their positions. Demand for energy is increasing worldwide, even the US is consuming more gasoline this year than last, so don’t expect prices to fall for long. Even if crude prices do fall, consumers are in for a disappointment. Retail prices for gasoline and home heating oil did not rise as much as crude oil, the refiner’s margins took the hit, so don’t expect prices at the pump to fall by much.
The economy is still the big fish (a feeble attempt to tie to my opening sentence). The economic outlook and the problems facing the economy haven’t changed. Thus, the swing in investment sentiment we saw last week is not justified. Don’t get caught up in the moment. This is not a time to become aggressive. Stick with your long term investment strategy and don’t get hooked.
