Five Things You Need to Know: Emergency Rate Cut, What It Means and What to Do
While we are still in the very early rounds of deflation for the economy, the stock market is fighting a bout of its own at a different pace.
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Emergency Rate Cut: What It Means and What to Do
This morning the Federal Reserve moved to lower both the Federal Funds and Discount rates in an emergency cut for the first time since 2001. This is also the first time in its history that the Federal Funds rate has been lowered 75 basis points since the Fed Funds rate became the central policy-making tool. The question now is, what does this mean?
First, let's look at the crux of the Fed's brief statement:
"The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."
The key points in here are:
1) While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate...
2) [C]redit has tightened further for some businesses and households...
3) [I]ncoming information indicates a deepening of the housing contraction as well as some softening in labor markets.
The conventional wisdom is the Fed responded to crashing equities. But that's simply not the case. The decline in equities are merely symptomatic of the disease, not the disease itself.
2. It's Not About the Stock Market
It's not about the stock market. Although the causal relationship seems easy enough to identify - stocks worldwide plunged, the Federal Reserve responded by cutting rates - the reality is that this is not about stocks. This is about leverage and the consumer-led recession already underway.
Even before the emergency rate cut this morning, the Wall Street Journal was already prepared to go front page with what we've been discussing for a full year; the spread of the credit crunch from subprime mortgages to just about everything else - from housing, to commercial real estate to credit cards and automobile loans.
"While companies with strong balance sheets still can borrow what they need at good rates, others are beginning to feel the chill," the Wall Street Journal reported. "In particular, start-up and smaller companies are finding that banks are setting higher rates, seeking more collateral or lending smaller amounts."
In its statement this morning the Federal Reserve readily acknowledged this credit restraint, noting, "[C]redit has tightened further for some businesses and households."
But this is just one side of the issue facing central bankers and policy makers; it's not just a matter of how to make more credit available, but how to get people to use the credit. Remember, it's about increasing the velocity of money in the economy. By lowering rates, the Federal Reserve has merely turned the money engine on; it's up to the consumer to press the accelerator.
3. It's About Consumer Leverage
Unfortunately, the consumer has other ideas...
And so the consumer balance sheet repair meme continues to grow. As those who have read Five Things over the past couple of years know, this is not a behavior that began in August or September as the credit crunch began to manifest, it's something that has been building for years.
Consider talk show host and television personality Dave Ramsey. Chances are pretty good that by now you know who Dave Ramsey is, but just in case, he's the host of a popular, widely-syndicated show, "The Dave Ramsey Show," that is heard on the more than 300 radio stations and seen on Fox Business Television.
Ramsey has been talking about the evils of debt and the virtues of debt-free living for more than a decade. In fact, his career began in 1992 when he began selling books on financial health following his own personal bankruptcy crisis in the late 1980s. But only recently has Ramsey really been able penetrate the mass public's consciousness. Why? It's not because Ramsey suddenly improved his message, it's because social mood finally reached a point where his message is not just acceptable but sought out.
The psychological factors that have made Ramsey a household name are the same factors now working against the ability of the Federal Reserve and the government to stimulate credit demand.
4. Bullish Percents at Extremes
Of course, while on the one hand there's the economy, on the other there's the stock market. Although they are frequently confused as one and the same, the reality is they do different things at different times. And now, just as the public is beginning to recognize the depth of the deflationary forces in play, equities are reaching an important negative extreme.
So, where do we stand with our equities indicators now? After today's action, regardless of where the market finishes, the bullish percent index for the NYSE will be at an historic extreme. All bullish percents are now well below the 30% low-risk level; reversals up from here are, historically, excellent low-risk buying opportunities.
Below is where we stand with the point and figure bullish percent indicators for equities.
- NYSE Bullish Percent: Os (Negative), 20.7%
- S&P 500 Bullish Percent: Os (Negative), 17.9%
- Nasdaq Composite Bullish Percent: Os (Negative) 19.3%
- Nasdaq-100 Bullish Percent: Os (Negative), 19%
- Russell 2000 Bullish Percent: Os (Negative), 19.5%
- NYSE High-Low Index: Os (Negative), 12.3%
- Nasdaq High-Low: Os (Negative), 5.7%
So now what?
Let's look back at the last secular bear market, between 1965 and 1980.
5. The Secular Bear Market: 1965 to 1980
During the 15-year span between 1965 and 1980 the S&P 500 returned roughly 27% or so, excluding dividends. That's 15 years of gains average out to a little less than 2% a year. tough going for the buy-and-hold investor. Meanwhile, throughout that period were frequent rallies of 20% or more, occurring on average about once every 18 months. That is why it's important to note the most recent extreme in the bullish percent indicators.
The NYSE Bullish Percent is now close to 20%, its lowest level since August 1998. After today it will likely fall below that level. For perspective, how unusual is this? How low can these bullish percents get?
The NYSE Bullish Percent, dating back to 1955, has reached the following low, extreme levels below 20% on just :
- October 1957: 8%
- May 1962: 6%
- September 1965: 8%
- July 1969: 10%
- September 1974: 8%
- April 1980: 14%
- October 1987: 6%
- September 1990: 18%
Below is a chart of the S&P 500 between 1965 and 1980 with the extremes of the NYSE Bullish Percent (above 80% - high risk; below 20% - low risk) overlaid.
Note, bullish percents are not strict timing devices. Instead, they identify extremes in sentiment, but given the general upward drift in equities, buying stocks when the bullish percents are at low extremes has proved to be very successful over the long run.
The bottom line is that while we are still in the very early rounds of deflation for the economy, the stock market is fighting a bout of its own at a different pace, and at least for now, the initial rounds are probably over. There will be more drama to come, but we'll have to take those blows as they fall... perhaps literally.
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