Shortage of clarity bedevils investors
The best gift Wall Street could get this season would be a little clarity.
Instead, the outlooks for the economy and the financial markets got murkier this week. That brought the sellers out again -- this time, not just in stocks but in Treasury bonds, which had been a refuge for some nervous money in recent months.
Anyone hoping for a letup in market volatility isn’t finding reasons to be encouraged.
The Federal Reserve riled the markets Tuesday, when it cut both of its benchmark short-term interest rates by a quarter of a point instead of the half-point many investors had wanted. That was good for a fast 294 points off the Dow industrials.
On Wednesday, the Fed sprung another surprise that should have been better received: The central bank said it would launch a special lending program to get money to commercial banks that are struggling to line up the cash they need amid the global credit crunch.
The Dow shot up 272 points early Wednesday -- then gave nearly all of that back by the closing bell.
Thursday and Friday brought more bad tidings. Wholesale and consumer price indexes surged in November, mostly because of energy costs, the government said. But even excluding food and energy, prices were up more than expected.
The Dow wrapped up the week on Friday with a 178.11-point slide to 13,339.85. For the five days, the index fell 2.1%.
The wholesale and consumer price data also rattled bond investors, who hate rising inflation because it eats away at fixed returns on bonds.
The yield on the bellwether 10-year Treasury note jumped from 4.09% on Wednesday to end at 4.24% on Friday, the highest since Nov. 14 and up sharply from the multiyear low of 3.84% reached Nov. 26. That means there’s less of a chance for lower rates on mortgages, which are tied to bond yields.
The Nov. 26 low came when the hunger for Treasuries was ravenous. At that point, Wall Street was gripped by fear that the housing sector’s slump and the credit crunch it had induced would drag the economy into recession.
But the stock market then abruptly turned higher, led by battered financial-company shares. Help was coming, some bargain hunters bet.
They were right -- sort of: The Bush administration on Dec. 6 announced a program to stem the foreclosure wave, under which mortgage lenders would voluntarily freeze interest rates for some homeowners with sub-prime adjustable-rate loans.
And the Fed’s two-step program this week -- its third consecutive interest rate cut and the bank-lending plan -- at least showed that policymakers were taking the credit crunch seriously.
But market action in recent days suggests that worries about the health of the financial system remain intense.
The New York Stock Exchange’s index of 373 financial-company stocks tumbled 7.1% Tuesday through Friday, wiping out two-thirds of its rebound since Nov. 26.
What’s more, news of the Fed’s bank lending program, which it will undertake in coordination with major foreign central banks, failed to significantly pull down interest rates this week in the London interbank offered rate market.
That market is where banks borrow from one another, and the relatively high cost of those loans has been one of the clearest signs of banks’ own fears about the sturdiness of the financial system.
As for the U.S. economy, the November retail sales report the government issued Thursday showed that consumers had not closed their wallets.
Nonetheless, it’s difficult for the stock market to shake its recession concerns. That was evident in the performance this week of hotel stocks, a sector whose fortunes are tied to the economy’s swings. Marriott International dived 6.9% on Friday, and 15% for the week, to finish at $31.49.
It didn’t help that former Fed Chairman Alan Greenspan warned Friday that recession risks were “clearly rising.”
Martin Feldstein, the eminent Harvard University economist, this week put the odds of recession next year at 50-50.
They may yet be dead wrong. But here’s where things get sticky, or perhaps stickier.
If the November inflation data are signaling that price increases are more pervasive than had been supposed, the Fed could find it difficult to continue easing interest rates to help the banking system and the economy through this rough patch.
Rising prices would challenge the Fed to prove that it’s serious about restraining inflation. That could mean holding the line on interest rates -- at the moment the economy needed cheaper credit.
That is one of Wall Street’s worst nightmares because it poses the risk of stagflation: rising inflation amid a stagnant economy. We saw this in the late 1970s, one of the most miserable periods for stock and bond investors in modern times.
“It smells stagflation-esque,” said Gary Pollack, head of bond trading at Deutsche Bank Private Asset Management in New York.
If the Fed can’t ride to the rescue, the mortgage-rate-freeze plan also could be jeopardized. The administration wants the owners of sub-prime mortgage-backed bonds to sacrifice some of the yield they expected to earn in order to save homeowners.
That may be more difficult for the investors to swallow if market interest rates hold steady or, worse, rise.
For now, Pollack and many other analysts believe the Fed will continue to cut interest rates early in 2008. But the inflation data this week may explain why policymakers were willing to disappoint investors Tuesday with a quarter-point cut instead of a half.
The inflation reports also add one more element of uncertainty for beleaguered investors to contend with.
And uncertainty is a recipe for more stock market volatility -- which, except for day traders, is no one’s idea of a happy holiday.
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