Being Street Smart July 01/05
by Sy Harding
July 01/05
THE FIRST HALF IS HISTORY! WHAT'S NEXT?
The June fiscal quarter, and therefore first half of the year is now history.
It was an unusually difficult period for market participants, no matter the market, whether stocks, bonds, or currencies. Money managers, fund managers, and Wall Street analysts, missed their forecasts in almost all categories.
At the beginning of the year, the consensus forecast was that the U.S. dollar would continue to decline sharply. Instead it rallied as much as 11%. Crude oil prices, which were forecast to stabilize at around $40 a barrel, instead soared, and closed the half above $58 a barrel. Bond yields were forecast to rise, which would send bonds into a bear market, as the Fed would continue to raise short-term interest rates. The hikes in short-term rates would also succeed in raising mortgage rates enough to cool off the too-hot real estate market.
The only thing they got right about that scenario was that the Fed would continue to raise short-term interest rates. But long-term rates, including bond yields and mortgage rates, actually declined some, preventing bond prices from collapsing, and driving the real estate market to an even higher spike-up in home sales and prices.
And the stock market was projected to enjoy a strong first half. However, the Dow ended the half down 4.7% for the year so far, and down 6.1% from its March peak. The Nasdaq was down 5.5% for the first half of the year. Somewhere in the middle there was a rally off the April low, but that seems to have run out of steam several weeks ago.
Wall Street may have missed its forecasts for the first half, but has not lost its enthusiasm, now calling for a strong second half of the year.
Perhaps - but the stock market will be facing even stiffer headwinds for the next quarter.
Not only is the third quarter of the year usually the worst performing quarter of the year, but the negatives that troubled the market for the first half of the year have piled higher as we enter the third quarter.
For instance, short-term interest rates are higher than six months ago, after the Federal Reserve raised short-term interest rates four more times since January. And puzzled why that has still not led to higher long-term rates, the Fed repeated again this week that it will continue to raise the Fed Funds rate "at a measured pace". Historically, the market has not liked rising interest rates, which choke off economic growth and cut into corporate profits. In fact, it's interesting that with their decline in the first half of the year, both the Dow and the Nasdaq are just about exactly where they were one year ago, when in June of last year, the Fed began the first of what has now been nine hikes in the Fed Funds rate.
Meanwhile, with short-term rates rising, and long-term rates actually declining fractionally, the yield curve has flattened dangerously, and is close to 'inverting', which is the situation when short-term rates become higher than long-term rates. Historically inversion of the yield curve has been followed by economic recessions. Always bullish Wall Street spokesmen, much as they said about the stock market in 1999, are now saying about the threatening inversion of the yield curve, that 'this time is different', that with both short-term and long-term interest rates so low, inversion of the yield curve, should it happen, would not be as serious as it has been in the past. Perhaps, but there is no statistical evidence of that being true.
In the meantime, crude oil prices, which were thought to be high at the beginning of the year when they were hovering around $40 a barrel, are now above $58 a barrel as we enter the third quarter.
On the subject of oil, it is increasingly one world - economically anyway. So a report in The Taipei Times this week is of interest. It described growing concerns in Asia that oil prices, now 50% higher than they were a year ago, have reached a level where Asia's important economies could begin sliding into recessions. The article reports officials in South Korea, the Philippines, Japan, and Malaysia, are expressing concerns that crude prices at these levels could "take a heavy toll on economic growth" this year. With economies in Europe already reporting slowing economic growth, the U.S. does not need to see the still strong Asian economies, strong markets for U.S. products, soften. But not to worry - regardless of the concerns of officials in those countries, Wall Street says it won't happen.
Need I even mention those macro U.S. problems, like the budget and trade deficits, or consumer debt, which are at still higher record levels now than they were six months ago.
Or that the hot engine driving the U.S. economy, the real estate sector, is showing some signs of reality setting in, even before the Fed gets long-term rates up where it wants them. The Commerce Department reported on Friday that residential construction declined 1.7% in May, having previously reported that the median house price nationally had declined 6.5% in May.
So,
rather than seeing conditions improved to where they will produce a strong
September quarter, it looks like conditions are worse than six months
ago, a situation that continues to support my earlier forecasts that the
stock market will see its low for the year in the October to November
time-frame.
Sy Harding is president of Asset Management Research Corp., publisher
of The Street Smart Report Online at
www.streetsmartreport.com and author of 1999’s Riding The Bear
– How To Prosper In the Coming Bear Market.
