Why?
Though there is never a really good answer to why the market moves up or down in a dramatic fashion, today there are several points that have converged to make an explanation serve at least in a lesson on how our markets work.
Just over a week ago hopes were high that a new Federal Reserve chairman might end the latest series of Fed Funds rate increases. The Fed's statement said future increases would be tied to econimic data. Today, the Consumer Price Index release showed prices rising .6% (a 7.2% annual rate) and "core" inflation, which excludes food and energy, rising .3% (a 3.6% annual rate). This news means the liklihood of more increases from the Fed just went up.
Inflation has remained relatively tame considering the huge increases in oil prices over the last year, but with petroleum used so pervasively in the manufacturing processes of so many products it is inevitable that those increased expenses must either be passed on to the consumer, creating inflation, or production must fall as profitability is eroded causing recession.
When the Federal Reserve raises interest rates it serves as a brake on economic growth, which lowers future earnings of corporations, which lowers the implied future value of individual companies and stocks. Rising rates also causes bond prices to fall, as the income stream from fixed income investments becomes less valuable on two fronts. First, if rates continue to rise, who would want to buy a bond today that may well pay less than bonds issued tomorrow. Secondly, the inflation data shows that the purchasing power of that fixed income investment may well be eroded by rising prices and the principal payment received when the bond matures may buy less groceries tomorrow.
Higher rates also strengthen the dollar. Foriegn investors could find our rates higher in relation to rates available in their home country, so they sell investments in their local currency and purchase US dollar denominated securities. This rise in foriegn investment can help moderate interest increases here, but is dangerous for American's who own foriegn securities.
Recently the dollar has been falling in relation to other currencies, which explains part of the reasons why foriegn investments have outperformed the US markets in the last few years. If you own foriegn securities you have sold dollars and purchased another currency. When the dollars value declines relative to that currency you can convert your investment into more dollars when you sell that currency than when you began. So in the last few years US investors in foriegn securities have enjoyed returns from those company's rising earnings and from the appreciation of the foriegn currency.
Finally, investor psychology, just two weeks ago CNBC (which is usually playing in the backgound in my office) started talking about the Dow reaching and surpassing it's all time high. Pundits were queried about when they thought it would occur. It was remenicent of the markets glory days when there was a party as we watched for the Dow to reach 9,000 then 10,000, then 11,000. What a contrarian signal! Understandably, many felt it was time to take some profits, and some came late, afraid they would miss the dance. The market has a way of inflicting the maximum amount of pain to the maximum number of people, and so it seems once again.
Bottom line oil, the Fed, inflation,and currencies all converged to create more uncertainty and fear this week. People generally dislike uncertainty and risk so they vote with their feet, leaving the dance in droves. When will it end? Maybe tomorrow, maybe next week, no one really knows. But it will end. Nick Murray put it well when he said the price of the permanant ups in the market are the temporary downs.
Just over a week ago hopes were high that a new Federal Reserve chairman might end the latest series of Fed Funds rate increases. The Fed's statement said future increases would be tied to econimic data. Today, the Consumer Price Index release showed prices rising .6% (a 7.2% annual rate) and "core" inflation, which excludes food and energy, rising .3% (a 3.6% annual rate). This news means the liklihood of more increases from the Fed just went up.
Inflation has remained relatively tame considering the huge increases in oil prices over the last year, but with petroleum used so pervasively in the manufacturing processes of so many products it is inevitable that those increased expenses must either be passed on to the consumer, creating inflation, or production must fall as profitability is eroded causing recession.
When the Federal Reserve raises interest rates it serves as a brake on economic growth, which lowers future earnings of corporations, which lowers the implied future value of individual companies and stocks. Rising rates also causes bond prices to fall, as the income stream from fixed income investments becomes less valuable on two fronts. First, if rates continue to rise, who would want to buy a bond today that may well pay less than bonds issued tomorrow. Secondly, the inflation data shows that the purchasing power of that fixed income investment may well be eroded by rising prices and the principal payment received when the bond matures may buy less groceries tomorrow.
Higher rates also strengthen the dollar. Foriegn investors could find our rates higher in relation to rates available in their home country, so they sell investments in their local currency and purchase US dollar denominated securities. This rise in foriegn investment can help moderate interest increases here, but is dangerous for American's who own foriegn securities.
Recently the dollar has been falling in relation to other currencies, which explains part of the reasons why foriegn investments have outperformed the US markets in the last few years. If you own foriegn securities you have sold dollars and purchased another currency. When the dollars value declines relative to that currency you can convert your investment into more dollars when you sell that currency than when you began. So in the last few years US investors in foriegn securities have enjoyed returns from those company's rising earnings and from the appreciation of the foriegn currency.
Finally, investor psychology, just two weeks ago CNBC (which is usually playing in the backgound in my office) started talking about the Dow reaching and surpassing it's all time high. Pundits were queried about when they thought it would occur. It was remenicent of the markets glory days when there was a party as we watched for the Dow to reach 9,000 then 10,000, then 11,000. What a contrarian signal! Understandably, many felt it was time to take some profits, and some came late, afraid they would miss the dance. The market has a way of inflicting the maximum amount of pain to the maximum number of people, and so it seems once again.
Bottom line oil, the Fed, inflation,and currencies all converged to create more uncertainty and fear this week. People generally dislike uncertainty and risk so they vote with their feet, leaving the dance in droves. When will it end? Maybe tomorrow, maybe next week, no one really knows. But it will end. Nick Murray put it well when he said the price of the permanant ups in the market are the temporary downs.
posted by Joe Taylor at 3:09 PM
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