In last week’s column, I concluded with the statement that the extreme volatility that the market had been undergoing will be a “warm-up for the major event today [last Wednesday] when the Fed tells or does not tell us the time-frame for the beginning of the end of their current stimulus program and to what extent the monthly dose of the $85 billion medicine is about to be tapered down.” And I added the caveat that “the market’s movements are going to be a real barnburner.”
And sure enough, this is exactly what has occurred, as the recent volatility has continued, but now the downside pressure has become more noticeable as the Dow has undergone three triple-digit losses out of the past four days through Monday since the Fed statement and the subsequent Chairman Bernanke press conference. And as the old saying goes: With friends like that, who needs enemies?
The prepared statement at the conclusion of the F.O.M.C. meeting mentioned that “the committee sees downside risks to the outlook for the economy and the labor market as having diminished since the fall,” and that it is prepared to increase or reduce the pace of purchases depending on the outlook for the job market and inflation.
But what got the markets so bent out of shape were the Chairman’s subsequent comments at the press conference that “if the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year,” to which he added that “If the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”
This is all that a fragile stock market that had been feeding off the monetary policy of record Fed purchases of Treasury bonds and mortgage-backed securities needed to hear. This policy is believed to be the major force behind the global economic recovery and the more than doubling of stock prices since early 2009. As a result of the perception that this situation is going to be ending, the Dow plunged to the downside and ended lower by 203 points last Wednesday, the day of the Fed and Bernanke comments, and this was followed by a 353-point downside disaster on Thursday, the largest loss of the year, while the S&P suffered its worst one-day beating since November 2011. Then, to put the icing on the negative cake, on Monday the Dow declined by another 140 points.
And it was not just stocks that suffered, as the bond market underwent even larger declines, as yields on the 30-year Treasury bond and the all-important 10-year Treasury note rose to levels not seen in almost two years, up to 3.6 percent and 2.6 percent respectively. And this is already having an effect on mortgage rates, which have risen by five-eighths of a percentage point in the last month alone.
As a result of these rising U.S. interest rates, the dollar has strengthened and this has resulted in most commodity prices taking a downside beating as well, as gold has now plummeted to its lowest level in three years at $1,280 an ounce, copper prices have declined to a three-year low, and even crude oil, which has a very strong historical tendency to rise as the peak summer demand driving season gets underway, has also come down somewhat. This should ease pressure on consumers who will catch a bit of a break in terms of gasoline prices remaining stable so far in the early part of the summer. This is perhaps the only good thing that has come out of this most recent financial market debacle that has taken place in the past month which has wiped off more than $2 trillion in value from global stock markets and far more than that from the value of global bonds since the Fed hinted at tapering off its stimulus programs at the May 22 meeting. That day saw the top of the market, with both the Dow and S&P reaching all-time intraday highs at 15, 542 and 1687 respectively before the current downward plunge began.
In the process, the 149 days without a decline of five percent for the S&P is history, as this index is now 5.8% below its all-time-high closing level, which was the longest such streak since the record 173-day accomplishment that finally ended on February 20, 2007. The Nasdaq has now undergone its worst four-day streak since November 2011 and the Dow has closed with a triple-digit move on 15 of the past 20 days, with the scorecard reading six higher and nine lower.
Markets might be overreacting to these Fed developments as Bernanke virtually guaranteed that short-term interest rates would remain at zero until 2015 regardless of economic conditions and he emphasized that the Fed’s 6.5 percent unemployment rate was not a target or “trigger” for higher interest rates, but merely a “threshold” before which rate hikes would not even be considered. He added that the Fed’s objective was to reduce unemployment to well below 6.5 percent and that monetary stimulus would continue even if this threshold was reached as long as inflation remains below 2.5 percent.
And it was not only developments in this country that have put the markets back on their heels, as to our malaise has been added the breakdown of the Chinese stock market that has fallen into a bear market with a decline of more than 20 percent. This was due to a potential freezing up of their financial system as benchmark money market rates rose to a record high 30 percent as their central bank did not conduct open-market operations to ease the resultant cash squeeze. The overnight repo rate was at 15 percent early on Monday morning but since came down to a more reasonable seven percent level as their central bank insists that there is a “reasonable amount” of liquidity in the financial system.
With the world’s second largest economy in a potential slowdown and the various financial markets selling off sharply in this country, the past month has not been a pleasant one for investors.
The “Market Maven” column will resume on Thursday, July 18.