The Good Times Keep Rolling

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Even with the disappointing jobs report this past Friday, the good times just keeps on coming for equity investors, as all the major indexes finished in the black for the first full trading week of October.  It was a week where we saw declines in both government jobs and private sector jobs, yet a week where we also witnessed the Dow Jones Industrial Average hurdling past the 1,000 mark for the first time since this past May.  Apparently most professional money managers are betting that we’ll be in for another round of quantitative easing, which the government achieves by buying bonds.  It’s now a matter of ‘when’ as opposed to ‘whether’ the government steps in in order to keep deflation at bay and help bring on conditions that will lead to more jobs and more consumer spending.  Also helping out the blue-chip equity names this past week was the stock of bellwether aluminum giant Alcoa, which kicked off the earnings season by reporting third quarter profit that more than doubled versus a year earlier and raised its 2010 forecast for global aluminum demand on Thursday.  The company cited strong demand from the emerging economies such as China, India, Brazil and Russia, which led to increased revenue for the third quarter.  They were also able to beat their earnings consensus figure thanks to large increases in the construction and aerospace markets.

On the milestone week, the Dow Jones Industrial Average rose 1.63% to end the week at a level of 11,006.48.  Meanwhile the Standard & Poor’s Index jumped by 1.65% and has now attained the 1,165.15 mark while the Nasdaq Composite popped by 1.31% and sits at 2,401.91.  The smaller-cap names as represented by the Russell 2000 had an even brighter week, as this index jumped by more than 2.14%!  On a year-to-date basis the figures are still somewhat more  muted with the Dow up 5.55%, the S&P 500 up 4.49%, the Nasdaq Composite up 5.85% and the Russell 2000 up 10.94%

With this backdrop of a weak economy in the midst of a stock market bull run, the $64,000 question going forward is whether our policy makers can do enough to keep the market heading north.  Right now the apparent disconnect between the upbeat stock market and the downbeat economy is considered ‘conventional wisdom.’  Some market sages are saying that this market is an “Alice in Wonderland” market, where we have poked our heads inside the looking glass and everything we now see is inside out and makes absolutely no sense whatsoever. And when you really think about it, the Dow popping through the 11,000 mark is really nothing new.  The index first eclipsed that back in 1999, during the dot-com and technology bubble, and has crossed back and forth several times since.  Many of the market prognosticators have played down the 11,000-point milestone, dismissing it as little more than a headline-grabbing number.  For days now, as the Dow flirted with that mythical figure, CNBC and every other news outlet was delivering a steady stream of will-it-or-won’t-it coverage. And part of that notoriety is the fact that it is just human nature to get excited about big round numbers when it come to the stock market. However, one must still take into account that even with the Dow just over the 11,000 barrier, the Dow is still well off its 2007 high of more than 14,000.

Don’t be surprised if the market tends to consolidate here or drift slightly downward over the next several weeks, especially given the fact that the markets had a 9% jump in September.  Currently there are a tremendous number of imbalances out in the economy, whether it’s the deficit, the job market, the housing market, the deficit, zero percent interest rates or the bloated federal balance sheet.  Investors have been moving money out of mutual funds in droves which just indicates how scared the average investor really is.  Since October 2007, investors have pulled some $262 billion from funds that invest in domestic stocks, according to the Investment Company Institute.  Meanwhile, investments in bond funds have jumped by around $634 billion over that same time period.  And also consider the fact that currently there is some $55 billion invested in State Street’s gold exchange-traded-fund alone.  So while the market may continue to chug on below its previous highs, it may take a few more months like September’s outsized jump in stock prices for the average investor to once again feel like he or she is missing out on something.  Until then, look for a choppy equity  market at best.

With respect to the bond market, investors are convinced that the Federal Reserve will launch another big bond-buying program by end of the year which helped the bond market continue its torrid pace of driving yields lower.  As we’ve already mentioned, most pundits feel that the Fed will begin buying more bonds within the next few months which will continue to drive bond yields down.  Currently, seventy percent of institutional fixed-income investors recently polled feel the next round of quantitative easing will begin at the November 3rd meeting of the Federal Open Market Committee. What makes this Fed meeting all the more dramatic is that the interest rate decision and policy announcement will come the day after the elections that are looking as though they could be more and more historic by the day.  With this anticipation, bond yields continued to fall this past week (bond prices and bond yields are inversely related,) as the 10-year bond yield fell to a fresh low for the year at 2.332%, a level last seen in January 2009.  Yields on the two-year and five-year Treasuries also reached historic lows.

One benefit to low interest rates is that of the mortgage market.  Rates on 30-year mortgages fell to their lowest level in decades for the ninth time in 12 weeks.  The average rate for 30-year fixed loans has now dropped to 4.27%, mortgage buyer Freddie mac declared this past Thursday.  That’s the lowest on record dating back 39 year to 1971.  The average rate on 15-year fixed loans, a popular choice for refinancing, dropped to 3.72 percent.  Let’s just hope that these attractive rates will help the housing market soon start to get out of its doldrums!

Thus in closing, it’s truly a confusing state of affairs as it relates to the stock market and the overall economy. With all the doom and gloom out there, why do stocks keep rising?  Printing money and buying Treasuries, mortgage-backed securities, and bad bank debt is no way to grow your way out of a recession, but that is exactly what the government and the Fed are doing.  It makes you wonder just what the “Powers That Be” are thinking!  There is no doubt that the current weak employment picture will weigh heavily on the incumbents in next month’s mid-term elections.  Voters are livid and ready to “run the bums out of town.”  Thus as we’ve already mentioned, the stock market will likely stay on pins and needles until the election anger runs its course. However, be sure and stay tuned as it will definitely be an exciting pre-election season and the markets will most likely continue to hand out surprises.

Sources:  Barron’s, The Wall Street Journal, The Kirk Report, Kiplinger’s, The New York Times, Associated Press, Reuters, Morningstar

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