-- William McChesney Martin, the longest (1951-70) serving chairman of the Federal Reserve said the central bank's role is to take away the punch bowl just when the party starts getting interesting. Raising interest rates to slow economic growth is the Fed's way of removing the proverbial punch bowl. A few weeks ago, Ben Bernanke, current Fed chairman announced a whopping rate cut of 1/2 percent which meant the Fed was not removing the punch bowl but spiking it to boost economic growth and demand in a widely touted and much heralded effort to keep the party going.
My past few columns explained how stocks and commodities have been moving in tandem most of this year. How they rallied and peaked within days of each other in July. Then promplty rolled over and dropped sharply until bottoming on August 16. From that low, both rallied into the Fed rate cut two weeks ago. And when the Fed spiked the punch bowl, both markets sky rocked even higher.
For example, commodities as measured by the CRB index posted the largest monthly gain this September than any month in the past 32 years. The rally was led by wheat, crude oil and gold as the slumping US dollar fell to a 15 year low. The widely followed index rose 8.1 percent this month, the most since July 1975. Wheat hit an all time historic high of $9.61 a bushel, crude oil hit $84 a barrel and gold prices jumped to $760 an ounce, the highest since January, 1980.
The stock market is doing nearly as well despite a sharp decline in July and August. The New York Times in an article dated September 29 and titled, “What Plunge? Stocks Back Near Highs Hit in July” said, after a tumultuous and brutal August, the stock market has regained its footing and is within striking distance of the record highs it set in July. The surge began building before the Federal Reserve cut interest rates last week and has come at a time when news from the housing market remains bleak.
The same article states, “Since August 15, when the stock market hit its lowest point in five months, the Standard & Poors 500-stock index is up 8.5 percent and the Dow Jones industrial average 8 percent. The increase has erased much of the decline from late July and early August and left the indexes up modestly for the third quarter, which ended yesterday.
A chief strategist was quoted, “if you went away sometime in July and came back about now, you might say, Nothing happened while I was gone.”
To begin with, the low set for the Dow and the CRB was August 16, not the 15th. On the 16th, the Dow fell more than 300 points at one time and the CRB slipped 1500 points, the largest one day sell off in history. Buying either market on the 15th would have led to massive losses on the 16th. Of course, those with deep pockets and an iron constitution able to hold on tight for a few days after the 16th, caught an enormous rally that remains in place through this week. But on the 16th, it seemed the world was crashing.
And yes, if you were not around and came back about now, you might say, nothing happened while I was gone. But the fact is, something considerable did happen. What happened, for the benefit of those gone, stranded on a deserted island, or even more isolated and camped in the wilds of Montana hunting elk, this was the big news; the world's central bankers pumped billions of dollars into their economies giving an enormous boost to stock and commodity values. The US Fed in particular panicked, fearing a sharp economic downturn or even worse, a prolonged recession.
The dreaded word, recession, has on average caused the Dow Jones to fall 40 percent before bottoming out. A recession also plays havoc with demand, causing commodity prices to decline in value. In a recessionary economy, the only markets that do well on the upside are bonds, the debt markets.
A sea of change occured when the Fed cut rates double what was expected. The abrupt change in monetary policy is an admission they see something requiring decisive and immediate action. Only the dreaded “R” looming on the horizon would cause the Fed to change policies so abruptly. Nothing else.
Though the CRB just posted a new all time historic high along with crude oil, wheat and a new 27 year high for gold, my work flashed a sell signal for each of those markets because they ended today and the week lower in value. The lower settlement was a bonefide key reversal to the downside if there is follow thru selling in the days ahead. The sell signal, interestingly enough comes just as October, one of the most bearish months of the year for stocks and commodities arrives. Expect a very bumpy ride in the final quarter of ‘07.
(The information in this article is the opinion of Commodity Insight's Jerry Welch and subject to change without notice.)