August
21, 2007 (Weekly Update)
11:00 A.M. ET
DJIA 13,102.00
Al
Goldman,
A.G. Edwards Chief Market Strategist
The Fed Gets
Friendly
For two years until last summer, the Fed had raised interest rates
-- not a friendly gesture but probably necessary to slow down a
strong economy and a booming real estate market. Then, for 15
months, the Fed kept interest rates unchanged as they were still
concerned inflation could lift its ugly head -- they probably
stayed unfriendly a bit too long, but no one is perfect. Last
Friday, after four weeks of a sharp stock market decline (almost
10%) and a serious credit market problem, the Fed lowered the
discount rate to 5.75% from 6.25%. They also encouraged banks to
come to the discount window and extended the normal overnight
borrowing time to as much as 30 days. The Fed also said they would
do more if necessary to keep the economy from sliding into a
recession and to ease credit market problems. The result was a
dramatic rally in the stock market -- the Fed got friendly and
provided investors and borrowers of all shapes and sizes an
emotional boost.
No one knows at
this time whether the Fed will have to do more to settle down the
credit market, but we all know the Fed is in a friendly mood.
Another question on most folks' minds is whether the recent stock
market drop is a normal correction in a still-OK bull market or
the start of a bear market. In our opinion, the conditions that
usually create bear markets are not in place. There is no
"irrational exuberance" that is normally seen at
important stock market tops. We do not have an overheated economy
or runaway inflation that can cause the death of a bull market.
The economy is in a soft landing, and the Fed's action
substantially reduces the risk of a recession. And the emotional
condition of the stock market is not at all characteristic of a
pending bear as concern about the economy and the future of the
stock market is high. Fears and concerns are usually very low at
market tops. Think about March 2000.
We believe the
recent sharp decline was a normal, albeit very unpleasant,
correction in a still ongoing bull market. Stocks were overdue for
a normal 10% correction, and the subprime mortgage/credit market
debacle provided a very valid excuse. The economic positives
remain corporate earnings, the labor market, personal income and
no inflation problems. The overall stock market is now selling
approximately 14.4 times 12-month forward earnings for the S&P
500, which we believe is around 10% undervalued. Main Street
investors and workers are doing just fine and will probably not be
hurt long term by the subprime mess. The hurt belongs to those
greedy mortgage companies, hedge funds and banks who thought they
had found an easy way to get even richer. We believe the stock
market has resumed its primary uptrend, but don't expect it to be
straight up. The stock market is like a mere mortal after major
surgery -- first you shuffle along, then you walk, and then you
run. The friendly Dr. Bernanke has helped the patient recover.
Support for the
DOW is 13,200 while resistance is
14,000.
The
Weekly Commentary section provides an
informative read on the market from seasoned veteran Al Goldman of A.G.
Edwards. Few if any are better at Al's insightful analysis that
only many years of experience can provide.