Making Money Alert
Trading Range and the Fed
06/28/2006
We've got one more day to wait before we get word from the Federal Reserve on the fate of interest rates. The conventional wisdom on Wall Street is that Ben Bernanke and his band of central bankers will raise the cost of capital by another 25 basis points. A quarter-point move in the federal funds rate would bump up the interest banks charge each other on overnight loans to 5.25%. That would be the highest rate in more than five years, and the 17th increase of that size since the Fed began tightening the purse strings in June 2004.
Some Fed watchers are predicting a 50-basis point increase in the cost of money, but that seems unlikely. I think the Fed will raise 25 basis points tomorrow, but they will likely leave the door open for another quarter point hike at their next meeting.
So what does all this mean for the stock market? Well, it means that everybody is pretty skittish about making any big bets on the direction of stocks. It also means that there's a war raging between bulls and bears that's kept this market stuck in what's called a trading range.
Take a look at the chart below, which depicts the price movement of the S&P 500 index over the past four months.
As you can see, the real action occurred with the May 9 drop in the index. Until then, stocks had meandered around the 1300 level. Since that big downturn in the market stocks have leveled off, and we now see the S&P 500 stuck in the mid-1200 range, with a low of about 1220 and a high of about 1280.
Now, there are three likely scenarios for this market going forward. The first one is that the bulls get the news they want out of the Fed, i.e., there will be another quarter-point interest rate hike but the statement accompanying the Fed's decision will signal an end to tightening cycle. If this happens, stocks could start their ascent from the low end of the current trading range.
The second thing that could happen is that the Fed makes an aggressive inflation-fighting move and lifts interest rates by 50 basis points. If this takes place stocks are likely to get toasted, and the S&P 500 will sink well below that 1220 bottom end.
The third likely outcome is that the Fed lifts rates a quarter point, is ambiguous about its future intentions, and the market stays in its current seesaw battle between diehard bulls and doomsday bears.
My solution to the uncertainty in the market now is to not try to anticipate, guess or divine what stocks might due going forward. I want to get my money in when the getting is good, and get it out when the market tells me to. Right now, the market is telling us to stay away. Until things change, I will be calmly watching the battle between bulls and bears from the safety and security of a very high cash position.
How we can remain steadfast, calm and in control even in the midst of all of this market uncertainty? Because we have a proven, time-tested investment strategy based on objective analysis of what the market is actually doing, and not what we think it is going to do.
HOUSING -- THE RETURN OF THE KEYS
I read a great article this past weekend in Barron's by the always articulate Alan Abelson. The piece was titled "Call to ARMs" and it was a tongue-in-cheek warning about the flood of lawsuits on their way to former Fed chairman Alan Greenspan.
Here's the money quote from the Abelson piece:
"…Mr. G. stands guilty of committing a capital crime several years back by regaling the peasants, who considered his every word a divine utterance, on the joys of adjustable-rate mortgages (as opposed to the old stodgy fixed-rate variety)."
The reference here is to Greenspan's pro-adjustable-rate mortgage language some years back, right when yields were at their lowest level in 40 years. This year approximately $1 trillion worth of adjustable-rate mortgages are due to reset, with another $1.7 trillion due to reset next year. Given that mortgage rates are substantially higher now than they were back when Mr. G spoke so highly of them, the result could mean that homeowners across the nation will have to pay 25% to 60% more every month just to make their house payments.
In my opinion, that means a great many homeowners will just "return the keys" to the bank and let their properties slip into foreclosure. This will exacerbate the busting of the housing bubble we've discussed so often here in the Making Money Alert and over the airwaves.
Folks, make no mistake about it, the housing crisis is just beginning to take shape, the same way a tropical storm takes shape before it becomes a hurricane.
ETF UPDATE -- SHAKING THE WISDOM TREE
You all know what a big proponent I am of ETFs. So when a company comes along with a new twist on these offerings, I want to share the news with you. The new fund company jumping into the ETF game is WisdomTree, and this year they are introducing 20 new dividend-oriented ETFs that could be quite interesting for investors.
The unique thing about the WisdomTree ETFs is that they will focus on "fundamentally weighted" indexes in contrast to market-cap weighted indexes. The weighting of WisdomTree ETFs will be determined by either the amount of cash dividends that companies in each index pay, or the dividend yield of the companies in each index.
Although WisdomTree is a new company, its principal players are by no means Wall Street novices. Hedge fund luminary Michael Steinhardt is one of the initial investors who supplied WisdomTree with $9 million in seed money, and their CEO is Jonathan Steinberg (son of Saul Steinberg, and married to CNBC "money honey" Maria Bartiromo). The WisdomTree team also includes Jeremy Siegel, finance professor from the University of Pennsylvania's Wharton School of Business, and Bruce Lavine, who helped introduce ETFs to industry leader Barclays.
In a recent conference call introducing these funds, Steinberg said, "We've created a unique approach that could move the indexing industry in a new direction and has the potential to change the way people think about indexing and investing."
Hey, I'm all for innovation in this industry, and new ETFs with a twist could just be what the doctor ordered for investors out there whose primary goal is achieving solid monthly dividends. We'll be monitoring these funds closely over the next few weeks and months to determine if they are appropriate for any one of our advisory services.
Here is a listing of the new WisdomTree funds:
WisdomTree Dividend Top 100 Fund
WisdomTree LargeCap Dividend Fund
WisdomTree MidCap Dividend Fund
WisdomTree High-Yielding Equity Fund
WisdomTree SmallCap Dividend Fund
WisdomTree Pacific ex-Japan Dividend Fund
WisdomTree Pacific ex-Japan High-Yielding Equity Fund
WisdomTree Japan Total Dividend Fund
WisdomTree Japan High-Yielding Equity Fund
WisdomTree DIEFA Fund
WisdomTree International LargeCap Dividend Fund
WisdomTree International Dividend Top 100 Fund
WisdomTree International MidCap Dividend Fund
WisdomTree DIEFA High-Yielding Dividend Fund
WisdomTree International SmallCap Dividend Fund
WisdomTree Europe Total Dividend Fund
WisdomTree Europe High-Yielding Equity Fund
WisdomTree Europe SmallCap Dividend Fund
WisdomTree Japan SmallCap Dividend Fund
WisdomTree Total Dividend Fund
THOUGHTS FROM AN ECONOMIC GIANT
"Government cannot make man richer, but it can make him poorer."
– Ludwig von Mises, free-market thinker and dean of the Austrian School of economics
As we get ready for yet another rate hike by the Fed, we have to keep in mind the damage that has already been done by all of those years of "easy money." The Greenspan years at the turn of the 21st century caused many Americans to borrow recklessly, and caused our personal debt levels to soar to extraordinary heights. It also caused the current housing market bubble. Perhaps worst of all, it's caused so many Americans to just give up on saving money in favor of luxury cars, plasma TVs, outlandishly expensive vacations -- the list goes on and on.
My warning to you is don't be suckered in by the allure of easy money and credit. Devote yourself to saving and investing, and then you won't have to worry when the Fed decides to raise interest rates, or when mortgage interest rates climb, or when bank credit card rates surge. Keep your debt manageable, and keep you savings and investment steady. Don't let the government's policies make you poor!
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Making Money Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars, or anything else.