Sunday, October 18, 2009

Can the Markets Rise, When Economies Dive?

During the course of an economic cycle, interest rate increases are used to restrain rapid inflation or growth during a bullish market, while rate cuts are used during market mayhem (a bearish market), in hope that the declining rates will encourage consumer consumption, returning the economy to a normal and healthy state.

Throughout this cycle 2003-2009, the Fed has used numerous methods apart from its standard rate cuts to propel the economy. The recent one has been quantitative easing, where central banks have participated in the bond market, while injecting money into the financial system.

Over a year and a half ago, analysts thought the claim that a market recession reaching the scales of the 1930’s depression is ‘farfetched’. To date those investor’s thoughts are quite different as exploitation of the housing sector has caused a snow-ball affect throughout the world economy, forcing government officials to make coordinate efforts to redeem the world’s economy.

Over the last couple of months government interference in the markets has intensified as numerous banks and large caps have been nationalized, to help prevent further loses across the globe. In addition, economic data continues to pour out showing a deteriorating economy, forcing officials to come out with new creative methods.

Despite the negative data and gloomy outlook the markets have recently increased, making investors question as to whether the recent rally is a change in trend or just a simply a bullish rally in a bearish market.
While it is too early to determine any change of trend, one must take into consideration the following:

1) Interest rates reductions or increases can take up to 9 months to leak through the system, affecting the economy.
2) The markets work on expectations; therefore if government officials are aiming for a market turnaround towards the end of this year, the indices will price it in beforehand.
3) Once the indices retrace a fair part of their losses, demand will increase on positive sentiment, driving the markets even higher.
4) Low interest rates will eventually spark demand across the board as consumers will take advantage of the low rates, especially as rates like these might not last.

Last week’s trading session presented mixed signals as the U.S housing sector suddenly showed signs of slight improvement. According to the National Association of Homebuilders, single family homes increased for the first time in seven months, adding an increase of 4.7% to new-home sales. In addition, over the last two weeks of trading the U.S government has addressed the market, stating that it intends to buy back government bonds and the far end of the curve, in an effort to reduce the costs of home purchasing. By taking a look at the homebuilder’s index one can see the recent increase, caused by the improving data and overall market momentum.

Will the Market Rally Continue?

While there is quite a lot of market moving data coming out this week, including the G20 meeting and unemployment results from the U.S on Friday, one must not steer away from the housing sector (the cause of the current economic situation).

Following this week’s U.S manufacturing data, housing figures are expected to be released and could show a further improvement in the sector. In addition unemployment data is expected to show another 656,000 job losses in the month of March. While one might think that the figures are devastating, the markets could react in a completely different way.

During the U.S ‘s last recession (2003-2003) the U.S unemployment rate continued to rise and Non-farm Payrolls decreased, while the markets were forming a bottom. The unemployment rate peaked during the middle of 2003, when the U.S indices were far off their lows.

With the G20 meeting coming up, an interest rate decision from Europe and employment data coming out, the markets could see some profit taking around current levels, accompanied by an increase in market volatility. Just keep in mind that the markets could surprise, especially when investors are already expecting further bad news. A ‘higher-low’ will give confirmation like in 2003.

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