The stock market held up better than we expected today in the face of 5 to 10% declines in the European and Asian markets during the past week (some markets were down more). The Federal Reserve cut rates in an effort to blunt any panic selling that might have taken place without the cut. The Fed said they would continue to supply liquidity to the system if needed. They also stated that due to the weakness in the economy, they were considering the cut even before the tragic incident of last week. With the incident, it was a “no-brainer”. The ECB and Canada followed with a 50 basis point rate cut that makes you think this was a coordinated move. The European markets all closed up today after the coordinated rate cuts. There were other measures taken that were attempts to stem the decline such as relaxing the rules on stock buybacks.
A Ned Davis Research study published in the Wall Street Journal today showed the percentage movement in the Dow Jones Industrial Average immediately after crises events and 126 days after the initial reaction period (page C-2). Although in most instances the Dow declined in the short-term, there was only one longer period, the 126 days after Pearl Harbor, which showed a decline worth talking about, and that was a little less than 10%. All others showed positive returns except a very small loss 126 days after the U.S. bombing of Libya. This seems encouraging, but we believe there are extenuating factors this time that were not in existence during any of the other crises. The main difference is the fact that the largest financial bubble in history broke 18 months ago. The second difference is the unprecedented level of public participation in the stock market.
According to Investors Business Daily “surprise non-financial events – such as acts of war, terrorism and assassination – usually have a brief and sometimes dramatic negative effect. But then the market’s prevailing trend, whether up or down, reasserts itself”.
We happen to agree with the statement from Investors Business Daily and the prevailing trend before the crisis was definitely down. With the major indices continuing to break down below their March and April lows we believe that any bounce back towards these lows will probably be an opportunity to sell stocks, not because of the terrorist action or the new war on terrorism, but for the same reasons reiterated in the daily comment dated 9-13-01.
The fiscal floodgates have opened and will continue to open as Congress approves funds to rebuild lower Manhattan and help industries such as the airline industry. The weak economy accompanied by these fiscal policies could wipe out the budget surplus for this year and the future. We believe the Fed will continue to lower rates to accommodate an economy that was showing increased weakness and lower consumer confidence even before the terrorist attack. As we stated in our daily comments dated 7-6-2001 “Deflation”, and 8-21-2001 “All Eyes on the Fed”, when Fed Funds get down below 3% there will be a recognition that the Fed is closing in on 0%, where they run out of ammunition. It looks to us that the 2% handle on Fed Funds is not too far away and even if that slows the market decline, the perception of the Fed running out of basis points could eventually lead the market much lower.