Fundamental signs look worse for economy, markets
The honeymoon is over for Federal Reserve Chairman Ben Bernanke. The Fed chairman is facing the toughest test since he took over for Alan Greenspan. As if the real estate problems weren’t bad enough, a report this week showed that the Fed’s chief enemy–inflation–is at its highest level in nearly two decades. Wednesday the Labor Department reported that inflation rose 4.1% in 2007, the worst number in 17 years.
Normally the Fed controls inflation by raising interest rates and tightening up on the money supply. But in a major speech last week Bernanke promised to aggressively cut interest rates to prevent the economy from plunging into a recession. Many economists now predict the Fed will lower rates by a half-percentage point at the end of a two-day meeting on Jan. 30.
There was another economic warning bell last week when it was reported that the nation’s unemployment rate leaped from 4.7 percent in November to 5 percent in December, a two-year high. That raised concerns that consumers, whose spending is vital to a healthy economy, would clamp down and send the economy into a tailspin.
And if anyone needed more evidence that the economy is in serious trouble, it came today when Bernanke, in testimony prepared for the House Budget Committee, addressed the need for an economic rescue package. He said the action should occur sooner rather than later and that the White House and congress can do more than the Federal Reserve alone in providing support for the economy. There was also confirmation from presidential spokesman Tony Fratto that the president believes that some sort of short-term boost is necessary to deal with the softening economy. In the past, economic stimulus has generally included some form of tax cuts.Of course all these negative reports are taking a toll on equity markets–and not just in the U.S. Emerging market funds dropped about 3% Wednesday over concerns about a U.S. recession. After all, U.S. consumers are the major buyers of world goods. If they quit buying, it isn’t just our economy that will take a dive.
The chart below shows the Nasdaq over the past three years. Notice that the current correction is the steepest during that entire time. The Nasdaq is currently about 15% below the peak it reached in October 2007. It is resting right on a key support line shown on the chart by the red line at about the 2380 level. Right now the Nasdaq is back to same level as in early 2006. If it breaks below this area the next support is about 2000.
The bottom portion of the chart is a moving average convergence divergence (MACD) of the Nasdaq. This indicator is at the lowest level of the past three years and is providing no evidence of an immediate turnaround. Fundamentally and technically this is a critical juncture for the markets. Investors holding long equity positions need to be prepared to move to the sidelines if the market continues to drop. At these levels, stocks are on the verge of reversing the long-term uptrend and beginning a new bear market. Normally a 20% drop is considered the level that constitutes a shift to a bear market. So a break below this existing support level would push the Nasdaq very close to that mark.
The markets will be closed Monday for the Human Rights day holiday. For those who get the day off work, enjoy your long weekend.
F.S.
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