Tuesday, February 19, 2008

Fed Rate Cuts Are Near an End

While many investors are betting the Fed will continue cutting interest rates, I'm starting to believe we are very near the end of this rate-cutting cycle for several reasons.

First, the Fed has already been extremely aggressive with its recent rate cuts, slashing them 225 basis points since September. Because interest rate reductions spur economic activity with a lag, the rate cuts delivered so far are probably just starting to kick in. The Fed would prefer to wait and see if more monetary stimulus is really needed.

Second, the fiscal stimulus package recently signed into law by President Bush takes a lot of heat off the Fed. While tax rebates are not as effective as tax cuts, they do give the economy a bit of a boost. This makes it much easier for Ben Bernanke and the Fed to hold off on further cuts.

Third, the stock market appears to be stabilizing. This also makes it easier for the Fed to stand pat. Bernanke was strongly criticized for reacting more to the stock market than to economic data. He no doubt is hoping stable stock prices persist.

Fourth, recent economic weakness put inflation on the back burner. But inflation cannot be ignored anymore. Any further evidence that headline inflation is creeping into the core rate will make it very difficult for the Fed to keep cutting rates.

The FOMC's next meeting is almost a month away. A lot more economic data will be released between now and then. You can bet the Fed is hoping that more rate cuts will not be needed.

Wednesday, February 13, 2008

Baseball Takes Center Stage in Congress

CNBC has been airing the Congressional questioning of Roger Clemens and Brian McNamee all morning. This is about as interesting as Britney Spears' travails. I thought CNBC was a business channel.

This also explains why we are so turned off by our political leaders. After delivering a fiscal stimulus package, Congress has nothing better to worry about than steroid use in baseball? Is it just me, or does anybody else see a problem here?

Monday, February 11, 2008

Dow Becomes More Finance Heavy

Dow Jones & Co. announced changes to its prestigious Industrial Average today. Altria Group and Honeywell are being dropped. Bank of America and Chevron will be added.

Dropping Honeywell is a bit odd since the company has been doing well for a prolonged period. Honeywell's predecessor company, Allied Chemical, was added to the Dow average in 1925. Honeywell's comparatively small size was cited as the reason for removing it, yet there are three stocks that remain in the index that have even smaller market capitalizations. General Motors, a seriously troubled company, is one of them.

Chevron was previously in the Dow index. It was dropped in 1999 when both Microsoft and Intel were added, which marked the first time (and so far the only time) Nasdaq-listed stocks were added to the index. This raised expectations that more would follow. Some observers are disappointed that today's additions did not include a mega-cap technology company such as Google or Oracle.

Bank of America's inclusion increases the Dow's weighting in financials. The Dow also includes JPMorgan Chase, Citigroup, American International Group, and American Express. Is this the committee's way of signaling a bottom in this beaten up sector?

Monday, February 04, 2008

Bearish on Economy; Bullish on Stocks

The following commentary was released last week to subscribers of the Forbes Growth Investor:

Regular readers know that I have been bearish on both the economy and stocks for quite some time. While I certainly enjoyed the ride, I could not understand why stocks were rallying so strongly during the first half of 2007. Although the sell-off that began in mid-July did not surprise me, I was perplexed by the full and rapid recovery that immediately followed. Unfortunately, as we all know, those gains did not last very long. The S&P currently stands about 12% below its October peak.

It was obvious that economic conditions were deteriorating. There was much discussion about the housing bubble and the subprime mortgage crisis. Every rational investor had to be worried about the potential ramifications of these problems and the real possibility that they would spread to other sectors of our economy. Yet I found it incomprehensible how the eternal optimists kept downplaying these concerns. I don’t know how many times I was told that subprime mortgages represent just a tiny fraction of all mortgages, or that housing prices would never fall on a nationwide basis.

One prominent and perennial bull, who once chided the media for giving bears too much air time, recently argued there is “so little evidence of serious trouble” in the economy. Admittedly, this remark came before the 0.6% fourth-quarter Advance GDP figure was released, and before the Dept. of Labor said initial jobless claims jumped to 375,000, pushing up the four-week average by more than 10,000 to 325,750. Yet there has long been more than a little evidence that the economy was headed for trouble.

As for the argument that subprime mortgage problems would be contained, almost all financial institutions have already announced massive writedowns. This is no surprise. What is surprising, however, is a recent release from pharmaceuticals giant Bristol-Myers Squibb. Bristol said it took a $275 million impairment charge in the fourth quarter due to soured investments in auction rate securities (i.e., collateralized debt obligations backed by mortgages and credit card loans). Furthermore, Bristol no longer considers these investments liquid and has reclassified them from current to non-current assets. I suspect Bristol won’t be the only major non-financial company revealing these kinds of writedowns.

There is much debate about whether or not a recession is coming. In my view, it has already arrived. But whether or not it’s an “official” recession is largely irrelevant. The Federal Reserve is obviously so alarmed it has slashed interest rates at a record-breaking pace without regard to the inflationary consequences. Washington politicians are also alarmed. They are pushing through a fiscal stimulus package many observers thought would take months to reach the president’s desk. This combination of strong monetary and fiscal stimuli will prevent a recession from becoming too deep or prolonged. While I remain bearish on the economy for the time being, as I explained on my blog (http://janjigian.blogspot.com) on Jan. 21, I am turning more bullish on stocks. I believe stocks have fallen enough to be attractive to all investors except those with very short horizons. It’s time to allocate more money to this asset class. This month’s Citigroup recommendation conveys my conviction that some of the best opportunities for long-term gains will come from the oversold financial sector.

Friday, February 01, 2008

We Can Thank Buffett for the Microsoft/Yahoo Deal

Shares of Yahoo soared following today's announcement that Microsoft made a bid for the company. Microsoft is offering $31 per share for Yahoo, which represents a 62% premium over Yahoo's previous closing price.

Microsoft is obviously hoping a Yahoo acquisition will allow it to compete more effectively against Google. Analysts are already debating whether or not the deal makes sense. However, other than the timing, there is really nothing surprising about the deal. As I pointed out last June (Speculating on a Microsoft and Yahoo! Deal) Susan Decker's promotion to president of Yahoo made a deal between Microsoft and Yahoo all the more likely. This is because Decker had also been recently appointed to Berkshire Hathaway's board of directors. Not coincidentally, Bill Gates, Microsoft's founder, also sits on the Berkshire board.

When all is said and done, Yahoo sharesholders should thank Warren Buffett for today's offer from Microsoft. After all, Buffett was instrumental in bringing together the major players in this deal.