Stock prices rallied yesterday after the Federal Reserve released the minutes to its Sept. 18 meeting on monetary policy. But my models show that stocks are due for a big drop within the next four weeks.
Here's why: The Fed repeatedly indicated in its minutes that it expects economic growth to slow over the coming months due to continuing weakness in the housing market and "some further slowing of employment growth." The Fed also said it expects unemployment to increase.
As a result of the Fed's expectations for a continuing economic slowdown, investors once again think there is a good chance the Fed will continue to lower short-term interest rates at its next meeting on Oct. 31. The Dow Jones Industrial Average rallied on Tuesday 121 points and the S&P 500 Index rose 13, versus Monday's close.
The Fed said that it expects inflation to slow in 2008 and 2009. However, the Fed hedged its comments by saying, "sustained moderation in inflation pressures had yet to be convincingly demonstrated." In addition, the Fed said consumer prices could rise if the dollar were to lose more ground.
Of utmost concern, members of the Federal Open Market Committee said that they expect slower consumer spending in 2008 on a decline in household wealth, slower gains in employment and income, and a drop in consumer confidence.
The Fed's comments probably sound very familiar to those of you who've been reading my recent articles. Just yesterday, I informed you that retail sales in September grew at the slowest pace in the past five months and that consumer spending will likely fall over the coming months due to the continuing decline in housing prices.
So, at the risk of sounding like a broken record, I urge you once again to not get sucked into thinking that equity prices will continue to rise. My investment models suggest quite the contrary — stock prices will big drop within the next four weeks.
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