Yesterday afternoon, the Federal Reserve lowered the interest rate at which commercial banks can borrow from one another for the sixth time since September 2007, cutting the target Fed Funds rate to 2.25 percent from 3.00 percent.
Stocks prices reacted favorably to the Fed's latest rate cut, with the Dow Jones Industrial Average finishing the day up 420 points from the previous day's close.
However, trading volume was light and all of the major stock market indices failed to break up through price-resistance levels. Two of the day's bigger gainers, Goldman Sachs and Lehman Brothers also ran into overhead resistance, after rebounding from their prior day's losses.
In its statement to the press, the Fed said what I've been forecasting for several months now: "The outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened."
The Fed went on to say, "Inflation has been elevated, and some indicators of inflation expectations have risen."
Gee, what a surprise, inflation has been elevated!
My response: Of course inflation rates have risen. The exchange-value of the U.S. dollar has fallen 12 percent against the Euro and 9 percent against a basket of other major currencies since the Fed began cutting short-term interest rates on Sept. 18.
Other than the expected rate cut, the media attributed much of yesterday's stock market gains to announcements from both Goldman Sachs and Lehman Brothers that their first quarter 2008 earnings "beat analysts' expectations."
I heard little mention, though, of the fact that Lehman's earnings fell 57 percent, while Goldman Sachs' earnings declined 53 percent.
Both Goldman and Lehman also lowered their full-year 2008 earnings guidance on expectations that their underwriting fees for initial public offerings will fall throughout the remainder of this year.
Although my models suggest that stock prices may have bottomed, those models also indicate that stocks will trade in a volatile sideways pattern, at best, over the next couple of months.
The housing market remains in a slump, the employment situation has continued to deteriorate, and growth in personal incomes has fallen sharply over the past few months. In addition, household net worth fell during the fourth quarter of 2007 for the first time since 2002 and long-term interest rates have recently been rising, in spite of the Fed's cuts in short-term rates.
As I stated in an article that I wrote last week, my experience suggests that government agencies will continue to implement measures to prevent a potentially severe recession from occurring this year.
I expect the counteracting economic developments and government actions mentioned above to cause a lot of volatility in equity prices over the coming days and weeks. I therefore urge you to not get too excited about yesterday's stock market rally.
In fact, the market's attention will now likely turn to the significant increase in inflationary pressures, which are continuing to mount
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