Tags: Market | Eye: | The | Friendly | Carrot | Trend

Market Eye: The Friendly Carrot Trend

Monday, 16 June 2003 12:00 AM

The reason is an assortment of carrots.

June 25 the U.S. Federal Reserve will meet and there is widespread expectation in the market that there will be yet another cut in the short-term Fed Funds interest rate, by 25 basis points to 1 percent, or even by 50 basis points, to just 0.75 per cent.

Meanwhile longer term interest rates just keep falling. The yields on U.S. government paper, Treasury bills, are now astonishingly low. Treasuries with a two year maturity are yielding not much more than 1 percent, two year notes a little more than two percent, five years one a little more than 3 percent. Investors have the risk of holding the debt paper of a government whose deficit is soaring. Yet they are paying higher and higher prices for the paper and accepting lower and lower yields. Investments without returns: there will be a price to pay for that in the future.

Meanwhile the low interest rates on Treasuries are echoed in mortgage loans. Freddie Mac, one of the troubled government-sponsored players in the U.S. mortgage market reported last week that the average rate on 30-year fixed-rate mortgages fell to an all-time record low of 5.21 percent for the week ending June 13.

This means, too, that the refinancing bandwagon keeps going: Americans are refinancing their mortgages, cutting their payments, saving money -- and, often, borrowing more than is required to pay off their current mortgage in order to fund cheaply the purchase of a car or some such.

The carrots go on and on. We have not mentioned yet President George W. Bush's latest round of tax cuts.

But the biggest carrot of them all, a sort of 800 pound gorilla of a carrot, if we start to have a bit of fun with mixed metaphors, is that the U.S. economy is on the road to recovery.

Recovery would, of course, justify the bullish trend in the stock market because company earnings would then promise to be higher and the steady rise in the price earnings ratio on U.S. S&P 500 stocks to a current ratio of almost 33 -- higher than at the end of 1999, before stocks began to tumble in 2000 -- would then be less astounding, though probably not fully justifiable.

But will there be a recovery? The positive news today, from the Empire State survey of manufacturing, which showed a jump in manufacturing output in New York state, is another promising morsel that optimistic investors have leaped at. The Dow closed Monday, up by almost 202 points, a rise of 2.2 percent, taking it to an eleven month high.

The news of a manufacturing pick up in the New York area corroborates the findings last week of the Federal Reserve's Beige Book survey of current economic conditions which found New York the most buoyant of four (out of 12) Federal districts showing some economic upturn. Why New York? Perhaps one reason might be that the port area of the city and local exporters are benefiting from the one third fall in the dollar against the euro in the past year.

This week, the Philadelphia Fed survey, to be released Thursday, may possibly also find that the economy is stronger than some months ago. There would be every reason for that to be the case. We have listed them: the carrots. And any good news would help to keep the upward stock market trend going.

But what should give the rational investor pause for thought is that even with so many carrots being fed to it there is still doubt as to whether the U.S. economy is recovering at all, let alone strongly.

The supply of carrots is not limitless. How much lower can interest rates go? How much higher can house prices go? How much more can Americans mortgage their futures? How much more can taxes be cut?

Do very high price-earnings ratios on U.S. stocks find better backing today than they did at the end of 1999 when the market's belief that the US economy would continue to grow strongly?

As we have written previously, both Bush and Federal Reserve Chairman Alan Greenspan are responding to current economic weakness with what is probably the most stimulatory combination of policies the United States has ever seen in peace-time. They are doling out the carrots as though there were no tomorrow.

Our continued advice to investors is to avoid being asses.

Market eye is a weekly column giving an economist's view of the markets.

Copyright 2003 by United Press International.

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The reason is an assortment of carrots. June 25 the U.S. Federal Reserve will meet and there is widespread expectation in the market that there will be yet another cut in the short-term Fed Funds interest rate, by 25 basis points to 1 percent, or even by 50 basis points,...
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2003-00-16
Monday, 16 June 2003 12:00 AM
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