Wednesday, August 29, 2007

The Fat Lady hasn’t sung yet and may not for a while.

The markets were surprised yesterday at the release of the August Fed Open Market Committee meeting notes. With the market off 150 points markets, they were thinking about interest rate cuts and the Fed announces that it was discussing a rate increase two weeks ago. So, which one, the markets or the Fed is out of sink? As I said last week, I do not think short of a major meltdown the Fed will lower interest rates at the September meeting. Yesterdays almost 300-point decline could be considered a melt down in some places, but I do not think it is enough in its self to move the Fed. Keep in mind that almost half the decline in the markets yesterday came after the Fed release.

Last week people were more upbeat that the correction was over and the markets were heading higher again. The train is leaving the station you had better get on board or the opportunity is going to leave you behind. It appears to me that the train yesterday was at least diverted to a siding or derailed. I have no doubt that the markets will have wild swings up and down, but I do believe the direction of the market has shifted to down and will be down for some period.

By my guess, about 25% of the S&P 500 stocks are related to the housing or credit sector. I do not expect the third or fourth quarter earnings to be good and therefore they will bring down the total earnings for the S&P 500. If the earnings will decline then what is the right earning multiple (price) for the market? Something less than what it is today. It going to be hard for the markets to go up on a sustained basis given the changes in process of re-pricing of assets classes it has to deal with at least until the end of the year.

What is going on in both the credit and equity markets is re-pricing the value of assets. We have not yet figured out what the right price should be and until we do, prices will be volatile.

Dan Perkins

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