Wednesday, January 2, 2008

ISM Index Falls Below 50 For The First Time In Almost 4 Years

The ISM Index was reported today at 47.7%--anything below 50% and the economy is considered to be contracting. The stock market didn’t like the ISM number and in response to the ISM number the Dow Jones was off 220 points and it closed close to the low for the day. This 220-point decline in the Dow Jones, for the first trading day of a new year, is one of the largest declines in history. We have to go back to 1938 to find a worse opening day for the market on the first trading day of the year.

In this decline there wasn’t a typical flight to quality, selling stocks and buying T-Bills, as we have seen in the other declines during the last 6 months. I do need to clarify that statement to make sure you understand what I just said. In the past when the stock markets have had a significant sell off, investors moved their money into Treasuries out of stocks investors were selling risk, stocks and buying safety Treasuries. It is more common for investors, in the flight to quality, to buy the shorter term T-Bills, less than 6 months, because they may want to move back into the stock market and the liquidity of short term of T-bills gives investors the flexibility to sell their T-Bills and buy stocks at a moments notice.

Today was different. The short end of the yield curve, meaning 3 month to 6 month T-Bills were almost unchanged in yield. If we look out in yield curve we find that longer-term Treasuries rose in price dramatically with yields falling. The yield on the 10 year T-Bond was below 4% prices were up just about 1 percent. Why the shift?

If, as was indicated above, when the ISM Index falls below 50%, that is a signal, not the only signal, that the economy is contracting and we may, if the index continues to stay below 50%, be headed for a recession. If the chances increase for a recession then the Fed may have to be more aggressive in reducing interest rates. Lower interest rates mean rising fixed income prices. Investors, at least for today, were saying that there is more opportunity for return in owning T-Bonds than common stocks.

Over the last week we have seen a decline in excess of 500 points in the Dow Jones. The 220-point decline at the start of the New Year digs us a whole that may be difficult to recover from for the full year and produce a positive return for 2008. Later this week we have the jobs number on Friday, but almost as important as the jobs number is the outcome in Iowa on Thursday night. We may wake up on Friday morning with a whole different set of players and questions about other candidates that we didn’t have today.

If as the pundits say, on the Democratic side in Iowa it is dead heat between Barack Obama and Hillary Clinton and Hillary doesn’t win, the markets could take another tumble. All in all this the election, unemployment, and the jobs report could make for a rough start to the New Year. There is an old saying that says so goes January so goes the year. We could be in for a rocky ride in 2008.

Not that anybody noticed, but the price of crude oil traded at $100 today and the sold off to $99.60. Two major milestones reached today, one of the worst starts to a year since 1938 and oil over $100. I think there is better chance of oil continuing to rise than there is upward momentum for stocks for a while.

Dan Perkins

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