It has been almost ten full months now since the Fed first lowered interest
rates. If you remember at first there was a lot excitement over the Fed cuts.
The DOW and Nasdaq rallied to new 52-week highs a few weeks after the first rate
cut in September. The rally and promise of more Fed intervention for the market
made many big name commentators extremely optimistic about the market.
But just a few weeks later the market turned lower and has been stuck in a
bear market ever since. The banking problems multiplied and inflation
skyrocketed with oil rising almost double in price now from where it was a year
ago. The rate cuts tasted good at first, but are no longer palatable.
When thinking about the financial markets sometimes it is best to take stock
of things before trying to look ahead and decide if you need to make changes to
your portfolio or figure out where to look for the best investment
opportunities. I think a lot can be learned about looking at where the market
was a year ago and comparing it to today.
A year ago from today the DOW, S&P 500, and Nasdaq were all climbing
higher. They had experienced a fast and furious correction that took the S&P
500 down over seven percent in February of 2007. The financial media blamed that
quick correction on "credit worries," a fast drop in the dollar versus the yen,
and a huge correction in the Chinese stock market. Rumors also circulated that
some billion dollar Bear Stearns hedge funds were in trouble.
Over the next few months as the market went higher everyone thought that all
of these problems were gone. Then the financial press started to focus on oil
prices that were making new highs and the threat to inflation that they posed.
In July the market peaked as talk intensified that the Fed might actually start
to raise interest rates by the end of the year. Indeed Fed fund futures a year
ago were pricing in rates hikes by the end of 2007.
Fed officials gave repeated speeches and statements that sounded hawkish on
interest rates. At the same time though the drop in real estate prices started
to pick up and the value in "subprime" mortgage securities went into collapse.
Rumors abounded that several large hedge funds were in trouble.
The Fed publicly ignored all of this. At its August FOMC meeting they
released a more hawkish statement on inflation to prepare the way to raise
rates. The market dropped hard that day and James Cramer blasted the Federal
Reserve and Ben Bernanke on TV for knowing "nothing." His statement was one of
the most watched moments in financial TV reporting as people watched it millions
of times on the Internet.
At that moment he was right. Within two weeks the market went into a
mini-crash and the Federal Reserve lowered the discount rate in what looked like
a panic move. The value of "subprime" securities went to zero. They are still
being counted as "level three" assets on the balance sheets of some of the
world's largest banks but in reality they are worthless and have been worthless
since last August.
The Fed changed course 180% degrees in August and began to slash rates in
September.
