Markets brace for economic stall after interest rates rise

Overview and Observation: U.S. President Franklin Delano Roosevelt once made the statement that “you have nothing to fear but fear itself.” That may have applied to that time in history, but investors are finding that “fear” may be appropriate now. Their worst fears are coming to fruition as U.S. interest rates rose this week creating the potential for “stalling” what has been an “economic improvement” albeit slow, in the housing and mortgage markets. With better than forecast data on business activity, consumer confidence and expectation for a U.S. Federal Reserve scaling back of its stimulus programs, a real “fear” has developed. The Thomson Reuters/University of Michigan final index of consumer sentiment rose to 84.5, the highest since July of 2007, from 76.4 the prior month leading to expectation of the Federal Reserve scaling back of monetary stimulus.

We can only assume that the “question” of confidence was posed to “shoppers” leaving the mall with packages. The rest of the public, especially the 350,000 first time unemployed reported on Thursday are probably “not so confident.” This coming Friday we will see the all important jobs data issued by the Labor Department and it will be a defining factor in the marketplace going forward. The “fragility” of not only the U.S. economy but the global economies as well is being “muted” by the continuing rhetoric pronouncements of “recovery.” We do not see real evidence of a recovery but rather a “house of cards” ready to implode at any time. Now for some actual information…

Interest Rates: September U.S. Treasury bonds closed Friday at 140 8/32nds, down 8/32nds for the biggest monthly decline since 2009 as indications that the Federal Reserve may cutback on its monetary stimulus program. The improvement in U.S. economic data appears sustainable by the investment community and that could prompt higher rates. That being the case it would negatively impact an already fragile U.S. economic recovery and lead to sharp corrections in the U.S. equity markets. This Friday we will get the jobs report, which is expected to show the U.S. added 165,000 jobs in May and that the unemployment rate stayed at the four year low of 7.5%. However, with the weekly jobs lost (by virtue of first time unemployment applications) of 350,000 against that expectation, we do not see any improvement in the all important labor situation in the U.S. European unemployment data is mixed with some ranging as high as 12% in some quarters. Our overall view of global economies continues to reflect our assessment of recessionary trends and cannot be simplified by “optimistic” rhetoric. I would suggest hedging your positions by adding a few bond calls to your portfolio.

Stock Indexes: In Dante’s “Inferno” the inscription at the gates of Hell “Abandon hope all ye who enter here” could easily apply to an imaginary “plaque” over the entrance of some brokerage firms. If our assessment of a severe market correction comes to fruition, investors may once again suffer the consequences of not preparing for what we feel is an “eventuality.” On Friday the Dow Jones industrials closed at 15,115.57, down 208.96 points or 1.4%. Over 7.5 billion shares traded on Friday. When I first entered the brokerage business as a clerk on the floor of the New York Stock Exchange in 1959, the volume was around one million shares and not many households owned stock. Today nearly every household owns stock in one form or another, either money market, mutual funds, or outright ownership of individual securities. If another sharp correction were to occur, the loss in dollar could once again be in the trillion with a “T” category and further exacerbate an already, in our opinion, fragile economy with reduced spending and higher unemployment. For the week the Dow lost 1.23%. The S&P 500 closed at 1,630.74, down 1.4% and for the week lost 1.13%. The tech heavy Nasdaq closed at 3,455.91, down 1.01%. For the month, however, the Dow posted a gain of 1.86%, the S&P 500 2.08% and the Nadaq 3.81%. We view those monthly gains as a potential “last hurrah” and once again suggest strongly the implementation of hedging strategies.

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