Ticker Sense

Are Rate Hikes Good or Bad

To the surprise of all but one economist (out of a poll of over 50), earlier today the Bank of England raised interest rates by 25 bps.  The move quickly sent the FTSE 100 down nearly 1% from its intraday highs.

Last week, we asked if investors were missing the bigger picture regarding Fed rate hikes.  When the Fed (or any other central bank for that matter) raises interest rates, they are usually doing it as a pre-emptive strike to keep the economy from becoming too overheated and causing inflation.  When they cut rates, it is usually meant as a crutch to support a weakening economy.  With this in mind, interest rate hikes are not necessarily a bad thing.  Which would you rather have -- a broken leg that would probably heal just fine with some therapy, or a perfectly healthy leg that simply needs a rest?

Getting back to the Bank of England and the FTSE, it appears that after that initial sell-off this morning, cooler heads prevailed as the index has since recovered its losses (and then some!) from the initial rate decision.

Weaker Than Expected CPI

Today's CPI report for November came in weaker than expected on all fronts.  This confirms the thesis we began discussing in the Summer that inflation was trending lower. On the news equity and bond futures have spiked higher and also pushed European markets further into positive territory for the tenth straight day.

Who's Got It Right? Stocks or Bonds

Over the last few days, we’ve been witnessing a somewhat unique event in the markets, as both stocks (S&P 500) and bonds (US long bond future) have been trading at or near 52-week highs. Since 1982 there have been sixteen prior periods where this occurred.

Since strength in the stock market is generally regarded as a sign of a strong economy, while rallies in the bond market usually imply a weakening economy, investors are waiting for a resolution, or at least wondering who has it right - the bond guys or the stock guys. Conventional wisdom says that when it comes to the economy the bond market usually has it right. We put this argument to the test and provided the results below.

While both asset classes have continued to gain in the weeks and months following prior occurrences, we found that following 100% of the prior occurrences where stocks and bonds hit 52-week highs, stocks have been higher six months later for an average gain of 8%. Bonds have averaged a gain of 4.1% and risen 75% of the time. 75% is pretty good, but stocks have been right 100%, which makes you wonder why so many people say the bond market usually has it right.

CME Housing Futures Update

S&P/Case-Shiller recently released their September home price data.  Since the CME now trades futures based on the S&P/Case-Shiller home price indices, we looked to see what the February, May and August 2007 futures are forecasting.  The table below shows the expected percent change in single family home prices in the ten cities that Case-Shiller tracks as well as a composite for the entire country.  The change is calculated from the most recent September actual data (the data lags two months) to the 2007 months when the futures contracts expire.

Inflation and The ISM

This morning's CPI report once again confirmed what the ISM commodiites survey has been telling us for some time- inflation is trending lower.  Below we have updated our chart of the ISM commodities survey vs. the year/year CPI.  As the chart details, last month's decline in the number of commodities rising in price correctly anticipated today's decline in the CPI.

Economic A/D Line

Today’s release of the minutes from the Fed’s October meeting showed that Fed governors saw a decline in the risk of downside growth. With that in mind we updated our economic indicator Advance/Decline line where we calculate the net number of economic indicators which came in stronger than forecasts over a 25 day period. As the chart details, we are well off the lows we saw in August, but still remain in negative territory i.e,. the economy continues to surprise to the downside.

This chart also illustrates how most of the indicators we spend so much time analyzing are rear view in their nature. In late September, when this indicator was at its lowest reading in over three years, the Dow was hitting new highs for the year and on its way to new all-time highs.

Tuesday's PPI Report

In addition to advance retail sales at 8:30, traders and investors will also closely be watching the 8:30 release of the October PPI. Many of you may recall the market’s sell-off last month following this report when even though the headline PPI came in lower than expected, the core reading showed a larger than expected gain (see table below). Although the S&P 500 only finished 5 points lower that day, on an intra-day basis, the market was down by nearly 1% before rallying back.

Last month’s report also illustrates the difference between the investors and emotional money. When the report came out, emotional investors blindly sold positions on fears that inflation was too high which is bad for stocks. Investors, on the other hand, combed over the report and saw that most of the gain was due to seasonal adjustments in new car price component.  Seeing that the upside surprise was more of a statistical anomaly than runaway inflation, they took advantage of the weakness and are now sitting on a nice gain of over 2%. Keep that in mind Tuesday.  Before making any quick decisions, make sure your logic is sound.

Update:

The release of today's PPI report came in weaker than expected on all fronts.  Also noteworthy is the fact that the gains we saw in Motor Vehicles and Light Trucks last month were more than completely reversed this month. Passenger Car prices which rose 2.8% in September fell 2.3% in October, while Light Truck prices which rose 3.5% last month, fell 9.7% this month.  So once again, the main culprit to the shift in prices was centered in the motor vehicle space.

Election Issues

Besides the issue of Iraq, one of the major campaign issues in this year’s mid-term elections concerns fiscal responsibility. Democrats argue that spending has spiraled out of control, while Republicans counter that since our country is at war, temporary increases in spending are justifiable (I guess it all does come back to Iraq after all).

Putting our national debt in perspective however shows some interesting statistics. Looking at the current debt levels of the G7 countries (courtesy of Bloomberg) shows that total debt as a percentage of GDP in the US is lower than every country except the UK. So while debt in the US may be high, its minor when compared to the debt of other countries.

How does this all matter to us as stock investors? What does the stock market think about the current level of debt? As the lower chart highlights, not much. Based on the performance of each country’s equity market since 2001 (when George W. Bush took office and spending increased), there appears to be little connection between low levels of debt leading to better equity market returns. If anything, the higher the debt, the better the markets performed, as Japan and Canada have had the best returns and they have two of the three highest levels of debt as a percent of GDP.

Futures Update

Let's continue our recent habit of checking in with the prominent online futures markets (sometimes referred to as "prediction markets" by wisdom of crowds devotees) as to what their last-minute bets on the races look like.

According to Tradesports.com, the GOP is losing steam in the race for House control but still looks to maintain its grip on the Senate.

GOP House and Senate Control Contracts (quotes as of approximately 9 AM EST):

Meanwhile, the Iowa Electronic Markets are telling essentially the same story, giving the Republicans a solid 70% chance to hold the Senate but over an 80% chance of losing a significant number of House seats.

Updated Futures on Tomorrow's Elections

With voters hitting the polls on their way to work tomorrow morning, we thought we would take one last look at what Internet futures speculators are expecting from Tuesday's elections.

Tradesports' GOP Congressional Control Contracts (click to enlarge):

Iowa Electronic Markets' GOP House Control Market:

Iowa Electronic Markets' GOP Senate Control Market:

For explanation of the definition of "Gain," "Hold," and "Lose," see our first post on this subject.

As you can see, both markets are confident in a Republican Senate and a Democratic House when the dust settles.