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Being Street Smart 9/26/4


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#1 TTHQ Staff

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Posted 26 September 2004 - 11:29 AM

BEING STREET SMART ____________________ Sy Harding CAN THE ECONOMY WITHSTAND RISING INTEREST RATES? September 24, 2004. The Fed raised interest rates again this week, the third rate hike in as many months, as it continues its first tightening cycle since that of four years ago. Let's hope this tightening cycle doesn't have the same result. Four years ago the Fed began raising rates in June (1999). It had raised rates three times by November, added another increase in February, 2000, and the next month the 1990s bull market ended as the stock market began anticipating the recession that began in 2001. The Fed's move this week, and its signals that more rate hikes lie ahead, is aggressive given the situation in a number of key areas. In announcing this week's hike the Fed said the economy has "regained some traction" since hitting a soft spot in the 2nd quarter, and the employment picture has "improved modestly", so it can raise rates without fear of slowing the economic recovery. The bond market seemed to disagree. Even as the Fed was raising short-term interest rates, bond investors began driving long-term bond prices up, causing long-term rates to decline. This creates what is known as a flattening of the yield curve, which implies that the bond market believes a slowing economy lies ahead. The economic numbers of recent months also seem to raise questions about the Fed's optimism. It's no secret that consumer spending was the driving force that lifted the economy out of the 2001 recession and managed to hold it on a slow growth path in 2002, 2003, and into the spring of this year. But in the 2nd quarter of this year the economy ran into what the Fed called a temporary "soft spot", and while the Fed seems to believe that soft spot is history, the economic numbers haven't been all that encouraging in the 3rd quarter. That's particularly true of those numbers tied to consumers and consumer spending (which accounts for 65% of the nation's Gross Domestic Product). For instance, auto sales weakened significantly in the summer months in spite of very aggressive rebates and financing. Housing and retail sales have become choppy as interest rates rise. The Conference Board's Consumer Confidence Index, which had been rising all year, declined sharply in August. On Friday the National Association of Realtors reported that existing home sales fell 2.7% in August, after falling 2.9% in July. That came on the heels of last week's report that new home sales rose only 0.6% in August, and permits for future construction plunged 5.5%. In the background, on top of corporate loan rates that are rising, oil and energy prices remain high, which raises the operating and shipping costs of manufacturers. It hasn't bothered the trucking, railroad, and shipping companies as they are able to pass the additional costs along to businesses. But it's not good for manufacturers since they can't pass their increased costs along to consumers who are already more interested in buying imported goods than those with Made in America labels. So perhaps it shouldn't be surprising that an increasing number of companies are warning that they are not going to meet current Wall Street estimates for their 3rd and 4th quarters. Reuters Estimates reports that so far in September the pace of 3rd quarter corporate warnings is running at double that of the same period last year. It is encouraging on the energy front that the Administration has finally agreed to allow some crude oil to be taken from the U.S. Strategic Oil Reserves. The rumor of that happening spread on Wednesday. And on Friday, Shell Oil revealed it has an agreement with the Energy Department to receive oil from the reserve to make up for the shortfall from hurricane-hit drilling platforms and backed up oil freighters in the Gulf of Mexico . But the news hardly budged the price of oil, which since falling back to $42 a barrel a couple of weeks ago, has now spiked back up to $48. Put it all together; high consumer debt levels, declining consumer confidence in the face of high energy costs and rising interest rates, questions about the sustainability of the housing market, increasing warnings from corporations, etc., and it does seem like a gutsy move on the Fed's part to raise interest rates again, and indicate that still more rate hikes lie ahead. We'll just have to hope the Fed knows something the rest of the world doesn't, and that they are right in believing the economy's soft spot is history, in spite of evidence in July, August, and early September numbers that seem at odds with that position. Sy Harding is president of Asset Management Research Corp., publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999's Riding The Bear - How To Prosper In the Coming Bear Market, which warned in 1999 of the approaching bear market (and that it would be the most severe since 1929), just 9 months before the Dow topped out on January 14, 2000. Since 1990, Harding has been frequently ranked in Timer Digest's Top-Ten Market-Timers for the stock market, gold, and bonds.