The new year on Wall Street kicked off with a bang. The S&P 500 yesterday jumped 1.6%, with all 10 sectors in the venerable index gaining ground as well. The S&P 500, as a result, is again within shouting distance of the highs set last month, which were the loftiest since 2001.
Hope, in short, is alive and well thus far in 2006. But for all the initial celebration, debate about what comes next rages like never before, and with the stakes arguably higher this year than last it’s getting harder for investors to take a wait-and-see attitude.
…..THE BAROMETER OF HOPE
The fun starts with economic prognostications, which were stoked yesterday with the release of the December 13 Fed minutes. For some, the message embedded here was that the central bank would soon stop raising interest rates, a habit in force since June 2004. Old habits are said to die hard, and this one’s proving to be no exception.
But if there’s an end in sight of monetary tightening, it won’t be immediate, or so 29 economists surveyed by Bloomberg News forecast. Rather, another 25-basis-point hike will arrive on January 31, when the FOMC meets next, or so predicted this group of dismal scientists. Richard DeKaser, chief economist at National City Corp. in Cleveland, summed up the sentiment for Bloomberg by advancing the theory that “we’re awfully close to the end of the game. They’ve got another quarter point in them. We’ll see it later this month.”
A belief in the end of the current tightening cycle, whenever it comes, cheered stock investors yesterday, but there are other implications as well, and not all of them are cheery. In particular, what does a cessation of rate hikes mean when the interest-rate yield curve still threatens inversion? One could argue that the Fed is becoming more sensitive to squeezing the economy at a time when anxiety’s once again on the rise about growth. We’ve been there, and done that, of course. But even a broken clock’s right twice a day.
As such, does the traditional message of an impending slowdown or recession still hold in these strange times? Yes, is the short answer from Paul Kasriel, director of economic research at Northern Trust, in a research note yesterday. Although some have said the inversion isn’t meaningful this time around, Kasriel begs to differ, arguing,
In Q3:2005, the annualized growth in real final sales to domestic purchasers was 4.5%. Now, because growth in real consumer expenditures in the fourth quarter will be lucky to be positive, I expect that growth in real finals sales to domestic purchasers in Q4:2005 will be considerably slower than in Q3. Moreover, I expect that a fundamental slowing in final domestic demand is in the offing for 2006.
In short, “the shape of the yield curve is a leading indicator,” Kasriel warns.
But consensus is hardly in abundance with the birth of a new year. David Gitlitz, chief economist for TrendMacrolytics, to cite one name, thinks the brief yield-curve inversion of late all light and no heat. His reasoning boils down to the fact that the real (inflation-adjusted) Fed funds is significantly lower at the moment than when the yield curve inverted in the past. As a result, the recent, and so far fleeting inversion of the yield curve is less than definitive in signaling the approach of economic stumbling. “When inversions have presaged recessions, such as in ’81 and ’00, they have accompanied exceptionally tight monetary policy, with a real Fed funds rate exceeding 4%,” Gitlitz writes in a note to clients yesterday. Yet the real Fed funds rate is just slightly above 2%, he observes. As such, Gitlitz concludes:
Given the ample signs that this economy remains in vigorous health amid solid expectations for sustained growth — including tight credit spreads, rapid growth in household wealth and a highly positive outlook for capital spending — we view the chances as minimal that the curve is signaling that recession or even a significant slowdown is in the offing.
Nonetheless, there’s always a few smoking guns out there to keep pessimism bubbling, and yesterday’s ISM index of manufacturing activity for December is among the more topical ones to arrive, courtesy of its larger-than-expected decline last month to a four-month low. Some economists say that manufacturing, although a shrinking piece of the economy, still harbors clues about what’s coming. As a result, the December slump in this gauge is once again raising a warning flag.
To be sure, the ISM manufacturing index is still comfortably in the black, which is to say above 50 and thereby indicative of growth in the sector. As students of the measure will recall, there was a previous scare last year with this index, when it appeared set to drop below 50, thereby ushering in a recession. But the economy found a second wind and manufacturing activity rebounded.
…..ANOTHER FALSE SIGNAL?
Is another dramatic turnaround in store for 2006? Will consumer spending continue to surprise on the upside? Will Jack Abramoff name more names? Will Ben Bernanke continue lifting rates after he succeeds Alan Greenspan at the end of the month?