The Stock Trader's Almanac

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Almanac Investor Alert
Chairman Bernanke's Defining Moment
1/24/2008

Weekly Changes

DOW 12378.61 219.40 1.80%
S&P500 1352.07 18.82 1.41%
NASDAQ 2360.92 14.02 0.60%

We believe that the stock market’s near term future is steeped in investors’ faith in the Federal Reserve’s handling of the economy. This is obviously not an epiphany. Fed policy has been an aspect of the U.S. economy since it was chartered in 1913, with its power increasing ever since. The august FOMC, which did not convene until 1936, has grown and evolved in lock-step with the economy. Simpler times called for simpler policy. Today the U.S. has the most complicated economy in history, and the Federal Open Market Committee has become more than just a steward. We expound on this theme in the Proving Grounds in the current issue of the Almanac Investor. Welcome to the era of the proactive Fed!

The Chairman’s unprecedented emphasis on transparency is new. 24/7 business news channels, as well the main-stream media outlets have access to information that traditionally has been shrouded behind the curtain. Professor Bernanke loves open debate and free discourse around his table; his recent predecessors, namely Volker and Greenspan, ran a tight ship and limited access to their inner sanctum.

Federal Reserve Chairmen have traditionally communicated in parable, in the foreign tongue of “Fed Speak”. Bernanke, being the consummate academic, lectures to us as if we were enrolled in his macroeconomic class at Princeton. He wants us to understand and learn from his lectures. He realized quickly though that loose lips sink ships. Who can forget when news of a private conversation between he and Maria Bartiromo tanked the markets?

In fairness, we have commended Mr. Bernanke frequently in this space as well as the Almanac Investor. He has done a good job in a difficult environment. Many of the problems currently weighing on the market were, at least in part, inherited. Since taking the reins in February 2006, he has guided the economy through a credit crunch, the deflation of the housing bubble, inflation percolating to the top of his acceptable range, and soaring energy prices to name but a few of the troubles that, thus far, have not completely derailed the markets or the economy.

It is, however, perception and faith in the Fed that is most important. As the economy steamed along and the markets surged to all-time highs, few had anything bad to say. After all, according to the data, jobs were plentiful, inflation was in check and a recession seemed implausible. The primary mandates of fostering growth and containing inflation expectations were being met.

But now, people seem to be getting nervous not just on Wall Street, but Main Street as well. The interim 75 bp cut in the Fed funds rate on Tuesday garnered massive media attention. Headlines from Boston to Boise alerted casual observers on the economy to an “Emergency Rate Cut.” The crawl tracked Wall Street’s wild ride. Just this morning at the coffee shop, one of our buddies, (who knows nothing about the markets), commented that Bernanke is messing up. When asked what he meant by that; he shrugged his shoulders and went back to reading the NY Post (a local daily rag). It is one thing to discuss monetary policy at the Bull & Bear Pub after the trading day, but when Fed Policy becomes fodder for coffee klatch kvetching in Nyack, you know that Bernanke is skating on thin ice.

Another warning sign that the Fed may be losing control of the situation is the recent stimulus package proposed by Congress. Is dropping $300 checks from the federal helicopter really the answer to the slowing economy? It is indeed, a quick fix, as politicians love to give out money, but it didn’t really work the last time they tried it during the recession in 2001. We will be analyzing in detail the history of economic stimulus packages and their effects on the economy and the markets in next month’s Proving Grounds. Spoiler alert: one has never been attempted before we were in a recession. It begs the question of whether or not next week’s Q4 GDP may indeed be negative, and do the Fed and the Congress already know this.

Which brings us to Bernanke’s defining moment. Next week, on the 29th and 30th the FOMC will meet for two days of policy formulation. Coincidently, on the 30th, the same day that the FOMC will announce if there is another rate cut, the Advanced Q4 GDP will be released. This may be the single most important policy decision of his two year tenure. The Faberge economy is in the balance. If GDP is bad, and The Street is uninspired by the Fed, we could be in for more trouble. Conversely, this could be Ben Bernanke’s moment to shine. Regardless, the near-term direction of this wildly-vacillating market will be a heck of a lot clearer.

STANDARD TRADING GUIDELINES!
BUY LIMITS ARE GOOD TILL CANCELLED.
ALL STOPS EFFECTIVE ONLY WHEN THE STOCK CLOSES BELOW THE STOP PRICE.
ALWAYS SELL HALF ON A DOUBLE.

Please Trade Carefully.
Jeffrey A. Hirsch, Editor
J. Taylor Brown, Director of Research

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