Wednesday, June 27, 2007

Grim outlook continues; is this what the market needs?

Equity markets yesterday did not make it over the hump as a second day of morning hope dissipated as the trading day developed. Overseas markets are extending the slump today. Today's open may not be so hopeful, so the markets follow through as the day develops will be telling.

Durable goods orders, announced at 8:30am, declined more than expected. This is especially troubling given that the Institute of Supply Management reported in mid-June that manufacturing in May accelerated at its fastest pace in a year. Is a parallel with the housing market developing. Homebuilders continue to build new homes and new housing permits issued have continued to grow despite increasing inventories of new and used homes. Manufacturing expands at the same time that business investment spending appears to be decelerating, which logically leads to higher inventories like what has already become evident in the steel industry.

A bad news is good news mindset would focus on the certainty that the Fed cannot raise interest rates with this quandary so obvious, and that the run up in longer term bond yields, if associated with the expectation of a faster growing economy, will back off. Of course sometimes bad news is just bad news and we'll get near term signals on that in this market day.

The most troubling comment of the day from this perspective came from Stan O'Neal, CEO of Merrill Lynch, who spoke at a London conference and stated that there is "no contagion" from the subprime mortgage issues into other parts of the bond and credit markets. While on the surface that appears to be a constructive comment, it is coming from a seasoned administrator at a firm that is not especially noted for its fixed income expertise and not from a market professional at a fixed income heavyweight. It brings to mind Oscar the Grouch's call to action when faced with a crisis, "Let's Panic".

For now we can just hope for a mirror image of the last few days, meaning a market rebound in the afternoon. Stay tuned.

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