Market Update - October 23, 2008

 

I FEEL LIKE A WRESTLER

 

Over the last week, I have started to feel like a wrestler for the WWF (World Wrestling Federation).  I thought, here I am, a 170 pound weakling being thrown into the ring with a 300 pound guy.  After the gorilla beat me up for about 10 or 15 minutes, I realized that I had survived and I was about ready to leave the ring.  Then the 300 pound wrestler tagged up with his partner, who was a 320 pound guy, and just when I thought I was getting a reprieve, he came in and pounded me again, mercilessly.

I’m sure that is how we all feel after a few months of this market pounding.  It is like we have been pounded mercilessly by the markets with a few daily reprieves of a 900 point up day, a 700 point up day, and two 400 point up days; then without notice the market takes back almost everything it gives us.

What I would like to do at this stage is bring you up to date on a few occurrences with regard to the markets and what is happening.

 

Paulson Speech

Secretary of the Treasury Henry Paulson gave a speech on October 21st, and his key points were as follows:

                               1.            The current challenges in the credit markets will continue for a number of months.

                               2.            The U.S. Government will do whatever is necessary to strengthen the banks and the financial institutions.

                               3.            World governments must continue to take individual and collective action to stabilize the financial markets.

                               4.            The 20 largest countries are supporting the stabilization process.

                               5.            The recent actions of the government and the FDIC are powerful and will unlock the credit markets.

                               6.            China (despite the slowdown) will remain an important engine of financial growth.

                               7.            The world financial markets are undergoing the most serious financial stresses in recent memory.

 

New stimulus package

Yes, Congress has proposed a NEW stimulus package and Fed Chairman Bernanke endorsed the package when he testified before the House Budget Committee earlier this week.  The package could cost between $150 and $300 billion and “seems appropriate” according to Bernanke.

Nancy Pelosi suggested the bill should include new spending on infrastructure, aid to cash-strapped states, extended jobless benefits and possibly a tax cut.  President Bush wants a plan that would “actually stimulate the economy.”

The Democratic leadership is considering calling lawmakers back to town after the election to vote on this package.

My note: Where is all this money coming from?  The printing press must be running overtime.

 

The Credit Markets

In order to understand the credit markets, you need to understand LIBOR.

LIBOR

London Inter-Bank Offered Rate.  This is the interest rate that banks charge each other for loans (usually in Eurodollars). This rate is applicable to the short-term international interbank market and applies to very large loans borrowed for anywhere from one day to five years.  This market allows banks with liquidity requirements to borrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of their asset base as liquid assets.  The LIBOR is officially fixed once a day by a small group of large London banks, but the rate changes throughout the day. It is for non-collateralized loans.

This global inter-bank market provides a means for financial institutions with excess capital to earn higher rates of return by lending liquid assets to those in need of the funds.

LIBOR is important because it is often used as the base for variable-rate government and corporate loans, mortgages, and derivative-based products such as credit swaps.

The Discount Rate

The Discount Rate is the interest rate banks are charged when they borrow funds overnight directly from one of the Federal Reserve Banks.  When the cost of money increases for your bank, they are going to charge you more as a result.  This makes capital more expensive and results in less borrowing. 

The Federal Funds Rate

The Federal Funds Rate is the rate that banks charge each other for overnight loans.  These loans are backed up by the Fed; LIBOR based loans are not.  

“Why would one bank borrow cash from another?” you ask.  The Fed can require banks to keep a certain percentage of assets in the form of cash on hand or deposited in one of the Federal Reserve banks.  From time to time,  The Fed will establish a required ratio of reserves to deposits; when this ratio is increased, more cash must be kept in the vault at night, making it more difficult (and expensive) for funds to be acquired.  When the reserve requirement is lowered, the money supply is loosened; because less cash has to be kept on hand it becomes easier to acquire capital.

The Thaw

There is one positive development in the last week.  The frozen credit markets are slowly showing signs of a thaw.  The three month LIBOR rate on Wednesday the 22nd had dropped to 3.54%, while the Federal Funds Rate was 1.5%.  One week ago the three month LIBOR was 4.64% versus a 1.5% Federal Funds Rate.  This is a very important credit indicator.

 

Type of Rate

10/22/2008

Week Ago

3 Month LIBOR

3.54%

(lowest since 9/24/08)

4.64%

Federal Funds Rate

1.50%

1.50%

 The narrowing of the credit spread between the three month LIBOR and the Federal Funds Rate shows that credit is starting to loosen.  You will hear more and more on the news stations, especially CNN and MSNBC, about the LIBOR rate.  If the LIBOR rate continues to decline, this is a very positive sign with regard to credit loosening.  It is also a very positive sign that the government’s plan is beginning to work.

~ ~ ~  

In the weeks to come, we will bring you more information with regard to what is happening in the markets, what is happening in the economy and what is happening in the credit markets.  We expect the equity markets, as well as the fixed income/bond market to continue to be bumpy for the next several months.  However, there are some positive signs developing, even though the earnings reports of corporations currently are disappointing.

~ ~ ~  

Warren Buffett of Berkshire Hathaway fame wrote in the New York Times recently that he has been buying U.S. stocks.  A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”

Best Regards,

Edward J. Kohlhepp, CFP®, ChFC

Edward J. Kohlhepp, Jr., CFP®, MBA

Note:  Several people have been asking if we would mind if they forwarded our emails to friends and family.  Not only do we not mind, but we appreciate the fact that you value the commentary enough to do so.

 

 

Market Update - October 31, 2008
Market Update - October 16, 2008

Archived Newsletters


Investment Updates

Newsletters Sign Up

Account Login

Contact Info

Kohlhepp Investment Advisors, Ltd.
3655 Route 202, Suite 100
Doylestown, PA 18902
Phone: 215-340-5777
Fax: 215-340-5788
Email: Info@KohlheppAdvisors.com

Securities offered through Cambridge Investment Research, Inc. a Registered Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services offered through Kohlhepp Investment Advisors, Ltd., a Registered Investment Advisor. Kohlhepp Investment Advisors, Ltd. and Cambridge Investment Research Advisors, Inc. are not affiliated.

Due to various state regulations and registration requirements concerning the dissemination of information regarding investment products and services, we are currently required to limit access of the following pages to individuals residing in states where we are currently registered. We are licensed in the following states: AZ, CA, CO, DE, FL, GA, IN, KY, LA, MA, MD, NC, NJ, NY, OR, PA, RI, SC, TX, VA, VT, WA


Check the background of this firm on FINRA's BrokerCheck