Bad Economic News…Good for the Stock Market?!

The mortgage industry melts down, credit markets tighten, home prices plummet, the dollar falls and oil prices reach a record high of nearly $84 a barrel. Naturally, the stock market was up for the quarter -- go figure. After the Federal Reserve cut rates 50 basis points, the equity markets rallied and erased their previous losses posted in July.

The S&P 500 was up 1.6% for the third quarter and 7.6% (excluding dividends) year-to-date. International markets, as measured by the MSCI EAFE Index, were basically flat for the third quarter and are up 10.9% year-to-date.

Here is the good news; the futures market has currently priced in two more Fed cuts by the end of the year. This would leave the WSJ Prime Rate, currently at 7.75%, somewhere around 7% at the close of the year.

Pre-election Years May be Good for the U.S. Stock Markets

Since 1950, pre-election years like 2007 have produced an average return in the S&P 500 in excess of 19%. Thus we may be looking at a positive 4th quarter, even with a potential recession looming in 2008.

Now the bad news; inflation fears spooked the bond markets causing long-term rates to rise and the dollar to fall. According to economist John Mouldin, “The last three times the Fed initiated a new easing cycle, 10 year bond yields dropped 20 basis points or more in the next five days. This time they rose 20 basis points. Since mortgage rates are typically geared off the yield of the ten year Treasury bond, this is a cut that has not helped the consumer as of yet.”