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January 21, 2004
Pleading Ignorance in The Land of Bliss

January is nearly over and few new themes in the financial markets have arrived. Rather, U.S. stocks are strong but probably toppy, the dollar is weak but potentially close to a near term bottom, and commodity prices are generally firm. As for U.S. interest rates, thanks to a soft jobs report and a continued promised from the Fed to keep interest rates low, no trend higher has emerged (as many analysts suspect soon will).  Rather, U.S. interest rates - which are the most watched indicator in the financial world today - have not seen any noteworthy gyrations since mid-2003.


Suffice it to say, until interest rates begin to tell the markets that the party is over the prospect of a stock market route seems remote. Granted, expectations that call for stellar profit growth this year could prove to be overly optimistic, and there has been some evidence that speculators are dumping stocks as soon as companies report earnings (‘sell the news’). However, the U.S. stock markets – fully liquefied by more new inflows away from fixed investments (i.e. sell bonds/money markets and buy stocks!) – are likely to generate a churning action rather than burning action until something unexpected happens.   

What might the next unexpected event be? Well, rising commodity prices – specifically energy prices - are becoming a more ominous threat to the economy.  And while hardly a new threat, a relatively new danger is that OPEC will continue to raise the price it wants for its oil if the dollar continues to fall and/or that OPEC will opt to start receiving payment for oil in something other than U.S. dollars*.

But the oil threat is hardly isolated to the unpredictable mandate of OPEC.  Rather, thanks to more demand for oil coming from in China, cold weather in America, and a 28-year low in U.S. oil stocks, the general threat is that current strain on supplies will persist for some time.
 

Rising oil prices and supply issues aside, the threat of oil alone stifling economic activity seems remote.  Rather, and if nothing unexpected happens, rising energy prices should be handily offset by government and Fed stimulus in the near term.  Longer term is another story, and relates to the story of a ‘post stimulus’ meltdown in America.


Suffice it to say, it is difficult to forecast what will happen to rattle U.S. financial markets.  Rather, the speculation from the uneasy equity investor is that purchasing stocks with a momentum approach is too dangerous; that stocks will fall hard when the music stops.  This is a speculation I continue to make – pleading ignorance while the financial markets enjoy a brief period of bliss.

Whatever the trigger is, it will be ultra important to keep an eye on U.S. interest rates. Greenspan and company are trying to goad other central bankers into cutting rates to try and create stronger markets for U.S. wares.  If these central bankers refuse to follow orders the U.S. dollar could come under further pressure…You have to wonder just how long the current dollar/interest rate environment can be supported by primarily Chinese and Japanese Treasury purchases…

*Incidentally, as of November 2003 OPEC owned $43.9 billion of U.S. Treasury Securities (this represents less than 3% of the outstanding total held by foreigners).

BWillett@fallstreet.com