Market Struggles As Fed Unlikely To Stop

After a mini rally in the market last week, investors were hopeful it would continue for a little while longer. However as this week has shown, such hope was overly optimistic. The S&P 500 is once again headed back down to its support levels. As much as Wall Street wants Alan Greenspan to stop raising rates, few people really think that will happy anytime soon.

The old adage “Don’t Fight the Fed” continues to hold true. The S&P 500 closed at 1,141 on June 30, 2004. That was day of the first rate increase in 4 years, when the FOMC took the Fed Funds rate from 1.00% to 1.25%. Ironically, the major support level for the S&P 500, which has held throughout 2005, is right around 1,140. Investors trying to fight the Fed have found themselves treading water in a market that has not budged since the first of the eight 25 bp rate hikes.

With earnings still growing nicely, valuations are not stretched by any means at this point. We just need a catalyst. Some economists believe Greenspan could stop right here at 3.00% Fed Funds. Others say he will go to 3.50%. While I am hoping for a stopping point at 3.50%, I truly think we are headed to 4.00%. The FOMC needs to leave itself some room to cut rates if something really bad should happen, and they have a history of going too far.

This time will most likely play out in a similar fashion. If the 10-year bond stays where it is, we might have an inverted yield curve before too long. The Fed might kill the economy trying to preempt inflation and the cool the housing market, even though inflation isn’t really a huge concern at the moment. And besides, mortgage rates are based on the 10-year, not Fed Funds.

All in all, the market will continue to be tough for most, if not all, of 2005, unless Greenspan remembers what happened last time he took rates too high (think March 2000) and decides to be more cautious this time around. Cross your fingers.