Wall Street Set for Strong Year-End Rally

by John M. Curtis
(310) 204-8700

Copyright October 27, 2010
All Rights Reserved.                                

              Taking some expected profits, the Dow Jones Industrials sold off in advance of Federal Reserve Board Chairman Ben S. Bernanke’s decision to make smaller buy of U.S.  treasuries securities.  Expectations about bigger purchases would have driven down long-term interest rates but potentially weakened the U.S. dollar.  “Because the United Sates’ issuance of dollars is out of control and international commodity prices are beginning to rise, China is being attacked by imported inflation.  The uncertainties of this are causing firms big problems,” aid China’s Commerce Minister Chen Deming.  During the G20 meeting in Seoul last weekend, China was critical of U.S. monetary policy for printing too much money.  China has experience as 3.6% inflation in the last year due to the U.S. dollar’s depreciation.  China’s Finance Minister Xie Xuren urged the U.S. to print less currency.

            U.S. and other G20 nations have tried to persuade the PRC to float its currency, which, invariably, would inflate its value.  Foreign manufactures in China wish to keep the yuan at its current depressed value.  Foreign companies get more bang for their buck when the yuan, relative to other currencies, remains weak.  Bernanke’s recent decision anticipates a higher dollar value, generally good for importing and for U.S. exporting.  China’s foreign minister Xuren, like most U.S. fiscal conservatives, believes in keeping the dollar weak.  Xuren sees the U.S. Fed’s loose monetary policy as devaluing the yuan and hurting dollar as a reliable reserve currency.  When the dollar depreciates, it harms foreign investors expecting financial stability.  Printing too much cash devalues the dollar and drives down the yuan.  Given Xuren’s concerns, Bernanke decided to ease off treasury purchases.

            Reading the tealeaves, Bernanke’s decision to hold off on “shock-and-awe” of heavy treasury purchases caused investors to defensively take profits.  Less treasury purchases means potentially higher U.S. interest rates, signaling Bernanke believes that the U.S. economy is poised for sustained recovery.  “The Fed was out there sending out a message,” said Jay Suskind, senior vice president with Germantown, TN-based Duncan Williams.  “It was a cure for the market that maybe from a commodity and dollar destruction standpoint, those trends went too far,” signaling the Fed’s stronger dollar policy that helps foreign investors.  With all the U.S. government bailouts, forcing the Fed to print trillions of dollars, the dollar was hammered.  Bernanke’s latest move signals that the Fed’s Open Market Committee leans away from deflation and more toward an inflationary bias.

            China currently holds about $890 billion in U.S. treasures, by far the biggest foreign investor.  Over the last two years, the Fed has printed untold trillions to bailout U.S. financial markets, devaluing the currency and causing foreign investors to lose billions from currency devaluations.  Bernanke’s decision to buy less treasuries caused the U.S. dollar to rise against more foreign currencies, enhancing U.S. purchasing power overseas, especially with major commodities like gold and oil.  Bernanke is now poised to buy about $200 billion in U.S. treasures, in contrast to the $2 trillion purchased during the 2008-09 financial crisis.  Expectations of a stronger economy allowed Bernanke to tamp down treasury purchases.  While Wall Street reacts to any change as reason to sell-off, the markets could bounce back when they realize the prospects for corporate earnings look brighter.

             Beranke based his decision on the durable goods number that rose 3.3% in September to an annually adjusted $199.6 billion, more than the expected 2.5%.  Increases in durable goods signals more manufacturing activity, a sign that the economy is coming back to life.  “A lot of rational people were coming out, saying let’s not throw the baby out with the bath water,” said Michael Shea, managing partner in Direct Access Partners, commenting about the bounce back in financial stocks.  He believes the foreclosure crisis will eventually morph into increased real estate sales, another sign that the economy has bottomed out and is on the way up.  Earnings and profit-growth have been generally positive boding well for a strong fourth quarter.  Bernanke’s reluctance to buy more treasuries caused the yield on the 10-year bond to bounce to 2.71%, the highest level in over a month.

              Today’s justifiable profit taking showed that markets may be poised for an upward trend in the fourth quarter.  Bernanke’s decision to buy less treasuries indicates that he sees the economy growing through the end of the year and beyond.  Hedge and Private equity funds are beginning to take longer positions, avoiding the pernicious short-selling that drove markets to new lows in March 2009.  Bernanke listened carefully to China’s concerns at the G20 that printing too much money has real consequences on global markets, including the yuan.  Allowing the dollar to rise should stimulate the Euro Zone and Asian economies, making foreign goods more attractive in the U.S.  Commodity prices, especially gold and oil, should fall with a stronger dollar.  Given more upward movement in the stock market, U.S. corporations should have more cash to eventually add to payrolls.

.About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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