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:: July 2003 | Page 4 of
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AN HYPOTHESIS
If our view of Fed strategies and responses has merit, an
intriguing hypothesis emerges. The Fed is avowedly concerned
about deflation (we almost said “tilting at the windmill
of deflation”) and has pulled out all the stops in
terms of using its interest rate ammunition. Manipulating
interest rates is a blunt and sometimes slow-acting instrument
because it affects actions by consumers and market participants
indirectly. The next step, if the interest rate medicine
does not affect the cure of revitalizing the economy, is
to inject the maximum amount of liquidity into the financial
system.
This pattern sounds a lot like a repeat of the events of
the Fall of 1999, when the market took off for reasons not
well understood at the time. As we suggested earlier, it
likely was driven by a huge liquidity injection by the Fed.
We could be seeing a replay. The Fed may have exhausted the
interest rate option and now must play the liquidity card.
If this hypothesis (and it is not much more than that at
this juncture) turns out to be useful, we may see a stock
market that has a significant further advance, attracting
some of the huge amounts of money sequestered in money market
funds, certificates of deposit and bond holdings. Such a
market would exhibit periods of strong advances, interspersed
with brief pullbacks. In this environment, active management,
prudent stock selection, and attention to value would be
vital to protect capital against the developments of another “bubble” in
equities.
Your thoughts and comments are always welcome.
Sincerely,
Johann H. Gouws, CFA
President
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