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It’s going to be a bumpy ride
Posted by: Dale Franks on Tuesday, January 22, 2008

Well, despite dropping 440 points at the opening bell this morning, the Dow managed to "rally" today, closing down "only" 128 points.

As of right now, action overnight in foreign markets has been mixed.
Signs of slowing growth in Europe and Asia — even in China — have been enough to set off panic selling in those stock markets. Japan's Nikkei 225 Index ($N225) plunged 5.7% to 12,573 Tuesday after shedding 3.9% Monday. Hong Kong's Hang Seng Index ($HSI) plummeted 8.7% Tuesday after falling 5.5% Monday, and India's Bombay Stock Index slumped 5% more after slipping 7.4% Monday.

Things were brighter Tuesday in Europe, where London's FTSE 100 Index ($GB:UKX) was up 2.9% after falling 5.5% Monday and France's CAC 40 Index ($FR:PX1) was up 2.1% after shedding 6.8% a day earlier. Germany's Dax Index ($DE:DAX) was down just 0.3% after plunging 7.2% Monday.
Much of the "rally" in Europe (note the scare quotes by the way, which uses the word "rally" to mean cutting some of the previous day's losses) comes from institutional investors figuring on the ECB dropping interest rates just as the Fed did with a 75 basis-point drop last night.

We've dropped off about 20% from the stock price highs of October, so we're about due for a rally. Especially with the Fed obliging everyone with rate cuts. At this point, though, I'd look askance at any rallies in stock prices over the near term. bear markets, after all, have rallies too, which turn out to be fuel for a little hope before reversing in crushing disappointment. Don't get sucked in by a bear-market rally, especially if the rally is sharp and quick. Chances are that it'll just be a spike in a general downward trend for stock prices. A spike that'll drive straight into your heart if you let it fool you.

But even a sustained rally over a few weeks, unfortunately, really doesn't change the economic fundamentals, which are looking more and more like a recession is in the offing in the near future. The fundamental issues of credit tightening are still there, and that implies greater hoarding of cash as credit becomes harder to get. As the economy slows, of course, earnings will drop, dividends will be cut, etc., bringing stock prices down, with investors moving into bonds or cash.

Speaking of earnings, we're in the middle of earnings season now, as companies post their 4Q 2007 results—that's 4Q for the calendar year, not necessarily the company's fiscal year. A lot of them look nice (financial institutions...not so much), but the real worry isn't how they did last quarter, it's the projection of how they'll do next quarter.

One earnings report to watch this week, though, is Harley-Davidson (HOG). It's a solid company with a loyal customer base—I'm one of them actually—but, motorcycles are a luxury item. For every guy like me that rides practically every day, and uses a motorcycle as their primary transportation—there are about 10 guys that ride for maybe 2,000 miles a year. Or less. Those people are gonna stop riding—and buying—new motorcycles.

In fact, if the rumors are true, they already have, and Harley's results for last quarter will be below analysts estimates. In the last year, Harley sold substantially fewer motorcycles than in 2006. Also, Harley's stock has already lost about half of it's value in the last year already, and disappointing earnings for last quarter won't help.

The thing is, Harley is an interesting proxy for luxury buying. If Harley's sales are looking bad on the 24th, when earnings are announced, that's a pretty good indicator that consumers are shutting off buying non-essentials, a good indication of belt-tightening, and general economic cooling.

So, some things to begin watching closely in the next few weeks are:

* Weekly unemployment claims every Thursday, which is a proxy for increasing or decreasing employment. A moving average above 400,000 indicates increasing job losses.

* The Institute for Supply Management's Purchasing index on the first of the month, which gives you a snapshot of how much activity purchasing managers in manufacturing are pursuing. A IPM index below 50 generally indicates a contraction in the manufacturing sector.

* Durable goods orders on the 29th will give us an indication of whether big-ticket item purchases are dropping off.

* On 30 Jan, the FOMC will make their regular policy statement, which should be interesting after a surprise 0.75% drop in the Fed Funds rate already this month.

* And finally, on Feb 1, in addition to the IPM survey, we've got car sales for January, and non-farm payrolls, which make that a big day.

No doubt many people will be scanning those reports for signs of weakness.

On the one hand, a slowing economy would seem like a (partially) good deal for borrowers, as increasing bond activity should bring bond yields—and interest rates in general—down. But I wouldn't get all excited over that just yet. Financial institutions are carrying a troubling number of potentially non-performing loans in their portfolios, and I suspect that will cause credit standards to tighten, as those institutions retain cash to help cushion the inevitable write-offs that will follow. Moreover, as housing prices continue to drop, banks will be very edgy about extending credit for depreciating assets.

If you have good credit, and had an adjustable-rate mortgage, you might want to begin preparing to apply for a fixed-rate mortgage as rates decline, and getting out of that ARM.

If you can. I suspect a lot of you, sadly, are going to get turned down as credit standards tighten, and house prices continue to decline, but it certainly never hurts to try.
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