Tomorrow's Market Decline Doesn't Matter

The markets had an excellent first half of the week, gaining back some of the losses of the current correction. One explanation that I have seen offered for the lift in stock prices is the expectation that Federal Reserve Chairman Ben Bernanke will announce during his speech tomorrow in Jackson Hole, Wyo., that the Fed will take new, extraordinary actions to address the slowing U.S. economy and the market's dour outlook. If that is true -- and it seems utterly plausible -- then markets will be disappointed tomorrow and U.S. stocks could experience a decline consistent with some of the swings we witnessed this month.

3 reasons that aren't enough
Let's take a look at the main causes of the August correction and whether they'll motivate the Fed to act:

  • Standard & Poor's downgraded the U.S. from triple-A to double-A. The U.S. debt overhang was no secret; instead, S&P were acting on what it correctly perceived to be a deterioration in policymakers' ability to address the problem. In this arena, all the Fed chairman can do is to advise politicians of the risks inherent in an unsustainable debt trajectory (which he has already done).
  • European sovereign debt crisis: Here, the Fed must consider some of the potential knock-on effects if the crisis were to flare up to a new level of intensity. There are some signs of stress in interbank lending markets (the markets in which banks borrow from each other), but we are nowhere near the breakdown that occurred in the wake of the Lehman bankruptcy. Furthermore, the Fed has already taken steps to head off the possibility of a similar situation by renewing its dollar swap lines for foreign central banks, i.e., dollar liquidity that the European Central Bank can lend on to any European bank that is having difficulty obtaining funding in dollars. One unnamed bank made use of the facility in the amount of $500 million. In addition, the Federal Reserve Bank of New York has increased its scrutiny of the American subsidiaries of European banks, demanding that they hold more dollars in cash, in order to minimize the impact of a problem at the European parent.
  • The U.S. economy is showing signs of slowing down and the risks of double-dip recession have increased: These risks fall squarely under the Fed's purview; however, a double-dip recession is no certainty at this stage. Even if it were, the Fed does not have the same margin for maneuver it had last August. Inflation has increased in the emerging markets over the past 12 months; a QE3 could well exacerbate this phenomenon and threaten growth and stability in these markets. This would be particularly problematic with regard to China -- a major contributor to global economic growth right now -- which is already battling inflation.
  • Finally, let's not forget that Bernanke has only recently thrown markets a bone in the shape of an extension of the zero-interest rate policy over the next two years. It's a very dubious notion to believe that he will follow this up so soon with another extraordinary policy measure when very little has changed since he announced that at the beginning of the month.

It's not coming
In sum, investors should expect no announcement of a QE3 or any other extraordinary measure -- it will not be forthcoming from Bernanke. Assuming the market is factoring in a major measure from the Fed (which I do think is the case), there will be a sell-off on Friday that I'd expect to produce a decline in U.S. stocks on the order of 3% to 5%. For short-term traders, this could be a problem -- particularly for those who leveraged.

It doesn't matter
The good news for long-term investors is that whatever the outcome of Friday's speech, either action or inaction on the part of the Fed will have no effect on enduring businesses' value. If you own pieces of these businesses, there is no need for concern. If you don't, know that fractional ownership of some of these businesses are on sale at a discount in the stock market, whether it be Berkshire Hathaway (NYSE: BRK-B  ) , Wells Fargo (NYSE: WFC  ) , Johnson & Johnson (NYSE: JNJ  ) , Microsoft (Nasdaq: MSFT  ) , or, yes, even Bank of America (NYSE: BAC  ) . Looking for more ideas? The Fool has identified 13 High-Yielding Stocks to Buy Today.

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool owns shares of Microsoft, Bank of America, Johnson & Johnson, and Berkshire Hathaway. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of Johnson & Johnson, Microsoft, and Berkshire Hathaway. Motley Fool newsletter services have also recommended creating a bull call spread position in Microsoft, as well as a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 25, 2011, at 3:25 PM, jimmy4040 wrote:

    "there will be a sell-off on Friday that I'd expect to produce a decline in U.S. stocks on the order of 3% to 5%. For short-term traders, this could be a problem -- particularly for those who leveraged.

    It doesn't matter

    The good news for long-term investors is that whatever the outcome of Friday's speech, either action or inaction on the part of the Fed will have no effect on enduring businesses' value. If you own pieces of these businesses, there is no need for concern. If you don't, know that fractional ownership of some of these businesses are on sale at a discount in the stock market"

    How can I politely describe this? Ok let me say that it is as*backwards. Traders are and have been already exiting their positions today and at the end of yesterday. It's the long term holders who will be hurt. Traders will buy back in at a new base perhaps as early as Monday. Long term holders will either be stuck with needing an increase in their stock price of 5-7% just to get back wherre they started from, OR averaging down.

  • Report this Comment On August 25, 2011, at 3:30 PM, jimmy4040 wrote:

    Here's a for instance. A 26% run up in BAC stock in two days, has only brought them back to where they were 10 days ago. Long term holders have made exactly nothing

  • Report this Comment On August 25, 2011, at 5:22 PM, xetn wrote:

    So, you are predicting that Bernanke will not resort to more money creation to solve the problem of too much money creation?

    And you believe that the Fed will not again try to jump start the economy back to growth?

    What else can they do? I really hope you are right and they do nothing. Which is what they should have done in the beginning,

    But then, who is going to be purchasing all of the US's debt? China, Japan? Neither? If the neither, then it will be the Fed. So the same result.

    The idea that you can cure the "too much debt and too much spending" with more of the same, amounts to insanity.

  • Report this Comment On August 25, 2011, at 5:39 PM, Quaker08 wrote:

    Does anyone really expect a Fed miracle tomorrow?

    If no one thinks it will happen, there will be no surprises.

    Everyone seems to know tomorrow's Fed meeting will "produce a decline in U.S. stocks on the order of 3% to 5% "

    I'm not saying it won't happen. I just don't know.

    "Nobody goes there anymore. It's too crowded." Yogi Berra

  • Report this Comment On August 25, 2011, at 5:44 PM, TMFHousel wrote:

    <<A 26% run up in BAC stock in two days has only brought them back to where they were 10 days ago. Long term holders have made exactly nothing.>>

    Lord help us when 10 days is considered long term.

  • Report this Comment On August 25, 2011, at 6:41 PM, 123spot wrote:

    rec+, Quaker. (Although I'm pretty sure the market is going to go up on a lack of Fed intervention ; ). Spot

  • Report this Comment On August 25, 2011, at 7:40 PM, TMFAleph1 wrote:

    Fed Chairman Bernanke is justifiably concerned about the European sovereign debt situation, but no amount of quantitative easing by the Fed will prevent it from metastasizing into a crisis of unpleasant proportions (as it looks increasingly likely to do -- European politicians are doing their damnedest to bring one about.)

    Alex Dumortier

  • Report this Comment On August 25, 2011, at 9:51 PM, extremist wrote:

    If the markets were anticipating QE3, I seriously doubt gold would have dropped $200 in two days, margin hikes or no margin hikes. I don't believe markets will drop on a ho-hum speech from Bernanke -- in fact, just the opposite. There should be a moderate, if not massive, rally if the Fed displays confidence in a recovery.

  • Report this Comment On August 25, 2011, at 10:03 PM, Momentum21 wrote:

    "I don't believe markets will drop on a ho-hum speech from Bernanke -- in fact, just the opposite. There should be a moderate, if not massive, rally if the Fed displays confidence in a recovery."

    If I were going to try and "game" tomorrow's statement I would agree with this comment from extremist. A bold step into QE3 might lead to a short-term rally but I think the implication would be extremely negative since this in fact would be symbolic of the last bullet.

    Those that are leveraged have already gotten their a$$ handed to them which explains the deep correction we have experienced.

    But my guess is as good as any...

  • Report this Comment On August 25, 2011, at 10:14 PM, jimmy4040 wrote:

    TMF:

    Nice non-sequitur. Way to avoid the point that if you bought BAC for the "long term" especially by dollar cost averaging, you just own more of a bad company, not a bargain.

  • Report this Comment On August 25, 2011, at 10:16 PM, jimmy4040 wrote:

    Alex:

    Agree with yours

  • Report this Comment On August 26, 2011, at 11:17 AM, TMFAleph1 wrote:

    Almost two hours into the trading day, and it appears that I was entirely right that Mr. Bernanke would not offer a specific policy measure to address the weakening economy, but I was entirely wrong that the market was expecting one.

    I thought I was taking a contrarian view, but it turned out to be the consensus view. I sometimes think that one of the market's functions is to keep investors and commentators humble... On to the next forecast!

    Alex Dumortier

  • Report this Comment On August 26, 2011, at 1:47 PM, jimmy4040 wrote:

    Alex:

    Today is a one off event. You can't sustain stocks, bonds and gold rising in price together. All this means is the only paragraph the market is reacting to is the one about revisiting stimulus in September.

  • Report this Comment On August 26, 2011, at 3:04 PM, Frankydontfailme wrote:

    Agreed Jimmy. Very frustrating. Can't Bernanke just shut up and let the markets equilibrate?

    Until he shuts his mouth, we will not be able to get back to long term investing.

  • Report this Comment On August 26, 2011, at 6:09 PM, jimmy4040 wrote:

    Alex:

    that ship has sailed.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1544293, ~/Articles/ArticleHandler.aspx, 12/20/2014 3:23:09 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement