[From Rick Marken (2000.01.03.1510)]
The Fed cut interest rates today and the stock market surged.
Nearly every report attributed this surge to investor hopes
that the lower cost of money would keep corporate profits high.
I think there is a much simpler explanation. Investors are
controlling for the rate of increase in their investment.
When interest rates go down, the rate of increase in interest
based investments goes down. So the stock market becomes a
better place to park investment money than, say, T-bills or
variable rate mortgages. One way to test this (to see whether
the composite stock market investor is controlling for corporate
profits or, simply, rate of increase in its investment) is
to see if there is any relationship between the rate of growth
of, say, the Dow Jones index and rate of growth in corporate
profits over time. I'll try to find that data but maybe
someone like Norman Hovda already has it.
The interest rate cut is also great for testing leakage theory
(in a general sort of way). If interest rates remain low or even
keep decreasing, we should see (through the first few months of 2001
at least) a decrease in inflation and a steady rate of growth (say
at 3.5%). If Bush is able to get a relatively healthy _across the
board_ tax cut and/or an estate/capital gains tax cut implemented
by the first congress, however, we might see increased leakage; this
would happen if Congress cuts spending to make up for revenue loss.
This leakage would lower growth (possibly even creating a recession)
and increase inflation a few months after it is implemented.
So my leakage based economic prediction is: steady growth sans
inflation throughout 2001 and then a slowdown (and possible
recession) with increasing inflation in 2002 if there is a
significant tax cut matched by reduced government spending . If
there is a tax cut and no spending reduction, we may still get
a recession if an increasing Federal debt leads the Fed to
raise rates again.
Best regards
Rick
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Richard S. Marken Phone or Fax: 310 474-0313
MindReadings.com mailto: marken@mindreadings.com
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