We've been following the bond market closely and for good reason. Earnings and interest rates drive the stock market. We are seeing a lot of signs of an economic slowdown, perhaps even a mild recession. As a result, earnings will not be spectacular and we'll likely continue to see companies lowering guidance. The equity markets are already discounting prices to account for lower profits in first half of 2008. Stocks have taken a huge hit to begin 2008, but divergences are indicating that selling momentum is slowing similar to what we witnessed in the summer of 2006. One of the hardest hit indices last week was the NASDAQ 100. Take a look at Chart 1 below and note that as the NASDAQ 100 has hit new recent lows, the MACD is actually much, much higher than it was at the time of the last low. This is a development worth watching as the same situation developed in the summer of 2006 before a significant advance.&n bsp; That setup can be seen in Chart 2.
Expect the Fed to continue lowering interest rates. We believe the next cut will be 50 basis points and we wouldn't be shocked to see the Fed step up prior to its end of January meeting and introduce this next cut between meetings. The bond market is clamoring for more rate cuts with the odds of a 50 basis point cut increasing. In previous articles, we've discussed the likelihood of falling interest rates as a result of the triangle breakdown on the ten year treasury yield. If that yield falls below 3.80%, there is little support until the yield reaches 3.05%. That would portend an aggressive rate cutting campaign by the Fed, which we believe is in our future. Continued decreases in interest rates will send "safe" money in the bond market back to equities as investors look for higher returns. Lower rates will further weaken the U.S. dollar, providing greater opportunities in gold and other commodities.
