Saturday, August 4, 2007

Two Steps Back

After a lackluster four days of up and down trading, the subprime woes and a weak jobs report hammered the market on Friday. With hedge funds, builders and mortgage companies melting down, the concern is the housing mess will spill over into other areas of the economy. Hence, the uptick of the unemployment rate to 4.6% gave traders one more reason to unwind their positions.

On Tuesday, the Federal Reserve meets and investors will be looking for any references to the problems in the credit markets or a change in the Fed's position on inflation. There is no indication there will be any change in the Fed's target interest rate of 5.25%, which has held steady for over a year now. Lehman Brothers anticipates the Fed's outlook on growth and inflation will remain unchanged and only a minor acknowledgement of market developments will be mentioned.

The biggest concern I have is how over leveraged the financial system is. Treasury Secretary Paulson has stated the subprime credit fiasco is contained, but others aren't so sure. Alan Abelson, of Barrons, cites concerns by Jeremy Grantham, who runs GMO, an insitutional money manager. Grantham feels we are "watching a very slow train wreck", and that in five years, because of over leverage, at least one major bank will have failed, half of the hedge funds and a substantial percentage of the private-equity companies "will have ceased to exist". One of the great equalizers of our markets is the fact that eventually unsound investments unravel and leave unwise investors holding a worthless bag. The question is how far down do these unsound investments drag the rest of us. Containment becomes a very important issue.

John Kaighn

Jersey Benefits Advisors

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