Careful Where You Point - The Fed May Have This One Right

 |  Includes: DIA, QQQ, SPY
by: Joe Wolfe, CFA

Given the deteriorating state of the economy, it has been easy to point a finger at Fed officials – past and present. And although the Philly Fed manufacturing index relayed more bad news yesterday, the Fed could actually be on time here.

Looking at the past two recessions, the Fed funds rate appeared to lag (by 6-9 months) the actual down turn in manufacturing. This time around, although not in direct correlation, interest rates appear to be declining with the slow down - rather than a few months after it. This suggests (to me anyway) that low interest rates could revive the economy in time to side step a recession.

However, there are plenty of impediments in the way of that outcome, such as tight (but not locked) credit markets, rising mortgage rates, a housing tail spin, and a subsequently weakened consumer. But it’s quite possible that with one or two more rate cuts, steady demand for American goods overseas, and a housing market that can find some life in the spring due to attractive mortgage rates, 2008 might turn out to be much better than anticipated.

In either scenario, data in the next few months will send this skittish market aggressively in one direction; a barbell portfolio at this point may turn out to be wildly profitable – whether the Fed is on time or not.