The stock market recently experienced a significant decline, which some optimists view as a normal correction after a period of profit-taking. However, the latest report on durable goods for October introduces a note of caution regarding the economy.
New orders for durable goods decreased by 8.3% compared to September, according to the Census Bureau. This drop is noteworthy and reminiscent of similar declines last observed in 2000. Year-over-year, new orders for October have only risen by 2.3% over the prior 12 months, marking the slowest annual growth rate of the year.
Despite this concerning news, there are glimmers of hope in recent updates. The National Association of Realtors has reported an increase in existing home sales last month, marking the first rise since February. As the old adage goes, “even a dead cat bounces.” But can this cat regain its footing? While optimism may be in order, it’s crucial not to overlook the fact that October’s new home sales remained significantly lower—down 11.5% from a year ago. However, for those believing the worst of the real estate downturn has passed, today’s existing home sales provide some encouragement. NAR’s chief economist, David Lereah, articulated this cautious optimism, stating:
“The current level of home sales indicates some market confidence, but sales are still below sustainable levels due to psychological barriers. The growing population demographics, historically low and declining mortgage rates, and healthy job growth suggest there are ample resources for home purchases across much of the country. Yet, many potential buyers are still hesitant. After a phase of price adjustments, we expect to see increased market confidence and a noticeable improvement in home sales by the first quarter of 2007.”
However, a stabilizing housing market doesn’t automatically ensure economic prosperity. Current risks remain palpable, as highlighted by the recent OECD forecast, which predicts a “mild and short-lived weakening” in the global economy for 2007. The OECD also pointed out that reducing core inflation from 2.8% to a targeted 2.0% presents challenges, potentially necessitating a prolonged period of restrictive monetary policy.
In practical terms, this means we shouldn’t expect interest rate cuts at the upcoming Federal Open Market Committee meeting. Fed funds futures traders share this sentiment; the market for the January ’07 contract is leaning towards maintaining the current rate at 5.25%.
The economic outlook remains uncertain regarding growth and interest rates, leading to a cautious stance in the bond market. Fixed-income investors seem to believe that slower growth, or even a recession, is on the horizon while inflation appears manageable.
The yield on the benchmark 10-year Treasury note recently dipped below its prior low of 4.53%, reached on September 25. At the moment, the yield stands at 4.52%, the lowest in over a year.
Ultimately, the current economic climate does not strongly favor one outcome over another. As a result, diversification across various asset classes has never been more advisable, even as it feels precarious given valuations and past performance. For those looking to seize opportunities in 2007, cash might be the safest bet. Nonetheless, for advocates of bonds, now seems like an opportune moment.
