Weekly Markets Commentary – November 4, 2008

David Joy — Chief Market Strategist, RiverSource Investments

For more commentary and insight, visit riversource.com/funds

A Long-Awaited Rally

Don't look now, but there's a bit of a rally going on. True, stocks did drift lower at the start of this week, but that could hardly be faulted after an heroic comeback last week. In case anyone's forgotten, with all that's going on, the S&P 500 Index surged 10.5 percent last week. The MSCI EAFE Index rose 8.9 percent in dollar terms. And not to be outdone, the MSCI EMF Index rocketed higher by 20.4 percent.

Each of these major indices bottomed out on Tuesday, October 27. So did the yield spread between the 10-year Treasury note and the Merrill Lynch High-Yield Master II Index. The DXY Dollar Index peaked the following day. A look inside the big move shows that more than 100 percent of the weekly rise in the S&P 500 Index came on the October 28, and almost all of the gain in the MCSI EAFE Index came on the following day. So, what happened?

It turns out that Tuesday was the day that the Federal Reserve began buying commercial paper, the operating lifeblood of corporate America. By day's end more than $67 billion of longer dated commercial paper was sold, compared to a daily average of just $6.7 billion the prior week. It was estimated that the Fed accounted for 90 percent of the total. The move was hailed as opening an artery of credit in a system suffering from credit arteriosclerosis. The previous scramble to cover yen-denominated carry trades was halted in its tracks as the yen fell the most versus the dollar in 35 years.

Nor was the Fed finished there. The next day it lowered the overnight rate by one-half percent, to 1.0 percent. It also announced $30 billion swap lines with Korea, Mexico, Brazil and Singapore to enhance dollar liquidity in those markets. On the same day, Mexico and Brazil surged rising 10.5 and 13.4 percent, respectively. The reaction in the Asian markets was more muted as Singapore climbed 4.0 percent and Korea gained 5.2 percent.

All the while, the three-month Libor rate has been showing continued improvement. After peaking at 4.82 percent on October 10, the rate is now quoted at 2.70 in early trading on Tuesday.

The availability of credit does not ensure an immediate renewal of economic activity. There is plenty of evidence that much of the developed world is in recession and will likely stay there for several more quarters. Few dispute that. However, the increased flow of credit does help avoid further unnecessary deterioration from credit deprivation, and prevents a bad situation from getting even worse.

It is this last point that investors seized upon last Tuesday. If credit can now find its way to those who want it, then the extent of the economic slowdown can begin to be quantified. Until last Tuesday, that was not possible. And if it can be quantified, then a judgment can be made regarding whether the slowdown has been fully discounted by markets around the globe.

At least since last Tuesday, the answer has been yes. However, that sentiment is likely to be tested by the economic calendar.

Economic Calendar

On Monday, it was reported that the Institute of Supply Management (ISM) manufacturing index registered its lowest reading since 1982. The Fed also released its latest survey of bank lending conditions which revealed a record increase in tightening of lending standards in the first half of October. Auto sales in the U.S. also fell to their lowest in 17 years in October, led by a 45 percent decline at General Motors.

On Friday, the October employment report is expected to show a loss of 200,000 non-farm jobs and a rise in the unemployment rate to 6.3 percent. All of this comes in the wake of last week's gross domestic product (GDP) report which showed the economy contracted at an annual rate of 0.3 percent in the third quarter.