Market Update

The major indexes moved sharply lower Friday morning. The Dow dropped below 13000 for the first time in a long time. As it stands now, the S&P is only up about 2% from the start of 2007. What is going on? It seems that fears that we may be headed towards recession, or are already in one, are getting priced into the equity markets, echoing the sentiment of the debt market. Jobs data came in, and showed that the economy had added the fewest number of jobs since August 2003, when the economy recovering from a recession. Yesterday, data came in which showed that the manufacturing sector, which had been holding strong, was weakening considerably. Car manufacturers, for example, reported a 3% drop in sales of cars and light trucks in December. All told, not a pretty picture for the real economy. Investors seem to be abandoning the hope that the turmoil would be limited to the financial markets.

While many expect a rate cut from the Fed at their next meeting at the end of the month, they may not be able to cut rates as far as they did in 2001. Surging commodities prices, caused in part by increasing demand from the developing world, turmoil in resource rich countries, and the increasing use of corn to make ethanol, have created significant inflationary pressure, as higher input prices trickle down throughout the economy.

But all is not lost. It is still possible that economies in the developing world, and to a lesser extent in Europe, will remain robust and help limit the downside to the US economy, and to American investors. The risk is that the theory of "decoupling," which asserts that financial markets are no longer tied to each other as strongly as they once were, does not pan out, and that weakness in America will spread to the rest of the world.

It will be fun to watch from the sidelines.