Newton's Third Law At Work on Stock Market Fluctuations

Action/Reaction - It's All About Ebb and Flow in the Financial World

May 31, 2008
By: Jerry Cole - Retirement, Investment

Newton's third law states that for every action there is an equal and opposite reaction. In the land of markets and the economy, this law is at work incessantly. This is obvious because for there to be a market at all, when someone wishes to sell, there has to be someone who wishes to buy. When a commodity becomes in short supply, its price rises, etc. etc.


For example, this week we saw a slight rise in interest rates. So how in the heck can that be when the Fed has cut interest rates seven times in the last 10 months and the economy is supposed to be on the brink of a recession? Well, simply put, it was a reaction to signs that show a recession now appears less likely.

Those signs came in the form of a slide in oil prices and a Commerce Department report that gross domestic product grew at a seasonally adjusted rate of 0.9% in the first quarter, up from an earlier reading showing 0.6% growth.This in turn gave bond buyers more confidence and more willingness to move out of the safe haven of Treasury's and into riskier assets. Thus there was a sell-off in government debt causing yields to rise (when bond prices fall, the yields rise.)

The benchmark 10 year note has risen about 0.8 percentage point from its March lows to its highest point in the year at 4.08%. Added to this the government on Wednesday reported durable goods orders came in higher than expected, and personal spending along with personal income climbed by 0.2% last month.

The reaction to this collection of stronger-than-expected economic data will be an increased focus on inflation.If you include food and energy, consumer inflation is now running at a rate of 3.9%. The ten year Treasury at 4.08% is higher and in an environment of rising inflation, investors will demand the higher rate.

Meanwhile, it is unlikely that oil prices will significantly break through this summer. Any small break is likely to be short-lived. It may not be responsible for the whole picture on oil prices, but supply and demand has to be the significant factor. The good news on demand is that U.S. drivers traveled an estimated 11 billion fewer miles in March of 2008 than in the same month a year ago. That's a drop of 4.3% year to year. In the first three months of 2008, U.S. drivers reduced their mileage 2.3%.

These drops, in response to higher gas prices, are a reason the U.S. Energy Information Agency projects the nation's petroleum consumption will drop by 33,000 barrels a day in 2008. (Increased use of ethanol is the other part of the picture). That amounts to a drop of about 1.6%

On the supply side, the news is scary. In Mexico, oil production fell in April to 2.77 million barrels a day form 2.85 million in March and 3.18 million in April 2007 , according to the state oil company Pemex. In Russia, the minister for natural resources has warned that production, which declined in the first quarter of the year, could fall for all of 2008. The Moscow government cut taxes for the oil industry and a second cut is being discussed in an effort to increase investment in the sector. But any increase in investment in production now will take years to turn into increased oil flow.

Let's hope our leaders are looking at the big picture and can formulate the programs and incentives that will stop what could become a run-away train.....and soon!

In the meantime, be sure to keep your risk within your tolerance and keep ahead of inflation.

I invite your questions.

(The opinions expressed are solely those of the author and not Gen worth Financial Securities Corporation.)