Week of December 3, 2007

The Markets
 
Sometimes bad news is good news for the stock market.

Last week, Fed Chairman Ben Bernanke and Vice Chairman Donald Kohn both made comments to the effect that additional recent turbulence in the credit markets may require the Federal Reserve to lower interest again, according to reports from MarketWatch. Those comments helped spark a significant stock market rally that carried the Dow Jones Industrial Average to a 3.0 percent gain last week.

In this case, bad news is good news for the market because to some extent, the market tends to look to the future for directional cues. For example, lower interest rates may lead to higher corporate profits in the future. Knowing that, stock market investors may “stock up early” in anticipation of higher future profits. So even though corporate profits may not look great right now, some investors will overlook that and start making investments now, thus bidding up prices.

You may have heard the old Wall Street adage, “Buy on the rumor, sell on the news.” In this case, the “rumor” is that lower interest rates may lead to higher future profits. The “news” may come a year or two from now if profits do indeed rise. At that time, stocks may stagnate even though earnings could be rising significantly.

In the end, stock prices tend to be driven by earnings. The tricky part is that there could be a significant gap in timing between changes in stock prices and changes in earnings.    
 

Sources: Yahoo! Finance, Barron’s. Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly. Three-, 5-, and 10-year returns are annualized.  Assumes dividends are not reinvested.

A RECENT ARTICLE TITLED “SHOCK TREATMENT,” published in The Economist discusses reasons why our economy has rather easily absorbed high oil prices that in the 1970s sent the economy into recession.

Allowing that higher oil prices hurt the economy because they act like a tax increase and result in consumers having less to spend elsewhere, the article seeks to understand how consumers can adjust from a period six years ago when a barrel of crude oil cost as little as $20 to today’s prices that hover in the $90 range. Why, the article asks, has the “oil bogeyman become less scary?” The article points out that two new papers by three well-known economists come to similar conclusions: “Oil shocks do not hurt as much because oil is used less intensively than before, because the economy is more flexible, and because central banks are better at controlling inflation.”

The papers referred to in the article are: The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s So Different From the 1970s, by Olivier Blanchard and Jordi Galí, Massachusetts Institute of Technology Working Paper 07-21 (August 2007) and Who's Afraid of a Big Bad Oil Shock, by William Nordhaus, Preliminary draft (September 2007) prepared for Brookings Panel on Economic Activity.

Our global economy also appears to play a role in our ability to adjust to higher oil prices. Globalization has made U.S. companies more competitive and that’s helped drive down the prices of various consumer goods. Lower prices for some commonly used consumer items may have cushioned the blow of higher energy costs.   

IF YOU’RE CONTEMPLATING A MAJOR HOME RENOVATION, you may be wondering how much of your project costs you will get back when you sell your home. To help industrious homeowners answer that question, Remodeling magazine has for two decades produced an annual “Cost vs. Value” report. You can view it at www.costvsvalue.com.

Based on nearly 3,000 responses to a web-based survey conducted with Specpan and the National Association of Realtors, this year’s report found that due to the housing market slump, the percentage of construction costs recovered is down across all projects compared with last year. That said, however, remodeling is still a pretty good investment. Specifically, two-thirds of this year’s projects are projected to return between 65% and 80% at resale. That means you’ll pay just 20 cents to 35 cents on the dollar for most improvements you make to your home.
 
As you might expect, what you get back at sale time varies depending on your location, location, location. While the percentage of costs returned in New England and Mid-Atlantic cities has remained fairly constant year to year, in the Pacific region (California, Oregon, and Washington), remodeling costs recouped at resale are 14% higher than the national average.

Interestingly, cities in the southeast and southwest that are experiencing a building boom fall below the national average when it comes to recouping home improvement costs. This could be a function of the fact that because these areas have plenty of new homes lingering on the market and falling in price, buyers are turning their backs on even the most beautifully renovated older homes.

As the subprime crisis unfolds and continues to impact the housing market, it’s worth staying up-to-date on factors that impact your home’s value. Remember, as with investing, your decision of whether to remodel your home begins with a careful evaluation of your current circumstances and future goals.

Weekly Focus – So You Want to be an Entrepreneur?

A recent survey of small business owners conducted by online payroll service SurePayroll reveals that oldest, middle, youngest, and only children are equally likely to have entrepreneurial aspirations. The survey found that the career paths of an entrepreneur’s parents, not birth order, had the greatest impact on a child’s decision to start a business.  

Best regards,

Fredrick J. Livingston, CLU, CFP

Securities offered through LPL Financial, Member NASD/SIPC

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

* The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. 

* The Nasdaq Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

Brain Teaser Answer:  It contains the numbers one to nine, in alphabetical order.