Don't be fooled by the stock market rally

Stockmarkets soared yesterday after the Fed hinted that it may cut interest rates. The trouble is, it doesn't really matter what the Fed does because the US housing market - a key driver of the economy - is dead in the water.

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Well, after a few awful days the markets made a stylish comeback yesterday.

The Dow Jones Industrial Average positively rocketed, leaping 2.6% (its best percentage gain of the year so far) to 13,289. Meanwhile, the FTSE 100 had a similarly strong showing, jumping 2.7% to 6,306.

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So what was behind all this jubilation? You guessed it the Federal Reserve hinted that it might cut interest rates

Don Kohn, vice-chairman of the Federal Reserve, delivered some relief to investors yesterday as he said that the Fed would be "flexible and pragmatic" in dealing with the squeeze in financial markets.

Up until now, investors had been worried that the Fed actually cared about the collapsing dollar enough to perhaps try to avoid cutting interest rates any further. But this put paid to that.

As Jeffrey Kleintop of LPL Financial Services told Marketwatch: "Now you have Kohn pointing out that the Fed can take action to offset what is happening in the financial markets; it does suggest that the Fed is being responsive and is not just focused on inflation."

But as Lex points out, it's surprising that "the markets rallied so much, when all Mr Kohn did was state the blindingly obvious. The Fed is of course going to be flexible." We would go so far as to say that the Fed will bend over backwards to keep Wall Street happy, and it is indeed a surprise that anyone doubts it.

Given the choice between recession right now, or inflation now and a worse recession later, Ben Bernanke has continually made it very clear which side he backs. He will always sacrifice the dollar and US citizens' purchasing power in favour of trying to squeeze just one more bubble out of the economy before the day of reckoning arrives.

The US housing market is dead in the water

The trouble is, the Fed can do what it wants, but the US housing market which has been the core driver of the US's consumer-lead economy in recent years - is now well beyond the point of resuscitation. The National Association of Realtors reported that sales of existing homes fell 1.2% in October, while the supply of homes for sale hit a 22-year high. The median sales price fell by 5.1% in the past year (to $207,800), the worst decline on record, while sales were down 20.7% in the past year.

If the housing market is indeed, as the bulls over here always like to say, a simple case of supply and demand, then to put it politely, the US housing market is dead in the water. And if, as we think, the price of houses is more to do with supply and demand of credit, then well, it's still dead in the water.

If subprime has managed to cause so much trouble already, we dread to think what will happen when bad debts start rising among all those people with prime mortgages who suddenly find themselves in negative equity when they try to sell.

The funniest letter of the week

After that glum prognosis, you may need a laugh and prize for funniest letter of the week has to go to Meg Hillier MP, who writes indignantly in this morning's FT, responding to an editorial on ID cards: "Sir, I was bemused by your call for the National Identity Scheme to be abandoned." Among other things, her letter notes that "the rising threat of identity fraud cannot go unchallenged."

Has she been asleep for the past week? Or perhaps on a jaunt to the Antarctic? Because of course, anyone who was actually aware of the fact that the government has just lost half the population's intimate financial details, could never have the audacity or the arrogance to complain about press scepticism over ID cards.

Should any publicly-spirited readers out there feel inclined to write to the forgetful Ms Hillier and remind her of why we can't trust the government to organise a raffle, let alone an Aladdin's cave of personal data, then you can find her email on her website.

Turning to the wider markets

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US rate cut hopes boost markets

In London, stocks made good gains yesterday as Wall Street opened sharply higher. The FTSE 100 index added 165 points to end the day at 6,306. Business software provider Sage led the risers with a share price gain of nearly 10% after announcing significant revenue growth. For a full market report, see: London market close

Elsewhere in Europe, stocks were also boosted by the strong start on Wall Street. The Paris CAC-40 was 127 points higher, at 5,561. And the Frankfurt DAX-30 was 192 points higher, at 7,723.

Across the Atlantic, investors were cheered by doveish comments from US Federal Reserve chairman Don Kohn. The Dow Jones notched up its biggest one-day percentage gain so far this year, adding 331 points to close at 13,289. The tech-rich Nasdaq added 82 points to end the day at 2,662. And the S&P 500 was up 40 points at 1,469.

The Wall Street cheer spread to Asia too today. The Japanese Nikkei soared 359 points to 15,513. And in Hong Kong, the Hang Seng was 1,111 points higher, at 28,482.

Crude futures surge $3 on pipeline fire

Crude oil futures jumped over $3 this morning to $94.03 a barrel following a fire on a Canadian pipeline which delivers almost one-fifth of US oil imports. In London, Brent spot was also higher, at $93.20.

Spot gold was trading at $806.20 this morning, up from $803.70 in New York late last night. And silver was at $14.45.

In the currency markets, sterling had strengthened against both the dollar and euro this morning, and was last trading at 2.0646 and 1.3996 respectively. And the dollar was at 0.6776 against the euro and 110.04 against the Japanese yen.

And in London this morning, a report by Nationwide revealed that UK house prices fell by the most in 12 years this month, signalling the end of the housing boom. The average house price fell 0.8% from October to £184,099. Nationwide's chief economist Fionnuala Earley blamed 'poor affordability, weaker house-price growth expectations and the effect of earlier increases in interest rates.'

Finally, our recommended articles for today...

How green can Google go?

- Google has just revealed that it is to pour money into renewable energy sources such as wind and solar power. But could it be a PR stunt to detract from the increasing amount of energy consumed by their servers at the Googleplex in California. For more on the truth about energy-guzzling technology - such as how a Second Life avatar can consume as much energy as a real person - read: How green can Google go?

Why shoppers won't save the US economy

- For all the articles about Brits going on shopping trips to New York to take advantage of the cheap dollar, there really isn't that much actual shopping going on, says Merryn Somerset Webb. And retail isn't the only area of the economy that's suffering. To read more on why you should look out for a Christmas rout rather than a Christmas rally this year, see: Why shoppers won't save the US economy

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.