Financial Watch

Hurricanes Katrina and Rita failed to derail Alan Greenspan from pushing interest rates up further. In fact it appears the price spikes in many commodity products following the hurricanes prompted the Federal Reserve to take a more aggressive role in combating inflation. It now appears the Federal Reserve will continue to raise interest rates at every meeting until Alan Greenspan steps down next January. That would push short-term rates up to 4.5%. Inflation rates appear set to remain elevated in the coming months, but it appears this is a temporary phenomenon.

Financial Watch in our last article mentioned our cautious outlook for the stock market following a post-Katrina rally. Our predictions could not have been more accurate as the market has sold off sharply since our outlook. We remain concerned about the outlook for the U.S. economy. As the market moves into earnings season, Financial Watch believes the next couple months could cause volatile returns throughout various asset classes. Below is our short-term outlook. Investors should be careful to consider their own investment objectives and consult other viewpoints before making investment decisions.

Stocks
In our opinion the present sell-off in stocks does not offer investors an opportunity to profit from discounted stock prices. Financial Watch believes the stock market will test the 10,000 mark on the Dow as information on the full impact of Hurricane Katrina becomes available. Signs of trouble continue to grow in the market. Technical indicators are showing signs of breaking down and outlooks for the present earnings season appear inflated. Historically October has been a volatile time for investing in the stock market and it appears the risks are currently overwhelmingly tilted toward downside risk. Financial Watch believes there is approximately a 10% chance of a semi-major market crash occurring in the coming month that could drive the market averages down by as much as 10%. We do not believe investors should panic, but extra diligence should be taken to examine exposure to risky sectors of the market.

Bonds
Sell! Sell! Sell! Financial Watch warned long-term bond investors earlier in the year that the downside risk to bond investors outweighed potential investment returns. Our forecast appears to have been premature, but there is no doubt that long-term interest rates are moving higher. Historically the Federal Reserve overshoots in its goal to cool the economy. This time appears to be no different. Bond investors would be better served by investing in short-term securities that do not have risk exposure to interest rate risks.

Housing
The housing bubble is showing early signs of trouble. Rising short-term rates are beginning to cause deterioration in the speculative housing market. Condo prices appear to be most vulnerable to a downturn in the housing market, but many single family homeowners have over borrowed or exposed themselves to adjustable mortgages to take advantage of rising housing prices. Florida, California, and the northeast appear to be most vulnerable to an adjustment in housing prices. The actions of the Federal Reserve over the coming months will largely impact whether the housing bubble goes through a minor correction or panic.

Gold
Financial Watch is far from an expert on investing in gold, but this appears to be the most promising asset class for the coming months. We have long resisted recommending investments into asset classes that have experienced rapid price increases, but we believe the gold boom has further room to go. Talk of stagflation will almost surely dominate the stock market in coming months. In addition, a strong dollar and rising interest rates makes gold an attractive investment option until the end of this year.