Monthly Market Monitor

While the markets were having enough problems with the unrelenting price spikes in oil, a not-so-old ghost arose in the last part of the month to double-team stocks and bonds. Most major stock averages finished the month close to new lows for the year and almost 20% below the highs of last October. Through May, most investors had thought the damage from sub-prime loans to the financial industry and economy had been largely contained and written-off. Recently though, new signs arose that banks and brokerage firms were potentially facing substantial additional losses from their various sub-prime-related investments. Several banks were expected to have to again raise new money to offset the write-offs, after having done so only a couple of months ago. In some cases, there is rising doubt that large investors will once again pony-up the additional capital, having bought in too early the first time. Even if they did, the new developments raised valid questions about the weakened banking system's willingness to lend new money, crucial to the economy's health. The effects on small business expansion, a recovery in home sales, or continued consumer spending could become a significant drag on growth. Most economists still believe that the existing slowdown will be relatively shallow, but any new disruptions to a still uneasy U.S. financial system could delay the recovery. The ramifications of rising commodity prices, especially oil, on the economy have been tough enough for investors to handle. The unexpected news from the financial sector re-raises a significant uncertainty for the equity markets and means stocks could likely remain quite volatile until at least the banks' second quarter earnings are announced later in July.

What does the Fed fight first, inflation or recession? Unlike many foreign central banks, which are mandated to only maintain stable prices, the Federal Reserve has dual tasks of maintaining stable prices and a growing economy. Sometimes, like the present, those are in major conflict. Usually higher prices grow out of a quickly rising economy and can be somewhat self-regulating as demand falls back if prices rise too fast. This is most workable in a closed economic system, but the U.S. economy, more than ever, is not a closed system. As another sign of globalization effects, the U.S. economy currently faces both a slowing economy and inflation as the fast growing emerging countries compete for scarce world commodities more than ever before. In the last six months, the Fed has focused on the goal of protecting against recession by interest rate cuts. Inflation was not a serious factor even though gas prices continued to creep up. Wage and productivity gains helped offset the higher prices. However, foreign-induced inflation is now showing up in more U.S. products and harder choices by the Fed may be forthcoming. Further rate cuts to help generate borrowing and benefit a slowing economy could actually produce higher prices, especially oil prices, which make it harder on consumers. On the other hand, the usual Fed prescription to fight inflation, raising interest rates, could obviously slow the economy further, especially with the banks' current lending capabilities curtailed. Bernanke's ability to assess the risk and return of each policy, and when to enact them, will be an important factor for the stock and bond markets in the second half of the year. Capital markets will pay almost as much attention to possible Fed thinking as to the price of oil. Market traders believe that a break in the price of oil, at least in the short-term, will provide a psychological boost for the stock market. More importantly, it could relieve pressure on the Fed to raise interest rates while the economy's health is still so fragile.

Prepared by:
Martin Cosgrove, CFA
Vice President
Director of Investment Research Research Department, ING Advisors Network

1. Wall Street Journal7/1/2008

The views are those of Martin Cosgrove, CFA, Director of Investment Research Research Department, ING Advisors Network, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.