Issue 15 - May 4, 2004


Rising Rates and Tempers

This past month marked a significant change in the Federal Reserve’s rhetoric on interest rates. While many of the broad measures of the economy have been running at levels commiserate with a robustly growing economy, the Fed had stubbornly pegged its behavior to disappointing employment data. However, last month’s figure of 308,000 new jobs brought the 2004 average monthly gain to 171,000. Given that we now have essentially all major economic indicators reading strong, the only question remaining for the Fed is how best to raise rates.

It is important to appreciate how accommodative the Federal Reserve’s position has been. A neutral posture associated with an economy growing at over 4% (as it is now), would have Fed Funds rates in the 3-5% area. Rates are currently at 1%. It is difficult to conceive of a game plan which would please the markets at this point. If rates rise slowly, the Fed runs the risk of exacerbating an already overly accommodative position, thus spurring inflation. If rates rise quickly, the Fed will run the risk that some highly leveraged market participants are irreparably damaged and their problems could set off a chain reaction similar to what we saw in the case of Long Term Capital in the fall of 1998. If we look to recent history, 1994 provides some context. In the 14 months beginning in January 1994, the Fed raised rates from 3% to 6%. Clearly the Fed can act decisively if they feel compelled to do so. Coincidentally, the last time we had three consecutive quarters with growth above 4% was in 1994 and it is sobering to think how far Fed policy would have to rise to mirror statistically similar economies.

The Fed has clearly painted itself into a corner. Perhaps this was the lesser of evils from their perspective. The Fed has a good history of taming inflation while no central bank has had much success against deflation. It would not surprise us if they take a more deliberate (faster) approach given how clearly they have telegraphed their intentions to get rates back to equilibrium.

Google on Their Terms

Google’s long awaited filing of their initial public offering came with a twist. While
all of the marketing and registration mechanics will follow the traditional initial public offering process, the pricing and distribution will not. Google has instructed the underwriters of their offering that they wish to employ an auction process. For history fans, this is big. You may recall in our December 16th, 2003 newsletter we wrote about the ubiquitous use of auctions in today’s world with the glaring exception of the initial public offering. Google has the clout and prestige to change this once and for all.

In a typical underwriting the syndicate polls the institutional community for their indications of interest (how many shares and at what price). As Elliot Spitzer so emphatically pointed out, this is a process which has been ripe for abuse. It has also largely excluded the individual investor from participating in any meaningful way. The Dutch Auction largely solves both of these problems in one elegant stroke.

While many of the auction mechanics have yet to be confirmed, the process will be
as follows. The price of the shares will be set at the highest price which clears the market of all the available stock to be sold. The complaints from the institutional community are already coming fast and furious. This community was heretofore the biggest beneficiary of preferential allocations and discounted pricing. Their arguments attempt to take the high ground by declaring that the auction process will not develop a strong investor base or that having so many shareholders will
increase Google’s costs of corporate communications. Well, maybe. But mostly this is a big argument about the end of free money. No one is well served by the traditional process except the underwriters and their favored clients. Why should a company sell shares to the market for any amount below what the market will pay? Why should individuals not have the opportunity to compete for stock? There are plenty of pundits who are saying this will be a one-off underwriting, but we respectfully disagree. If this auction is a success, then the genie is out of the bottle and you can no more go back to an inefficient, highly biased process than put the rain back in the sky. Companies will demand that their shares have a chance to seek the highest price that the market will bear and Wall Street will fall in line ­ screaming all the way.


In this Edition

  • Rising Rates
  • Google IPO

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

14 -04.01.04
First Quarter 2004

13 - 03.02.04
2004: Encore Performance

12 - 02.03.04
Market Outlook/Cell phones

11 - 12.16.03
Auctions - eBay, US Treasury, IPOs

10- 12.02.03
Recent Economic Data
Market Implications

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

  4/30/04 3/31/04 12/31/03 12/31/02
DJIA US 10225.60 10357.7 10453.9 8341.63
S&P 500 US 1107.30 1126.21 1111.92 879.82
Nasdaq US 1920.15 1994.22 2003.39 1335.51
EAFE Int'l Equity 1302.92 1337.07 1288.77 952.65
5 Yr Treasury 3.65 2.89 3.231 2.74
5 Yr AAA Muni 2.88 2.38 2.45 2.59
10 Yr Treasury 4.536 3.874 4.225 3.82
10 Yr AAA Muni 3.930 3.49 3.6 3.72
30 Yr Treasury 5.203 4.69 5.01 4.77
30 Yr AAA Muni 4.89 4.51 4.54 4.69
EUR Currency 1.1966 1.2227 1.2612 1.0488
JPY Currency 4.89


106.92 118.69
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