Toshio Matsuda, Commentator & Intl Economist

Straight from the Shoulder No.497

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At just past 2:00 p.m. Eastern Standard Time on October 29, the Board of Governors of the Federal Reserve System, acting through the Federal Open Market Committee (FOMC), decided to lower its target for the federal funds rate by 50 basis points to 1 percent. That rate cut was implemented the same day. Reacting to this announcement, in New York the Dow-Jones average temporarily jumped by over $150 to climb above $9,000. However, it eventually fell back to close the session down $74 compared to the previous day at $8,990.

The notion that cutting interest rates will power stock prices to greater heights is based on the same genre of faulty thinking that considers a strong yen a negative factor for Japan’s export industries. Lowering interest rates because the economy is slack will actually serve to push down stock prices. As proof of this, we can see that stocks inevitably climb after interest rates are hiked.

So, with the recent upsurge in prices in New York, can we say that the market has bottomed out?

In my view, it would be hasty to conclude that the roots of recession can be eradicated simply with a bailout of U.S. financial institutions and normalization of the financial system. In the first place, financial policy plays a largely auxiliary role on the policy front, underscoring the necessity to use fiscal policy to hammer out the far more essential dimension of antirecession measures. In more explicit terms, the only way to emerge from the jaws of recession, generally defined as a prolonged decline in economic growth, is to stimulate private sector demand. Simply stated, without well-directed public investment, sparking job expansion in particular, there will be no turnabout to positive economic growth.

Furthermore, and as I have continued to state in this column, in the absence of intent action by Washington to launch concrete fiscal policy measures, we will see no recovery in economic growth or a rally in stock prices. Consequently, I can only conclude that the Dow has yet to hit bottom.

The market is most anxious about the financial system ? that is, the health of financial institutions in the United States and around the world. When it comes to Japanese financial institutions, insofar as they now find themselves in the position of buying up pieces of U.S. banks and brokerages on the brink of collapse, thereby helping to keep those institutions afloat, they should not be discussed in the same context as other financial institutions worldwide.

Up to now, nose-dives in U.S. financial institution stock prices have triggered across-the-board declines in Japanese banking stocks as well. Yet, if the shares of companies selling off their holdings go south, it makes perfect sense that stocks of the buyers of those stakes will gain ground. As I noted in my previous column in this series, Japan market players appear to have totally lost their sense of equilibrium. Or, perhaps it would be more accurate to say that they are being undermined by outside forces. At any rate, it is my prediction that, somewhere up ahead, and as we saw today in Tokyo, the Nikkei stock average will no longer simply follow the Dow into negative territory. Instead, it will muster its own strength to chart sharp increases. When all is said and done, this is the natural course of events that the market should and can be expected to follow.

So, has the Nikkei hit bottom? I previously advised investors to pick up Japanese stocks if the Nikkei fell into the 7,000 to 8,000 yen range. That’s because I figured this price level did in fact represent the likely floor. Under the momentum of the slide in New York stocks, the Nikkei has come close to sinking below the 7,000-yen line. On the positive side, perhaps the bottom has been reached sooner than I originally believed. Yet, although the Nikkei appears to have bottomed out, we cannot say the same for the NYSE.

I reserve judgment on the above, however, in the event that Democratic Party candidate Barack Obama is elected to serve as the next U.S. President. If Obama does prevail, in other words, I reserve the right to retract my current stance that the Nikkei has hit rock bottom.