False Breakout?

The rally we saw on Tuesday, which appeared to be a breakout moving the markets higher, seems now to have been a false breakout. Yesterday's total market downturn, another 90% down day on the NYSE, was followed by an additional downturn today. From a technical standpoint, the downturn on Wednesday could be seen as a pullback, but today's results seem to indicate that the market may be reversing direction and going back to test the lows of October 10th and 27th. The support level for the S&P 500, for instance, had been considered to be at approximately 930. As of this writing the S&P has broken through that level and is at about 904 (down over 48 points for the interday). In a similar fashion, the support for the DJIA had been considered to be at about 8900 and as of this writing it is at 8696. Historically, the market tends to backtrack and test its lows before rising on a consistent basis. This movement of a rally period followed by a pullback period can take several months after it appears a bottom has been formed in the stock market. I would not be surprised to see the DJIA go back and test, or break the low of 7882 set during the day on October 10th. We will see. For now it would not appear a rush into stocks is a good idea.

Is This the Turn?

Monday, October 13th saw a gain of 936 points, the greatest one-day point gain in the history of the DJIA. It was also the 5th largest percentage gain for the DJIA at 11.08%. The other four historic double-digit gains were back in 1929-1933. As a matter of fact, the next largest gain was on October 21, 1932 and was followed by a decline that took the DJIA down to 33 points and a bottom in February 1933. The point is that double-digit gains have been characteristic of bear markets. You need to have patience in this market. My personal belief is that the bond markets need to see interest move downward before a real economic change is possible.

Give Stocks Credit!

With a loss of more than 500 points on the Dow yesterday the Dow has now lost 875 points in two days. I don't think as a percentage drop this is a record but it is significant! As the stock market heads down my greater concern is with the bond market. In October of 2007 an investment portfolio of investment grade corporate bonds, with an average maturity of about 4.5 years, was offering a yield of approximately 4.75%. In March of 2008 the yield was about 6%. That same yield is now over 8%. As the interest rate goes up the value of the bonds goes down! To make matters worse, the average yield on high yield bonds during the same periods went from approximately 7.25%, to 11.85% and is now over 18%! These are very significant changes. To put all of this into perspective: currently the return on U.S. Government debt is paying interest of 1.68% on the three year, 2.46% on the five year and 3.5% on the ten year debt. What this means is that most of the money leaving the stock market, commodities, etc. is going into U.S. Government instruments. Yesterday the Federal Reserve indicated that they will begin major investments into commercial paper, which is short term lending covering a period from overnight to less than a week. This is an area that is very important to business borrowing. It is hoped that with this move credit markets will free up and money will move into other credit markets such as corporate bonds. If this happens we are likely to see interest rates on investment grade and high yield bonds begin to fall. Ultimately, when the credit market starts to free up the environment for business will get better. Over time this should lead to stock prices stabilizing and bring confidence back to the market. This will not happen overnight but will take time. We must learn patience!

Failed Bailout Vote!

Failed Bailout Vote! It was never certain that the vote on the bailout would pass. With five weeks to go until election day, and with a large segment of the population mad at the idea of bailing out big business, it was a tough call for the House members. What would have happened if the bill had passed? We don't know. My guess is that, with passage, the value of mortgage loans would rise because the Federal Government would be a ready buyer. As the purchases occurred, cash would flow back into the banking system. If the bailout did not pass, I would expect to see the value of the mortgage loans drop even farther, the stock market retreat because of the unknown, and greater amounts of money flying to US Treasury bills and notes, reducing the interest paid on these instruments to an insignificant amount. For the vast majority of our clients, we have a very heavy position in cash. On September 19, 2008 the Federal Reserve guaranteed these accounts for the full amount in the accounts, both taxable and tax exempt. As I indicated in a recent newsletter, the bonds in our accounts seem good, are paying interest and are paying back the principal when the bonds mature. I believe we have taken a defensive posture that we should maintain even while it appears there are buying opportunities in this market. I am not sanguine about what is happening. I believe that what we have witnessed in the past several weeks is a lack of leadership in Congress and the business community. Usually at times like this the Executive Branch provides the needed leadership, but this administration has lost its credibility for many and must rely on others to move the process along.

That Nasty Four-Letter Word!

It's a nasty four-letter word that none of us likes to use. Matter of fact, most of us never want to think about it. But it is a word that is always there, hovering in the background, pouncing when least expected. We are tormented with its unspoken presence in the media, our daily discussions with friends and family and in the workplace. The word of course is "FEAR". The idea of fear keeps us in place, like a deer caught in the headlights of a car, unable to move. What should we do? Where should we go? Will we be okay? This past year has been a period of increasing fear for many of us. First we read about subprime mortgages and how people were losing their homes. Then we saw the price of a barrel of oil go up to more than $145. Then we had the crisis with Fanny Mae and Freddie Mac seeming to bring ordinary people's mortgages to the brink and hurting home values. If this was not enough, we heard about three major investment banks going bust, with one being sold by the Federal Reserve for pennies on the dollar, another merging with a major bank and the third going bankrupt. Along with the investment banks we discovered the largest insurance company in the US was being taken over by the government! Fear! To say that this is unprecedented is not idle chatter. It has been compared to the period of the: "Great Depression" and the period just after WWII. Its root cause: greed! Not just plain old greed but a very high level of greed practiced by top executives of very large companies. It makes me MAD that we taxpayers are going to bail out companies who had the audacity to give their executives bonuses of $80 Million or more for their "stellar performance". I have no doubt that Congress, in which both political parties allowed this to go on, will do what they need to do to bring liquidity and an attempt at stability and oversight to the business community. Eventually we will all go back to our "normal lives" and this crisis will pass and be forgotten. The problem is that the solution seems to say to those large companies that took big risks and some of those individuals who took big risks, “we will not let you suffer the consequences.” For the majority of us who have been paying our taxes, doing things "the right way" we now have the privilege to aid those who pursued their greed. I'd like to see the US Government go back to the Chief Executives of Citi Bank, Merrill Lynch, AIG and others and collect back those big outlandish bonuses and terminate those lucrative pensions and give the money back to the taxpayers! Some have FEAR on this occasion. I am just MAD! I do not think we are a greedy society but a society that has some very greedy people who are in a position to hurt our society!

Today the U.S. Government announced that the jobless rate now exceeds 6.1%. This was an unexpected jump, with most analysts believing we would not see 6% until the end of the year. What might this mean? With this jump in unemployment, the Federal Reserve, which has been worried about the economy all summer, will likely leave rates unchanged after their meeting on September 16th. Also we will likely see consumer-spending decrease substantially in the third quarter, after the rise in spending from the incentive tax rebate of the second quarter. All in all, the economy appears to be slowing down and will likely show little growth, or perhaps a downturn, for the balance of the year. Additionally, the sub-prime loan problems have driven interest rates on bonds to recent new highs. Refinancing of the majority of sub-prime mortgage loans should be complete by February and we may see the housing market begin to pick up again this spring. In my opinion, the inflationary effects of the oil price increases will also take until February or March to totally work their way through the economy. When this occurs, we are likely to see prices stabilize. Perhaps the most important issue is that by November, we should know who has been elected President. The stock market likes to know who will be serving in the White House, and this uncertainty is likely to continue to make the market volatile through Election Day.

Can it rain and be sunny at the same time?

On Monday of this week, the inflation rate for the month of July was reported to be 0.8% or an annualized rate of 9.6%. This compares with an annualized rate in June of 7.2%. This would appear to be bad news because it means the price of goods and services are going up at a much higher rate than the Federal Reserve Board (Fed) would like to see (1.5% to 2.5%). In such a situation, you would expect to see the Fed increase their key interest rate. On Tuesday, the Fed met and left the key interest rate unchanged at 2%. This also means that the prime leading rate stays at 5%. The stock markets took this as good news, with a healthy advance in prices. The bond market took it as bad news with interest rates rising (and therefore the price of bonds declining). It would seem that, with the price of oil falling for the past week and the economy not looking its best, the Fed decided to gamble that prices will stabilize as oil prices are reduced. The lower oil prices could benefit food and transportation costs. This in turn could mean that inflation will be reduced. What we are seeing, in any event, is that the current Fed is more concerned with the economy than with inflation. Ed Mallon