President Obama, like so many in the Democratic party, idolizes Franklin Roosevelt. He has called for a new New Deal, portions of which are passing through the pork grinder called Congress and spent most of his campaign playing class warrior. In perfect Rooseveltian fashion, he spent the last week tongue lashing Wall Street over their pay packages, calling year end bonuses “the height of irresponsibility” and shameful after a report from the NY state comptroller. Despite the business bashing, weak economic reports, falling earnings and a new Treasury Secretary who acts a lot like the old one, stocks managed to hold their losses to less than 1%.
The economic reports got off to a surprisingly good start as falling prices are having the expected effect on existing home sales which rose 6.5% in December. Inventories fell by an impressive 11.7%. That’s still a 9 month supply at the current sales pace, but a vast improvement. The LEI (Leading Economic Indicators) also showed improvement moving up 0.3 for the month. The improvement is somewhat misleading as the biggest contributor to the gain was a rise in real money supply. The correlation between money supply and economic growth is not as strong as it once was and many economists feel it should be removed from the index.
Unfortunately, that was the sum total of the good news on the week. Jobless claims rose 3,000, Durable goods orders were down 2.6% and new home sales fell 14.7%, To wrap up the week on a slightly positive note, GDP came in at a better than worst case scenario -3.8% (annualized) for the fourth quarter. The GDP report was expected to be down 5% or more so this seemed at first blush to be better than expected. The difference, however, was primarily due to an inventory build which doesn’t bode well for future production.
The market had a positive bias until late in the week when the administration seemed to back off on the “bad bank” plan that was floated just a few days earlier. The uncertainty surrounding the banking system has been at the heart of the stock market performance for months now and until that uncertainty lifts, it seems unlikely that we’ll get a sustained rally. The uncertainty was created by the myriad market interventions of the last 18 months and ironically we now await another intervention to end it. That would seem to be the triumph of hope over experience.
All of the interventions to date have been designed to obscure to some degree the precarious condition of the banking system. It started in 2007 with the Fed’s TAF program which was designed to allow banks to borrow from the Fed without the transparency of the discount window. That worked so well, that banks, not knowing the condition of their counterparties, stopped lending to one another. While the Fed has followed TAF with numerous other lending programs, Treasury has been busy arranging loan guarantees and acting as the shotgun wielder in a series of forced marriages (and in the case of Lehman, using the shotgun). We’ve now arrived at a point where no one knows what is coming next and no one can differentiate between the healthy and the terminally ill.
The original TARP program, hurriedly approved by a frightened Congress facing an election, was designed to buy up the bad assets choking the lending pipeline. That idea was replaced with direct capital infusions via preferred shares when Treasury couldn’t figure out a way to price the assets high enough to keep the banks solvent but low enough to satisfy the public. New Treasury honcho Geithner revived the original plan in the form of a “bad bank” model but has apparently run into the same problem. I’ve seen a number of officials try to label this as an RTC type plan, but apparently they forget that the RTC didn’t actually buy anything. RTC took assets from failed S&Ls and auctioned them off over a period of time. The only way to have an RTC solution today is to do what everyone has been trying to avoid – let the bad banks fail. While that would undoubtedly be painful in the short run, it is the quickest way to resolve the uncertainty.
The uncertainty is also having a continued effect in the gold market which had another good week:
Gold has continued to move higher even as other commodities languish.
I still think commodities are making a bottom, but until the uncertainty of the banking situation is resolved and the flight to safety bid in the dollar ends, a sustained uptrend seems unlikely. Gold is unique in the commodity market but bull markets in the commodity asset class are built on a weak dollar, which has yet to manifest itself despite the concerted efforts of the Federal Reserve, a Congress seemingly intent on spending us into bankruptcy and a Treasury Secretary who couldn’t even wait for confirmation before bashing the Chinese about the Yuan.
January 2009 will go down in history as the worst start for the stock market in…well, ever. For the month, stocks lost about 9%. There’s been a lot of commentary over the last week about the January indicator which basically says that however the market goes in the first month of the year, so it will go for the remainder. That turns out to be yet another of those old Wall Street aphorisms that is true except when it isn’t. Of 22 down Januarys over the last 60 years, 11 lost money for the balance of the year and 11 made money. So, in down years, the January indicator is as reliable as a coin flip.
While the market has gotten off to a bad start there have been places to make money. A look at various sectors shows that the January decline was mostly due, not surprisingly, to the financials which lost almost a quarter of their value as a group:
There were investments that produced positive returns for the month.
Top returning indices, last 30 days and their respective IShares ETFs
- Silver 15.94% (SLV)
- Chile 10.83% (ECH)
- High Yield Bonds 6.3% (HYG)
- Gold 4.95% (IAU)
- Brazil 4.6% (EWZ)
- Municipal Bonds 3.69% (MUB)
- Medical Equipment Sector 3.65% (IHI)
- Biotech 1.62% (IBB)
- Emerging Market Bonds 0.73% (EMB)
The worst performers are dominated by financial and real estate:
- Global Financials -19.02% (IXG)
- Cohen & Steers Realty Majors -19.16% (ICF)
- FTSE NAREIT Retail -19.48% (RTL)
- FTSE NAREIT Industrial/Office -19.84% (FIO)
- Insurance -21.11% (IAK)
- US Financials -23.93% (IYF)
- US Financial Services -26.96% (IYG)
- US Regional Banks -31.78% (IAT)
How the market performs for the rest of the year depends to a large degree on sentiment. The economic statistics are likely to continue to be weak, but stocks will perform based on expecatations about the future. The first step will be for the administration to provide a viable plan for the financial sector and stick to it. A large measure of uncertainty can be removed by that action alone. The “stimulus” plan wending its way through Congress also needs to be seen as having at least a chance of success. What I’ve read of the plan so far is not encouraging, but I’m a Keynesian skeptic. More important will be the general public’s perception of the plan. The stock market rallied 43% in Roosevelt’s first 100 days in office with no discernible improvement in the economy. Let’s hope that President Obama’s Roosevelt imitation extends to the stock market.
Disclosure: Alhambra Investment Management and/or its clients have positions in: S&P 500 (IVV, SPY), gold (IAU), Russell 2000 (IWM), GSG, HYG, IBB, MUB and ICF.