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Remaining on Guard…

Posted by Larry Doyle on April 4, 2009 10:07 AM |

I much prefer a rallying stock market, but I am not a day trader trying to catch moves for quick flips. I look for changes in economic fundamentals (incorporating both private sector and public sector inputs), assess those changes with market technicals (overbought and oversold conditions), and position myself accordingly.

The big wild card in current analysis is the impact of public sector inputs. Many of the maneuvers utilized by the Treasury and Federal Reserve have never been used prior to this economic downturn. Are they working? To what extent? What are the unintended consequences? What is the time delay from implementing a program to measuring its impact on the economy? These questions are the topics of protracted discussions by economists, bankers, analysts, and money managers around the globe. I’d also like to address them here at Sense on Cents.

My market instincts tell me that programs injecting trillions of dollars across wide swaths of the market are not without costs. These costs in the form of “crowding out“, distorted competition, changed behaviors (AIG undercutting insurance rates), moral hazards, and inflation are very real. The challenge is assessing the risks of these long term costs versus the necessity of providing sufficient capital and liquidity backstops to support the economy. 

I do think a particular challenge for our economy at this juncture is the public’s view of providing more bailout money. I heard more than a few times this week Secretary Geithner indicating that the domestic banking system may still be sitting on $1 trillion in embedded losses. Will the administration ask for another large capital outlay? Will Congress grant it? Will the public accept it? 

To that end, the relaxation in the mark-to-market will provide enormous capital relief to the Federal Home Loan Bank system, Freddie Mac and Fannie Mae, and a wide number of banks. I personally think it is a lot of smoke and mirrors to protect a number of institutions from realizing real losses. Believe me, Freddie Mac, Fannie Mae, and the FHLBs are not overly complicated portfolios. They do not own distressed, highly leveraged CDOs.

I am also very concerned about the pending defaults in the commercial real estate markets. While some owners of commercial real estate may be able to refinance existing mortgages as they come due, there will be plenty of mortgages defaulting. Will the commercial real estate industry receive a multiple hundred billion dollar bailout? I have to believe they will ask for one.  

On the plus side of the ledger, there are hints of positive developments within housing. New home sales and housing starts show signs of turning up. I want to see a few months worth of these numbers, though, because home prices continue to decline, unemployment is moving higher, and consumer spending is still anemic.

In regard to interest rates, I am concerned here as well. Yesterday, long term interest rates moved appreciably higher. Those rates have completely retraced the downward move that resulted from the Federal Reserve’s announcement of quantitative easing. If the Dow is fairly priced at 8000, I do not think the 10yr U.S. government bond represents any sort of value at 2.90%. One of those valuations has to give. 

In regard to the G-20, not surprisingly the powers that be put a happy face on the proceedings, as well they should. There remain more questions than answers. In thinking through all of the pronouncements, I keep wondering how they intend on “jumpstarting international trade.”

In summary, we have had a very nice 4 week rally in equity markets and seeing postive returns in the monthly statements is nice. In reading a market review this morning in the Financial Times, Beware the Bear Market BounceI was struck by the fact that the S&P 500 has rallied 23% from the lows 4 weeks ago. My feelings are that fundamental analysis in the market remains very clouded, as I have highlighted in this piece, and that the market is currently dominated by short term, technically focused traders. That 23% level just so happens to be a Fibonacci Retracement level. 

Is it time to take profits and sell positions?

In summary, I am remaining on guard!!


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