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May 2009 Market Review

Posted by Larry Doyle on May 29, 2009 11:23 PM |

Welcome to the Brave New World of the Uncle Sam economy! Let’s review the price action across the market, add some analysis as we look behind the numbers, contrast these returns with developments in the economy, and chart our path forward as we navigate the economic landscape!!


Market Returns:

Equities: while market analysts continually measure the market from March 6th, unless one purchased the market on that date and at that point, it is much more intellectually rigorous to measure returns on a YTD (year-to-date) basis. Although I will incorporate short term movements, focusing solely on the short term increases the risk that we “miss the forest for the trees.”

The equity markets posted solid returns for the third month in a row. Although the returns in May were positive, they were not as largely positive as the prior two months. Year to date, the DJIA is slightly below unchanged while the S&P 500 is slightly positive. The tech heavy Nasdaq continues to outperform and is solidly positive (+12.5%) on the year. Why? Many tech companies have significnatly less debt burden and refinancing risks.

Bonds: the high yield sector continued to outperform (+9.7% MTD, +24.3% ytd). The mortgage and municipal sectors largely marched in place. The front end (shorter maturities) of the U.S. government bond market held steady as the Federal Reserve indicates they will keep the Fed Funds rate at 0-.25% for an extended period. The long end (intermediate to long maturities) of the government bond market sold off dramatically (+35 basis points on the 10 yr) under the weight of very heavy supply.

Currencies: the U.S. dollar had a very difficult month relative to almost every other major currency. The greenback gave back almost 4% relative to the Japanese yen, although it remains within the trading range for the year. The dollar particularly suffered versus the Euro on concerns of a potential downgrade of U.S. government credit due to the ongoing fiscal deficit. 

Commodities: this is where the real action occurred this month. Commodities, in general, posted their largest monthly gain in 34 years. Oil was up 30.1% on the month and 55.6% on the year. Gold rallied 11% on the month and is up a like amount for the year. 

Looking Behind the Numbers . . .
As I view the monthly and annual numbers, I am drawn to a comparison of a football pass thrown in a game. That is, when the football is thrown, three things can happen and two of them are not good. The pass can be completed, fall incomplete, or be intercepted.

Similarly, our economy can gradually improve with credit lines opening, housing and employment stabilizing, and markets improving – much like a completed pass.

Our economy can stumble under the weight of a surge in delinquencies and foreclosures in the residential space, a wave of commercial real estate defaults, and a double digit unemployment situation – much like an incomplete pass.    

Our economy can stabilize with enough traction to create velocity in the growth of the money supply. Given the trillions of dollars injected both directly and indirectly, a hint of velocity will likely spark a sharp increase in the expectation of inflation even prior to actual signs of inflation. The price action in the commodity and currency space are sending warning signals on this front. This development is akin to an intercepted pass. 

Economic Review . . .
As I look back on the wealth of economic data, I am continually struck by the downward revisions to prior months’ numbers. Although consumer confidence has increased, in my opinion, virtually every other statistic both here and abroad shows ongoing caution signs. These numbers include retail sales, housing, employment, and industrial production. Overseas the export data is decidedly weak.

Perhaps the markets are discounting an expectation of improved economic data due to the $780 billion Stimulus Bill starting to kick in later this year. The major money center banks have clearly been stabilized, although it took a fabrication in their accounting (via a relaxation in the mark-to-market) to do so.

The movement in commodities is clearly indicating a sign of improved economic activity and/or heightened inflation, or both. It is not inconceivable that our economy does get inflation sooner than later combined with minimal credit flow due to ongoing writedowns on delinquent or foreclosed loans. Combine these two components and we have a very real chance of stagflation over the next few years.   

The Path Forward . . . 
The steepening of the yield curve (rates on short term maturities relative to long term maturities) is very positive for our banking industry. The banks can continue to borrow money at extremely low rates and earn significant interest on almost any sort of lending that occurs. That said, new loan demand is not strong while demand for refinancing is quite strong.

My concern currently is not with the major money center banks. I am VERY concerned with the non-bank banks (Freddie Mac, Fannie Mae) and the Federal Home Loan Banks (FHLBs). Given the ongoing surge and expected high levels of residential loan defaults, these institutions will bleed money. The insurance sector, despite some recent improvements in their stock prices, also concerns me given their commercial real estate holdings primarily.

I do believe longer term interest rates will continue to work their way higher under the weight of supply of global government debt, and expected ongoing heavy demand (May was a very heavy issuance of both bonds and stocks) by municipal and corporate issuers. Do not be surprised to see our 10 yr Treasury note get to 4% and 30yr fixed rate mortgages get to 6%.

The deleveraging process will continue as the economy adjusts to life without a vigorous securitization business (remember the securitization business on Wall Street provided 40-45% of total credit to our economy).

Add it all up and I think the following will occur:
   – equity markets will now move sideways in range bound fashion;
   – the bond market will move lower in price, higher in rates; 
   – the dollar will gradually decline;
   – our economy will be filled with more stops than starts.

Please share your thoughts and comments!! Thanks.


  • that’s an ultra magnificent thread!

  • shimmy

    larry, that’s a pithy look at a fun filled month… looks like we’re in for some good old fashioned economic mud wrasslin’ this summer….

  • Always Learning

    Great market review, LD. Very thorough. THANK YOU!!

  • fiscalliberal

    Alternative view might be:

    If inflation kicks in, housing prices might go up cutting down on the defaults.Higher bond rates, possibly means higher interest rates on my CD’s, decline in dollar means our exports might pick up, creating more jobs and more stops and starts might make the culture appreciate a job more, producing higher quality work. More over stops and starts weeds out the inefficient.

    That is kind of a contrarian view, but could happen. In the end, the sky will not fall.

  • Fiscal….all salient points. It’s ultimately all about the timing. Can we get a whiff of inflation soon enough to forestall the incipient surge in delinquencies, defaults, and foreclosures? On this front, I do not think so. Those delinquencies and resulting defaults are in the pipeline right now.

    A pickup in inflation will help those who may be able to withstand the pressures for now.

    If inflation picks up, though, will it actually hit the demand side of the eaquation as housing affordability outpaces wage growth?

    I do agree with you that the Fed will be forced to increase short term interest rates sooner than they would prefer and that CDs and other short term rates will increase. This should help savers.

    The race to increase exports will be a global development. For that very reason, China wants to keep its currency artificially deflated.

    Our culture needs a wakeup call. More than anything else, the need to readjust our ethics across so many fronts is paramount to our being able to compete going forward.

    Your views are always appreciated!! Thanks for sharing.

  • TeakWoodKite

    LD Thank you for the insights. There is a fourth thing that can happen with the pass. It can be a completed pass and even a run in for a touch down, but due to the holding offensive holding call, it will be deemed as it never happened.

    Which means on balance even though there maybe some good news to spin politically, financially the constant hum of being sacked repeatedly…will lead to a punt.

  • kbdabear

    There’s few other possibility with a pass. It can be a short pass completed but short of the first down marker, or it can be completed but fumbled on the run after the catch.

    Gas prices have gone up by nearly a dollar since January and are rising steadily. That negates the $13 a week tax withholding reduction along with other price inflation due to transport costs. With Just in Time inventory practices, those rises will be almost immediate even before inflation caused by renewed demand and debt monetization do their thing.

  • The fed will have to start buying dollars again in next Q, otherwise the rise in mortgage rates and the continued rise in commodities will trash their alleged “green shoots.” Stocks will also have to decrease. Bank stocks will have to readjust prices after all of their offerings settle down. So why should I be even cautiously optimistic? I say we need DEFLATION and we need it sooner rather than later.

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