01/21/09   The Slope of Hope

Editor’s Corner

The Slope of Hope

Ron Rowland

Banks are once again in the headlines, and it’s not good news.  The latest domino to fall was State Street (STT), which plunged 59% on Tuesday after marking down its bond holdings.  It didn’t help that the European banking sector is approaching full meltdown; Royal Bank of Scotland (RBS) opened the week with a 70% one-day drop.  The Obama Administration appears to be putting together some sort of dramatic rescue plan, but details remain sketchy.  If the plan consists of more capital injections and asset guarantees it will probably fail.  Unless and until the banks open up their skeleton closets and demonstrate that all their assets are fairly valued, they cannot be trusted.  There are no signs that any major bank intends to do so.  Is this because they know a fair accounting would render them insolvent?  You be the judge.

In other news, the Consumer Price Index for December came out last week and revealed the economy is sliding inexorably toward outright deflation.  CPI for all of 2008 was up only 0.1%.  Recent trends are more disturbing.  On an annualized basis, inflation in the 4Q was a negative 12.7%.  Much of that was due to the slide in oil prices, but the collapse in consumer spending played a big part as well.  Speaking of oil, crude broke to new lows before recovering along with stocks today. 
The year 2009 is off to a terrible start by almost any measure.  YTD returns for the major benchmarks would look bad even if they were for an entire year.  We aren’t even through the first month yet, and the major benchmarks have undergone double-digit declines.  There is a rule of thumb that a 20% loss could be called a bear market.  By that standard, some sectors have had bear markets just within the confines of January 2009.  The S&P Select Financial SPDR (XLF) has lost nearly a third of its value so far this month.  Today’s rally trimmed the losses somewhat, but the downtrends are still firmly in place.  The only good news is that negative momentum is at unsustainable extremes.  The fastest-falling sectors like financials and real estate will have to at least slow their decline in the next few weeks or face the prospect of disappearing completely.  
Treasury yields rose in the last week but remain far below the level of two months ago.  The 10-Year Treasury closed today just below its January 6 peak of 2.61%, a level that will likely serve as a good stopping place for now.  There is a great deal of concern about the new administration’s spending plans.  We suspect that will ease once the Obama team provides some clarity about its strategy and tactics.  Their bet is that the massive asset destruction of 2008 will give them room to run huge deficits.  That remains to be seen, but as we have been saying for weeks, it is hard to imagine any scenario that would take Treasury yields sharply higher in the near-term.  The low prices on Treasury Inflation-Protected Securities, or TIPS, suggest that inflation is the last thing people are worried about for now.  Yields for municipal and corporate bonds are looking very attractive, but with the economy still weakening we continue to advise caution.
Health Care and Utilities are on top of our rankings and, not coincidentally, have the best performance so far in 2009.  Of course by “best” we mean “least bad.”  Even these defensive sectors are declining at an alarming annualized rate.  Consumer Staples is back in the top three after a pullback in Telecom.
The Large Value category includes many financial stocks and has accordingly dropped in our rankings.  It is debatable how many once-iconic institutions still qualify as “Large Cap” stocks.  The decline in market cap for the major banks is nothing less than staggering.  We will not be surprised to see many of those stocks moved into the Mid-Cap category following the next round of index reconstitutions.
The above-mentioned banking turmoil in Europe brought the U.K. and E.U. down to the bottom of our charts, even below China and Pacific ex-Japan – more evidence of how the mighty have fallen.  The impact was intensified by a huge drop in the British Pound and the Euro against the dollar.  The U.S. remains near the top of the charts, demonstrating that however bad it seems here, the rest of the world is even worse. 


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“Today I say to you that the challenges we face are real.  They are serious and they are many.  They will not be met easily or in a short span of time.  But know this, America – they will be met.”

Barack Obama


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