01/28/09   Dissent at the Fed

Editor’s Corner

Dissent at the Fed

Ron Rowland

Major equity indexes jumped in the last week, as did Treasury rates and gold.  While any gain is encouraging, we view recent action as simply another bear-market rally.  Chartists will argue, correctly, that over the last two months the S&P 500 has marked a series of higher highs and that the January low was still well above the November bottom.  Today the index closed above its 50-day moving average for the first time in almost three weeks – an event that some analysts define as an intermediate-term uptrend.  All these facts are undeniable.  They are, however, hinged upon short-term action that unfolded in the last few days.  Bank stocks are flying higher because it appears the federal government is about to give them a lot more money.  This, along with a handful of good earnings reports, is the foundation of the current rally.  It is a very weak foundation, in our opinion.
Every bull market has to begin somewhere, of course, and someday we may look back and see that we are presently in the early stages of one.  At the same time, the economic backdrop does not seem consistent with a swift recovery from current levels.  Housing sales picked up in December, but only at much lower prices.  Consumer confidence indicators are finding new depths of pessimism, leaving retailers grasping at straws as they try to entice customers to buy things.  Unemployment is still rising rapidly as mass layoff announcements become a daily event.  Credit is still tight and getting tighter, despite the best efforts of the Fed and Treasury to force banks into lending.
Today was Fed day, and to no great surprise the FOMC took no policy action.  They did, however, make sure everyone knows they will continue spending enormous amounts of fiat money to “support the functioning of financial markets and stimulate the economy.”  The committee also said the Fed is prepared to purchase long-term Treasury securities if necessary.  At least one member, Jeffrey Lacker from FRB Richmond, apparently wants to do this right now, and the statement notes his dissent.  This would be a kind of “nuclear option”, and our guess is the Fed wants to keep the threat alive without having to actually follow through on it.
Treasury yields rose after the Fed news, continuing a short-term uptrend that began about two weeks ago.  We have maintained that this is simply a normal correction of the November-December unprecedented drop in long-term rates.  When we recall that less than three months ago the 10-year yield was close to 4% and dropped almost as low as 2%, today’s close near 2.65% looks like a fairly mild retracement.  The Fed wants mortgage rates to go lower, and it is willing to do whatever is necessary to achieve that goal.  We would not bet against them.
The top three and bottom three sectors did not change over the last week.  Despite a stratospheric rally the last three days, Financials are still in a severe intermediate-term downtrend.  Technology picked up some momentum after a few positive earnings surprises, namely Apple (AAPL) and IBM, but those appear to be the exception.  All sectors remain in the red, with only Health Care coming anywhere close to positive territory.
The Style categories remain bunched up in a narrow range, but we are starting to see a stratification of Growth over Value.  As noted last week, style and market-cap definitions are becoming strained thanks to the wild markets of the last few months.  Where any given company should be pigeonholed on any given day is often hard to say.  It will be interesting to see who lands where once markets settle back into some kind of normalcy. 
Japan is still on top from a global relative strength perspective, but in no way can it be said that Japan is strong in absolute terms.  In fact, a good part of the relative strength Japan shows for U.S. investors is a function of the strong Yen.  Unfortunately this same factor works against Japanese exporters, so we are not convinced Japan will retain its allure, such as it is, for very long.  On a more positive note, Latin America is rising in the rankings.  One country-focused ETF, iShares Chile (ECH), is even showing positive intermediate-term momentum.  How long Chile can keep it up amid so much global turmoil is unclear, but it is nice to see at least one market doing well. 


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.

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Former Senator George Mitchell (whose law firm defended the sheik of Dubai for using kidnapped children as camel jockeys).


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