A Dark and Stromy Night
As we have noted before, the primary obstacle is still how to value the so-called troubled assets that burden so many banks. Whether the government buys them with a Bad Bank, or guarantees them in an insurance scheme, or finances private parties who wish to buy them, the same dilemma remains in force. Pay what they are actually worth and the banks will collapse. Pay too much and enraged taxpayers will march on Washington with torches and pitchforks. Rhetoric about executive compensation aside, Geithner and Obama so far seem remarkably willing to let the bankers stay in charge. The executives want what executives always want: to keep the gravy train chugging as long as possible. Long-term consequences are not their concern. We are left with a train that will either 1) derail suddenly and cause great destruction, or 2) slowly coast to a stop from which it will be very difficult to get started again.
The short-term winners appear to be Treasury bonds and gold, both of which are up sharply this week. The gold rally makes sense; with the government blindly throwing vast sums of money in all directions, inflation is a good bet – though we may see additional deflation first. Bond action is more puzzling. Estimates suggest that at least $2 trillion in new supply will hit the market this year. Today’s 10-year auction was completed at 2.82%, higher than analysts were expecting. These are not bullish factors for bonds, but they must be balanced with the vast expansion of the Fed’s balance sheet. We suspect bond yields reached the upper end of the range Ben Bernanke is willing to tolerate, and he took action to prevent further gains. Such things are possible when you have a license to print money.
Bottom line: we may be entering a new and darker phase of the economic crisis. Tim Geithner was widely hailed as just the right man for the job at Treasury. Now his credibility to the markets, while not completely destroyed, is in serious jeopardy. The optimism that surrounded the new administration is dissipating quickly. There is no sign anyone is really interested in doing anything that will improve the situation. All economic indicators continue to point downward, yet the markets are in no way oversold. At this point the best-case scenario is for continued choppy, nervous trading in all the financial markets. The worst-case scenario is much harder to describe. The sun will rise again, of course, but we may have a dark and stormy night first.
The top three and bottom three sectors held steady in our momentum chart since last week. Health Care is still on top with a glimmer of green, followed by Technology and Utilities. Financials, Industrials and Materials are still the laggards. Technology had an especially good week. If current trends continue there may be some buying opportunities in the sector, though we still question how long any uptrend can last in this environment.
The three Growth categories solidified their hold on the top of the list as Value remained on the bottom. This is, at least in part, a result of the dramatic shifts in market capitalization over the last few months. The troubled Value companies are losing their ability to hold back the indexes, while the relatively few companies that still deserve the title of “Growth” are becoming more influential.
As we thought might happen, Japan tumbled down the list and was replaced by Latin America in the #1 spot. This was less a function of Japan becoming weaker than of Latin America, China and Emerging Markets becoming stronger. Note that the USA slipped into fourth place even though it gained momentum in absolute terms.
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.
“Most consequential choices involve shades of gray, and some fog is often useful in getting things done.”
Timothy Geithner, Feb 20, 2007
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