03/25/09   Leveraging the FDIC

Editor’s Corner

Leveraging the FDIC

Ron Rowland

Various economic reports for the month of February are showing improvement since January.  This is not particularly surprising; economic activity has been in a near-vertical downtrend the past six months.  Common sense tells us that the near non-existent activity was an overreaction and will not continue.  Common sense also dictates that even the slightest activity will register as a gain over the prior month in these monthly reports.
However, the inevitable improvement in the one-month reports is being greeted with cheers instead of common sense.  This morning’s announcement that durable goods orders increased +3.4% in February is a good example.  This was the first increase in seven months.  Moreover, today’s announcement also revised January’s report downward from -4.5% to -7.3%.  People are forgetting that the durable goods orders for the first two months of 2009 represent a -28.4% decline from the same period last year.  Also, keep in mind that the February report is subject to further revision, just like January.  So is the economy improving?  Maybe, but until we see gains over several consecutive months or positive year-over-year comparisons, it is premature to declare that recovery is underway.
Having said all this, we are still mindful that the stock market is a discounting mechanism.  It likes to look ahead.  The old rule of thumb is that the stock market typically starts to recover six months before the economy does.  Just like the disclaimer that you cannot directly invest in an index, you also cannot directly invest in the economy.  Therefore, we take our cues from the market.  Our analysis still indicates that recent gains represent nothing more than a bear-market rally.  Such rallies can go on longer than most people expect and can sometimes provide trading opportunities.  As of this writing, we do not think it prudent to jump “whole hog” into the equity markets. 
The latest Treasury plan to rescue banks, the so-called Public-Private Partnership, is already being picked apart by serious analysts and bloggers alike.  Our take: it will not solve the pricing conundrum.  More important, the fact that banks are allowed to decide which Legacy Assets (a new name for the same old “toxic assets”) they will offer for sale means bank balance sheets will remain disturbingly opaque.  Given that the purchases will be financed primarily by the FDIC, the main thing the plan accomplishes is to transform the guarantor of our bank deposits into just another highly-leveraged lending institution.  It is hard to imagine a good outcome for this.
Treasury bonds have given back much of their recent gain, but they remain well ahead of their price before last week’s Fed decision to enter the market on the buy side.  Corporate bonds have traced a similar pattern while inflation-protected TIPS and junk bonds are holding on to their recent gains.  Today’s failure of an auction in the U.K. for 40-year Gilts is an ominous sign for sovereign debt everywhere.  The Chinese continue to make their displeasure known.  Commodity prices are rising in anticipation of inflationary pressure, while the dollar looks vulnerable to a significant correction.
Newer readers may be unaccustomed to seeing green on our Edge charts.  This color represents an intermediate-term uptrend, and we finally have a few.  Technology and Telecom are gaining positive momentum, but volatility remains high in all sectors.  Financials are still red but have moved up from last place for the first time in months.  Even so, none of the uptrends you see in the charts should be regarded as stable.  A few down days could easily reverse them. 
All Style categories are still neutral or red, with Growth favored over Value.  Mid Growth moved slightly ahead of Large Growth.  We saw one story this week about small-cap fund managers who are finding, to their delight, that they can now buy many formerly mid-cap stocks.  We suspect the executives of those companies are not nearly so pleased.
Five of our Global categories have turned green: Emerging Markets, China, Pacific ex-Japan, Latin America and Canada.  As with sectors, none of these trends are especially stable yet.  Canada intrigues us, however.  With banks that have been relatively untouched, a strong currency and plenty of commodity exposure, Canada may actually be well-positioned for the current environment.  The trend should be watched closely.


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.

“Americans will need liquidity to finance all their measures and they will balance this with the sale of their bonds but this will undermine the stability of the global financial market.  All of these steps, these combinations and permanency is the way to hell.”

Czech Prime Minister Mirek Topolanek, (November 25, 2009)


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