06/17/09   Change, I Mean Reform, Is Coming

Editor’s Corner

Change, I Mean Reform, Is Coming

Ron Rowland

Once again, the financial headline stories are originating in Washington rather than New York. Today President Obama unveiled his plan to enhance regulation of the financial services industry. Given that much of it will require Congressional approval, the final result may or may not resemble what was proposed today. Many powerful groups will spare no expense in attempting to shape the legislation to their advantage. We like the president’s stated intent to close the legal gaps and excessive risk-taking that contributed to the current crisis, but we are still dubious the end result will accomplish those goals.

Financial reform may take a back seat to health care reform. The industry and Congress appear to have reached broad agreement on a plan that will require everyone to buy health insurance, force insurers to accept all applicants, and offer subsidies to those below certain income thresholds. The main sticking point is whether a new government-sponsored plan will be allowed to compete with the private insurance industry. Then there is the not-inconsiderable question of how to pay for it. If we get both health care reform and financial reform by the end of the year, Obama’s campaign promise to bring “Change” may prove to have been no exaggeration. Whether we will like the change is another question.

In the past six weeks the stock market has gone… nowhere. The S&P 500, Dow Industrials, and Russell 2000 are all showing fractional declines from where they stood in the first week of May. The Nasdaq Composite and Nasdaq 100 are up slightly for the same period. Among sectors, the defensive trio of health care, consumer staples, and utilities came out on top. Technology, energy and materials were also positive, while the losers were financials, consumer discretionary and real estate. Nearly all international markets are showing gains for this period, in part because the U.S. Dollar declined about -4%.

The last six weeks were also not kind to Treasury bond investors: the ten-year yield went from 3.1% all the way up to 4.0% before pulling back to its current level just below 3.7%. Mortgage rates are rising steadily; the much-ballyhooed 4.5% rate was in fact available for only a short time and only to the highest-rated borrowers. The housing market is still stuck in quicksand, with foreclosures and for-sale inventory growing and the number of potential buyers shrinking. The Federal Reserve will no doubt address this problem at next week’s policy meeting, but we do not see much they can do about it.

Inflation pressure appears to be easing somewhat, with the Producer Price Index and Consumer Price Index both bringing few surprises. Higher fuel and food prices are being offset by falling prices in other areas. The inflation-deflation debate drags on with both sides having many convincing arguments. We still do not understand who the Treasury thinks will buy the trillions in debt that must be issued in the next year. The answer will be key to our economic future. We should all hope for the right one.


The Materials sector was the biggest momentum loser of the week but had enough of a lead to remain in the top spot for now. Technology is the new runner-up and will likely overtake Materials for the top ranking by next week. Consumer Discretionary fell hard, losing -6.5% and 34 RSM points. It was a bad week almost all around; only Utilities and Telecom managed to post positive results. The gain for Utilities allowed it to move off of the bottom of our Sector Edge chart.


Our Style rankings were mostly unchanged in terms of relative position, but there was an across-the-board drop in momentum since last week. The Small Cap categories fell harder than Large Cap and have been losing strength relative to Large Cap since the first week of June.


The USA’s respite from the bottom of our Global rankings was short-lived, and once again our domestic markets are lagging the rest of the world. Nonetheless, the global pullback in basic materials stocks took a toll on many emerging markets over the last week. Canada slipped from #2 to #4 as its currency declined along with its equity markets. Emerging markets still hold a substantial lead over the developed regions of the world, a trend we suspect will continue for at least a few more weeks.


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.

“What happened to that hedge fund shows that when you’re really right, you always overstay the position and that’s when you get murdered. It’s better not to be right so much.”

Peter Bernstein


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