The $700 Billion Bait & Switch
Equities had another bad week, as is quickly becoming more normal than not. The Dow Jones Industrial Average dropped 1,342 points since Election Day, which was actually better than most global markets. The 10/10 lows are still holding for now, but another retest is underway. Substantially greater losses are likely if the current support fails. As we noted last week, the broad market seems to have entered a trading range, roughly bounded by 840 and 1045 on the S&P 500. This is a fairly broad range, about 24% from bottom to top, so in theory it might be possible to trade it profitably. Doing so, however, would require one have the fortitude to buy as the bottom seems about to fall out and sell as an upside breakout seems imminent. Few investors have the discipline to do either of those things, much less both. This suggests the best course is to leave trading to the traders.
Today Treasury Secretary Paulson revealed – if anyone had any doubt – that his $700 billion Troubled Asset Relief Program, or TARP, is a thoroughly seat-of-the-pants operation. He now proposes to focus his second installment, presuming Congress gives it to him, on consumer credit instruments such as car loans, student loans, and credit cards. Only last month we were originally told that Life As We Know It would cease unless Congress gave Paulson near-unlimited authority to buy boatloads of illiquid mortgage assets. Yet he has not done so, and life goes on. Is the whole exercise another giant government boondoggle? Not necessarily, but it definitely needs a new name. TARP is not buying “Troubled Assets,” it is not providing any discernable “Relief” to anyone, and anything that evolves this rapidly can hardly be called a “Program.”
For its part, Congress would prefer to spend money bailing out the auto industry, which by its own admission will disappear within months unless new cash can be found somewhere. Such a scenario would add millions to the unemployment rolls and possibly turn recession into depression. The problem is that GM, Ford, and Chrysler cannot transform into competitive entities under their current (mainly labor) cost structures. Additionally, the Democrats who control Congress do not seem inclined to take on their union supporters. As a practical matter, then, any bailout of Detroit will simply delay the inevitable. Bankruptcy remains a real possibility for the Big Three.
Treasury yields dropped today as the Paulson news, along with the weak equity market, sparked more flight-to-quality buying. Short-term rates are perilously close to zero. The yield curve has been steepening for weeks and is as close to vertical as we can ever recall seeing it. The prospect of unprecedented budget deficits in 2009 has a lot to do with this, and the Fed is running out of bullets. Emerging market debt is turning into a major headache; a wave of 1990s-style defaults is not out of the question. Worldwide there is virtually no appetite for credit risk, leaving sovereign issuers in the catbird seat.
Energy jumped up in our sector rankings, while Financials were again pummeled and lost relative strength. Consumer Staples, Health Care and Utilities are still the least-weak sectors but are by no means trending upward. In this environment, “defensive” equals “losing less” for equity investors who insist on remaining invested. Materials remain in the basement.
Our style rankings continue to favor large-cap categories over small-cap. Value is only slightly favored over growth. We are beginning to run into definitional problems as well: exactly what is a “small-cap” these days? Some blue chips have had their market capitalization pushed down to levels that once qualified as small-cap. This may explain some of the preference for Large Cap stocks. Why take the risk of the unknown small fry when you can buy a brand name that is temporarily (or so you hope) cheap?
Japan still has the strongest market in a very weak global environment, but as noted above with sectors, the difference is only in degree of weakness. Even Japan is in a serious downtrend. Emerging markets are still suffering the most, and particularly Latin America and China. It would be nice to think that this weekend’s G-20 Summit meeting in Washington will end with some sort of master plan to save the world. Unfortunately, we think the meeting is mainly a public relations effort. There seems little chance a group with such dramatically diverging interests will agree on anything significant.
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.
“If you don’t know who you are, the stock market is an expensive place to find out.”
George Goodman (b.1930) Economist, Author
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