Many market commentators are hoping for a stock market rally as the Obama Administration takes the helm of our great country. And for good reason, a roughly $850 billion dollar fiscal stimulus could be just the shot in the arm the U.S. economy needs. Markets seem skeptical. After traders returned from the holidays, gains made from December 24th through January 2nd were quickly erased. The S&P 500 has started the year with a 5.88% decline through January 16th. The financial sector has led the decline ending near November lows. Developed international markets (as defined by the MSCI ETF, EFA) are also under pressure, down 9.5% since the start of the year.
Concerns center on the need for capital at many banks. The TED Spread has narrowed since the spring of '08, but it is still negative and credit markets are still very tight. The recent need for a capital infusion at Bank of America and Citigroup has been echoed at other banks internationally and sheds light on the magnitude of the problem. Some analysts expect bank failures in 2009 to exceed those in 2008.
Earnings season has provided another headwind for stocks. Alcoa kicks earnings off with a larger than expected loss. Ahead of Alcoa, Time Warner announced a planned $25 billion write-off in the value of its cable, publishing, and AOL assets. Any rally attempt is likely to face a difficult earnings environment and the coming weeks will be very active.
It is entirely possible we will see a near term rally. The last two trading days delivered positive returns on an increase in volume in the face of some very negative headlines. On the other hand, we appear more likely visit or drop below Q4 lows in the near term based on how trading has developed since the start of the year. If markets do rally, I am hard pressed to believe it can be sustained. Leading economic indicators show no signs for an improvement in the U.S. economy in the next 2-3 quarters. Using leading economic indicators from Economic Cycle Research Institute to confirm a market recovery can be a powerful combination.
I find it interesting that many of the policies that contributed to our current credit crisis are being repeated. I realize the current circumstances are different but the need for the U.S. government to issue trillions of dollars in debt, far bigger that any amount in history is somewhat repulsive given the terrible shape our countries finances are in. Our debt just keeps growing and our deficit remains negative.
Many of the buyers for U.S. Treasury Bonds are other foreign governments. Can we expect them to keep buying our debt at such low interest rates, especially since some of them have announced stimulus plans that will require large portions of their reserves? The answer is it does not matter because whatever the Treasury can't sell they will likely send over to the Federal Reserve to hold on their balance sheet (which is already ballooning). The U.S. cannot afford to raise interest rates to make our bonds attractive to foreign buyers so much of it appears destine for the Fed.
Our debt funding at low interest rates cannot go on indefinitely and at some point is going to provide a wonderful money making opportunity. It is possible to profit from falling bond prices and it is a reasonable position to keep an eye on. Interest rates can be held artificially low for long periods of time and until the U.S. economy starts to improve I would not expect to see much movement up in U.S. interest rates.
The energy markets are another place I am looking to make money. I am specifically focused on income producing investments with a high correlation to crude oil. I am also ready to act if we do get an Obama rally, and metals & mining should do well from an expected infrastructure build out.
DISCLOSURE - Some Dightman Capital separately managed account clients hold a position in an energy related ETF. Clients also have exposure to a wide variety of equities, bonds, interest rates, commodities, and currencies through hedged mutual funds. An inverse Treasury ETF and metals and mining ETF are on our watch list. All accounts are custodied at Fidelity.