Don’s Outlook 1/16/09
It has been a long time since one could argue the market got ahead of itself, but by early January the S&P 500 Index had already rallied 27 percent from its intra-day low set during the dark days of late November. One could argue it was an impressive feat given the near endless deluge of bad news and dire headlines paraded before us by the media. Although we cannot expect a V-shaped recovery amidst the economic and financial turmoil surrounding us today, moves such as these are necessary before the stock market can heal itself.
After watching the S&P 500 Index fall more than 10 percent from January 6 through midday trading yesterday, the Federal government stepped into the markets once again, this time shoring up Bank of America. The company, perhaps acting on government wishes, had offered to take over Merrill Lynch in September, the same day that Lehman Brothers filed for bankruptcy protection. Now the government has to pay-up in order for the deal to move forward, as the losses at Merrill threaten to drag down Bank of America, which had also purchased Countrywide at the start of 2008. Treasury will inject $20 billion into the bank, and the Federal Reserve will pick up 90 percent of any future losses on $118 billion in assets.
Federal action may have slowed the market’s descent, but it is very likely that January 6 marked the end of the latest rally that began on November 20. Bear markets do not end until the lows have been tested, and we may see the first test soon, with shares only 10 percent above their lows. Some bearish analysts don’t expect the test to succeed though. Société Général cross asset strategist Albert Edwards thinks the market will break its lows because China will slip into a major depression. He based his estimates on factors such as Chinese electricity consumption and unprecedented drops in exports from Taiwan and Korea, which may signal a decline in intermediate good imports from China.
Nevertheless, I do not expect a return to the gut-wrenching volatility that besieged us last fall, provided the government continues to react with drastic but appropriate measures to provide ongoing stability and liquidity to market participants. These measures are not without their ramifications, but the devil you know is still better than the devil you don’t know. The largely unprecedented intervention provides the best chance we have for economic stabilization in 2009. The speed with which the government reacted last year was even more surprising than the vast market swings that accompanied the Fed and Treasury’s every move, but these efforts should prove appropriate and will keep us from a protracted downturn, and this is why today’s outlook does not resemble that of the 1930s.
