Don’s Outlook 2/27/09
Just one week after setting new annual lows, the major stock indexes are significantly higher this week after a four-day, record-setting rally. Once stocks declined far enough to coincide with other bear-market levels, investors rushed in to bid prices much higher. The Dow Jones Industrial Average, for example, rose 1,174 points, or 15.6 percent, over the course of four days. Not only have we not seen a four-day spurt since April 18, but this rally was the largest point rise ever for the Dow and its biggest percentage point gain since August 1932, which is approximately when the historic bear market turned a corner.
One measure that is set to surpass the extremes of that historic crash is volatility, which peaked at 68 percent during the crisis. S&P volatility for the past three months has already reached 66 percent and could easily outpace the worst financial turmoil in the past century. The presence today of hedge funds and the growing use of exchange traded funds to time the market has undoubtedly elevated volatility during this downturn. But savvy investors will look past this and realize that such fear spells opportunity, because no matter where the bottom rests, there is value for the taking in this market. In fact, the Chicago Board Options Exchange volatility index, or VIX, is widely used to measure fear among investors, and the VIX has begun to decline.
Stocks gained widespread support from additional government bailouts this week. Citigroup is the latest bank to receive a major injection from the government, which announced it would infuse $20 billion of new capital into the company and absorb as much as $249 billion in potential losses in poorly performing securities tied to real estate mortgages.
Also this week, US officials agreed to pump an additional $800 billion into ailing credit markets. Unlike previous plans—which all told are now approaching $4 trillion in financial commitments—a good portion of these funds will come from the Federal Reserve rather than the Treasury. The Fed will purchase $600 billion of debt from government agencies (e.g. Fannie Mae, Freddie Mac, etc.) and in conjunction with the Treasury will provide $200 billion to investors buying securities that are tied to consumer debt, such as car, student, and entrepreneurial loans. All of this activity has taken the Fed far beyond its traditional role of setting interest rate policy and transformed it into an enormous lender.
All of these bailouts are expected to weaken the dollar once the dust settles, and that argument must have gained attention last week. Gold, a store of value during difficult times, jumped to $820 per ounce after a five-day run that ended Wednesday. Although there has been no lack of panicked stock-selling among the broader market in recent months, gold bullion and gold stocks had so far failed to live up to their safe-haven status during much of this period. Gold bullion had maintained enough of its value to outperform other commodities, however, but it had succumbed to selling with each upward move in the US dollar index. One portfolio holding with significant exposure to gold stocks is Federated Market Opportunity (FMAAX).
