WEEKLY UPDATE

April 28, 2010



Stocks here in the U.S. staged a minor comeback from yesterday's selloff. The financial sector lead today's 53-point rise in the Dow as a relief rally of sorts came on the close of the congressional testimony of mega-giant investment bank, Goldman Sachs.

Damage was done yesterday:

Yesterday's +200 point drop in the Dow pushed the market below its 20-day moving average, which as you can see from the chart below is a level rarely tested during the past few months. The market was able to hold above the next level of support (the 34-day moving average) but only slightly so. With nearly every other technical indicator pointing to a larger selloff the market will need to soon bounce higher if this rally is to hold; otherwise, the market could be testing lower levels of support at the 89 and 200-day moving averages.



Banking Crisis in Europe:

I have talked for some time about the next stage of our economic crisis and that is the sovereign debt crisis in Europe (and in smaller part, here among our states and local governments). It should come as no surprise that Greece was downgraded to "junk bond" levels yesterday, but a slight downgrade of Portugal yesterday and Spain today is a bit of a surprise. Leadership at the European Union and the IMF are increasingly anxious about offering real money to back up their promises of support they offered Greece just weeks ago. Understandably so, there is still ample resistance among some Eurozone members to help Greece overcome their problems. If the European Union is able to reach a concrete agreement on a bailout for Greece by this weekend further declines in our market may be avoided, but that remains an uncertainty.

Bonds rally:

Some of the big rally yesterday in U.S. government bonds was erased today, but these losses were slight following the Federal Reserve's statement that it still plans to keep interest rates near zero for an "extended period." That is good news to bond investors!

Take care,
Greg

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April 12, 2010



Over the weekend, finance ministers of the Eurozone agreed on a €30B loan package to Greece to be used in the event that Greece fails to be able to raise sufficient capital in the open market. Officials say as much as an additional €15B would be supplied by the International Monetary Fund (IMF). Greece is hoping that this message of support will be a backstop to rising yields, which have recently made debt issuance very expensive for them. Greece needs to issue €10B - €12B in the next 5 weeks to pay off expiring debt and interest. With such high market yields on Greek debt, their path of debt issuance to finance debt issuance is simply unsustainable. While the Greek stock market rose on the news of this support, our market ended flat and Treasury prices strengthened.

While this remains mostly a European problem, if Greece's problems overflow to other countries throughout Europe (for example, Greece defaults and their debt held by banks in other European countries must be written off), then it will likely become an impediment in our effort to restore stability to our banking system.

This weekend's agreement opens the door for the IMF to help Greece and presumably Portugal, Spain, Italy and Ireland, if the need arises.

One expert on IMF bailouts is Kenneth Rogoff who is Professor of Economics and Public Policy at Harvard University and was actually former chief economist at the IMF. He noted over the weekend that these kinds of bailouts do not assure bondholder protection. He has documented numerous instances in which countries enter IMF programs to escape default but end up defaulting on their debt anyway. The most famous case is Argentina in 2002, but other recent examples include Indonesia, Uruguay, and the Dominican Republic. However Rogoff went on to note that some countries can grow their way out of debt problems, as China did with its 1990's banking crisis.

Are our local governments struggling with the same problems that Greece is struggling with?

Aside from our nearly effortless ability to issue debt while Greece finds it increasingly difficult, the answer is yes.

Greece has an aging population whose pension liabilities are growing faster than their economic activity. With tax revenues and savings rates so low, Greece has become increasingly dependent on debt financing to balance their budget. Today Greece is so deep in debt that bondholders are reluctant to give them any more money. For those of you who read the Modesto Bee you probably saw this weekend's article about how our counties are struggling with their pension liabilities in the same way Greece is. One day we may be asking for a Federal bailout just like Greece is today. Hopefully our local governments will be more responsible with our finances than the leaders in Greece have been with theirs.

Jefferson County settlement talks continue

Hopefully we will not fall into the same hole that those in Alabama have. Jefferson County, Alabama has been in little-publicized talks with bondholders and investment banks in an effort to avoid filing bankruptcy due to $1.4 billion in expiring debt that they cannot pay. The county has become the poster child, fairly or not, for small government's claim of being "duped" by bankers into buying risky Credit Default Swaps to limit the risk of selling bonds to finance their pension liabilities. Observers hope a resolution will be made in these negotiations in much the same way as those hoping for a resolution with the Greek debt crisis. A failure to pay more than $1 billion in local debt will have repercussions across America.

Bottom line

As long as governments and central bankers have money and the resolve to put out these "fiscal fires", we should be okay. Hopefully all of the fires will be doused before the money runs out! Until the problem of high debts matched by decreasing tax revenues passes, risk levels in all markets will remain elevated.

Take care,
Greg

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April 5, 2010



One year has passed since Washington began to re-inflate the financial markets, and what a year it has been. Stocks have recovered two-thirds of what they lost since reaching a peak of 14,000 (DJIA) and housing seems to have slowed its long slide. Still, unemployment is sky high, foreclosures are expected to increase by 60% in 2010 from last year (Realtytrac.com), nearly 700 banks need to be closed (FDIC) and half of all commercial real estate loans have negative equity. Without taxpayer support the economy would be in much worse shape than it currently is. Now that Washington is retracting the stimulus it flooded the system with, the question of the day is… "Is this a bull market or a bear-market rally for stocks?" It remains a bear-market rally.

In the last 110 years there have been three clear secular bear markets, and we can now see that the fourth began earlier this decade.



In secular bear markets the long-term trend is sideways to down. Within these bear markets there are often bear-market rallies that are certainly worth going after for investors who are willing to risk their capital in hopes of reaping short-term gains, but these are typically terrible conditions for buy-and-hold investors.

With credit conditions tight and economic storm clouds all around, investors need to be careful when calculating the risk and return of investing during bear markets. The past year has shown that those who were willing to risk their capital in the face of economic collapse were rewarded, but even these investors need to be equally astute at taking their short-term gains before the current rally fails. Investors who missed the early days of this rally shouldn't be too concerned. If this bear market is like those of the past, another bear-market rally will turn up too.

Take care,
Greg