WEEKLY UPDATE
December 20, 2009
There was a lot of news for investors to digest this week as the FED ended its last FOMC meeting of the year on Wednesday, concerns of sovereign-debt defaults continued to spread across Europe, and a Triple Witching Friday brought trading volume to record levels on Wall Street. It was a rather busy week!
Stocks
The chart below depicts trading in the Dow Jones Industrial Average this week. Stocks trended lower all week on light holiday volume, but Friday was "Triple Witching Friday" (i.e. the simultaneous expiration of Options, Futures contracts, and Stock Index Options). Trading volume reached record levels although even that did little to change the indexes for the week.
One indicator we take special interest in is the Investors Intelligence Bull/Bear Ratio. This indicator has a very good track record for revealing peaks in the stock market and as the chart below shows us the ratio of bulls to bears is as high now as it was in late 2007 (when the stock market peaked). This raises concerns that the U.S. stock market is reaching at least a near-term peak.
Bonds
Treasuries ended the week higher due in large part to investors shifting money out of stocks into the safe haven of U.S. Treasury Bonds. Treasuries were also helped by the Federal Reserve's outlook calling for a sluggish U.S. economy with very little risk of inflation in the near term. On Wednesday, the central bank reiterated it would keep U.S. interest rates low for an "extended period" but would allow its liquidity and credit-market support programs to expire as intended in the first quarter of 2010.
Sovereign Debt Problems
One of the central issues facing investors next year is the mounting sovereign debt problems. Dubai was first to default on their debt a couple of weeks ago. Now concerns are rising about Greece's ability to service their debt - they are expected to report a deficit equal to 12.7% of their GDP, substantially higher than the upper limit of 3% mandated by the European Union. Rumors of potential insolvency are also swirling around Spain, Italy, Ireland and even the United Kingdom. California did well to sidestep default this past summer as the nation's largest banks accepted its IOUs, but who will be able to step in to help entire countries refinance their debt? That is, in my opinion, a leading issue facing investors in 2010.
All in all it was a good week for us and the positions we hold.
Take care,
Greg
December 14, 2009
Last week: Stocks advanced slightly last week following Federal Reserve Chairman Bernanke's acknowledgement that the economy is still weak, suggesting interest rates are likely to be held low for an extended period of time. This helped support stocks and bonds.
This week: Our stock market opened slightly higher this morning following the surprising news that Abu Dhabi will loan fellow United Arab Emirate member Dubai $10 billion so it can avoid defaulting on several billion dollars of bonds that are maturing today; this buys more time for Dubai to seek a way out of defaulting on nearly $80 billion of debt over the next nine months. This news lifted our market futures overnight into positive territory, however prior to the news the market was trading down roughly 60 points.
On Tuesday we receive reports on producer prices (PPI), industrial production, and chain store sales. Trading remains very light as the year comes to an end so any surprises with these reports could move the stock market.
Banks seeking to buy time against $1 Trillion in bad loans: U.S. bank regulators will meet on Tuesday to consider a proposal that would give banks more time to build capital cushions against more than $1 trillion of assets that they have to move back on their books January 1, 2010.
The FDIC and FED have allowed banks to move bad assets off their balance sheets this year to avoid reporting insolvency (also known as regulatory forbearance). Now that is coming to an end. Banks are supposed to move these assets back to their balance sheets, but without more capital on hand that could lead them back into insolvency. We will be waiting for word from the FDIC and FED on this issue.
Wednesday marks the end of the last FED Federal Open Market Committee Meeting of the year. As this meeting concludes all ears will be listening to the comments following the meeting for any further clues to future interest-rate changes. The markets expect no change in monetary policy so any unexpected shift in policy would affect the markets.
Summary: Many market participants are hoping for a quiet end to this year but with so many economic reports and FED policy comments on the slate this week, no one can yet stay home for the holidays. A little stability as the year comes to an end would be a welcome change!
Take care,
Greg
December 5, 2009
Below is a quick recap of some of this week's highlights.
November Jobs Report Surprises Everyone. Friday's job numbers from the government showed that non-farm payrolls fell by just 11,000 jobs (analysts expected a loss exceeding 125,000). The unemployment rate fell to 10% from 10.2% from the previous month. The payroll data suggest that we might be slowly turning around, but some are unsure. The unemployment number came freshly off the heels of a disappointing service sector report on Wednesday, reporting that service sector managers were shrinking their plans with analysts expecting to see 83,000 jobs lost in the service sector last month - instead the government reported an 80,000 gain in service sector jobs. This 160,000-job swing from private analysts' estimates to the government's estimate surprised everyone and left them scratching their collective heads. Still, the trend has been improvement in this area. For the sake of our economy, our county and our fellow citizens, we all hope that the government's figures hold up.
Stocks remain flat for the week. Stocks ended the week largely unchanged. Internal indicators such as breadth, momentum and investor sentiment continue to indicate that the market rally is running on thin ice, but the market has been resilient of late and has had a tendency to bounce back every time a sell-off occurs. Friday was very interesting: In reaction to the stronger-than-expected unemployment data, the stock market futures were pointing to a strong open and they were not wrong. Thirty minutes into trading the Dow was up 150 points; that however was the high for the day. The stock market gave back all of its gains before recovering in the final hour to end with a 22-point gain. The reason for the failure? The stronger dollar.
Dollar Recovers. The US dollar had one of its best days in over a year, rallying strongly on Friday's unemployment news. This caused a pullback in both U.S. stocks and Treasury bond prices. The chart below shows the trading movements in the Dow and the U.S. Dollar Index this past Thursday and Friday. The dollar index (tan line) jumps Friday morning and continues to rally the rest of the day while the Dow (black line) opens strongly up on Friday but gives back most all of its gains the rest of the trading day.
Fueled by a zero interest lending policy from the FED, the dollar has been on decline for six months and is now oversold. We have been expecting a recovery in the dollar but Friday's rally came as a surprise. If the dollar can extend its rally, that would put even more pressure on U.S. stock prices.
Treasury Yields Rise on Friday. As I mentioned earlier, Treasury prices slipped and yields rose on Friday. The move on Friday was strong enough to offset a portion of the gains made in November but were not nearly strong enough to reverse the trend of lower rates. Friday's action affected U.S. Treasury and TIP bond funds to a greater extent than Mortgage Backed bond funds. The chart below shows the yields of the 2-year Treasury Note in Orange and the 5-year Treasury Note in Blue. For now Friday's reversal of bond yield does not call for a major adjustment in our positions.
Coming up this Week...
Mr. Bernanke speaks on Monday. Everyone will be listening for any change in FED policy with Chairman Bernanke speaks to the Economic Club of Washington, D.C. on Monday. Nobody expected much from this speech until Friday's job data was released; now everyone is interested in any tidbits the FED Chairman would like to reveal.
Climate talks could affect the markets. Monday marks the start of a two-week conference on global warming in Copenhagen. The United Nations is pushing hard for agreement among nations to reduce greenhouse emissions, cut the use of fossil fuels and reduce deforestation. The battleground is set between those who believe these measures are a solution to global warming and those who believe it is more about profiting from carbon taxes. Regardless of which side you may associate with, there is one thing many agree on - if a surprise agreement is reached in Copenhagen it could affect many aspects of our economic and daily lives.
Looking further down the road...
Our Banks need to raise more capital. Starting next year American banks will be required by the FED to raise their Tier 1 capital reserves from a 10% to a 12% capital-to-liability ratio. Noted banking analyst Dick Bove of Rochdale Securities predicts that 26 of the top 30 American banks will need to raise more capital to meet these levels. If true, this will put greater pressure on banks to maintain tight lending standards despite pleas from the government to loosen lending requirements to individuals and small businesses. Currently the nation's top banks are sitting on nearly $1 trillion in excess banking reserves.
Dubai is not alone. As I mentioned last week, Persian Gulf emirate Dubai is seeking to defer debt payments on nearly $90 billion in liabilities from their state-run companies; Dubai is not the only country in trouble. Latvia and the Ukraine are also in trouble, but few in the West seem to care about these small economies. The West is more concerned about Greece who is facing a possible downgrade in their credit rating as they struggle through their worst financial crisis in fifteen years.
Financial Planning notes...
Death taxes might not die. The federal estate and gift tax is set to expire on December 31 and be repealed for all of 2010 meaning that there would be no estate tax next year. The House of Representatives approved a bill on Thursday to extend the federal estate tax in its current form - that means that the first $3.5 million of a person's estate and the first $1 million of gifts would be exempt from tax but any value greater would be subject to estate tax. The tax at its highest rate would be 45%. The Senate would need to act before the end of the year if any change in law were to take place.
Remember RMD IRA distributions are waived this year. As part of our economic recovery plan, Congress decided to waive any IRA Minimum Distribution Requirements this year for folks who are older than 70.5 years of age. This doesn't mean that you can't take money out of your IRA this year; it just means that the government doesn't require you to. Next year however we are back to the old RMD rules.
IRA to ROTH IRA Conversion limits are relaxed next year. Before now folks who were interested in converting all or part of their IRA to a Roth IRA were subject to an income limit, thus eliminating many of you from taking advantage of this benefit. Congress changed the law so that this income limit is eliminated next year. There are many positive planning aspects to this conversion but the rules are complicated. I expect to be in touch with each of you next year as to how this may affect you, what advantages you might expect and what pitfalls we should be careful to avoid. More on this later.
Have a good week!
Greg
December 1, 2009
Stocks bounced back from the Dubai default Thanks to the Thanksgiving holiday, the U.S. stock market had more time than other global markets to digest the news that Dubai was defaulting on nearly $80 billion of debt. The U.S. posted a 150 point drop on the DJIA Friday before a recovery this week. This drop could have been much larger, as Asia experienced its biggest decline in three months and Western Europe its biggest setback since April. This serves to underscore the current resiliency of the U.S. stock market to bad news. Chartist and technical analysts are still calling for a turn lower from this bear-market rally, but as long as the FED is making dollars available at zero percent to the big money center investment banks the market will remain resilient.
Bonds strongly rally throughout November As stocks are slowly losing upward momentum, money is flowing into short-term treasuries. The chart below shows the yield of the five-year treasury (tan line) compared to the U.S. dollar index (black line). This chart illustrates two important and promising points: The first point is that big money investors are still pouring money into the safety of short-term treasuries. This is great for investors like us who are over-weighted in government bonds (funds) because it shows that the big boys would rather sit in treasuries than risk money in the stock market. The second is that all this talk about the demise of the dollar is a bit premature.
This chart shows that while the dollar has been declining, it is simply coming back to the levels it was at just before the crisis of 2008 occurred. So while short-term traders get all the headlines and interviews on television claiming that the dollar is collapsing, one only needs to take a step back to see that it is simply correcting itself to pre-crisis levels. The FED can raise interest rates to strengthen the dollar, but in doing so it will risk a setback for the economic recovery so the FED would rather keep interest rates at zero and let the dollar slowly decline than face the consequences of raising interest rates. I plan to talk about the risks of higher interest rates in this coming week.
Other shocks Much has already been written about Dubai's bond default. Not getting much press are the problems of other countries in paying their debts. Greece remains most vulnerable to default, but it is not alone - Turkey, Venezuela, and even Japan (the world's second largest economy) are suffering from too much debt. Most don't see Japan defaulting anytime soon, but that is not the case for the others. Dubai, one of the seven emirates of the United Arab Emirates, is relying on the U.A.E to bail them out of their mess but these other countries don't have a rich brother to lean on so what will happen when/if another shoe drops? No one really knows.
Bottom line: Both fundamental indicators and technical indicators (such as internal market momentum) point to a rolling over of stock prices, while a trend for higher bond prices remains firmly intact. The market remains susceptible to further shock beyond Dubai's default, but it is holding up relatively well at the moment because of zero interest rates.
Take Care,
Greg
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