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 March 2010 Focus on Washington
Tech stocks and the growthier issues of the Nasdaq were even more heavily hit, falling over 6.3 percent. Suddenly the riskier, lower quality stocks that led the 2009 charge were no longer in favor. Value moved back ahead of growth and bonds held up remarkably well given their historically low rates. What was going on? There were actually two causes for the reversal. First, the turn was precisely correlated with the release of fourth quarter earnings reports. Although most companies met or even exceeded expectations, stocks fell anyway in a classic case of "buy the rumor, sell the fact." A substantial minority of analysts had warned that good earnings news was already reflected in share prices at the end of 2009. Apparently they were right. Secondly, politics was a major contributor to investors' heightened risk aversion. Healthcare stocks enjoyed a one-day rally following the surprise Republican victory in Massachusetts, but the Democrats' populist response quickly snuffed that out. The specter of higher taxes and more government regulation left many fearing a generally tougher business environment just as the economy was attempting to emerge from recession. The "new populism" was not only a response to Massachusetts; it was an attempt to quell the unrest of lingering high unemployment. Despite economic readings suggesting the recession ended in early 2009, most Americans won't believe it until they're finally back to work or at least don't' have to fear for their jobs. Whatever the meaning of Massachusetts, the President saw it as an expression of disappointment over unemployment, so taxing the rich, fining banks that have actually paid back TARP funds, and another multi-billion dollar "jobs package" was the response.
Bonds and Inflation
Part of that stability can be attributed to the Fed's ongoing purchase of mortgage-backed securities, but that's scheduled to end at the end of March 2010. When it does, there'll be major implications not only for the fixed income market, but for the housing market as well. Washington's new-found populism may force the Fed to keep buying through the spring, particularly in light of the fact that January's new home sales fell by 11.2 percent, wiping out all of the gains of the past twelve months. Without the Fed backstopping virtually every mortgage written, the situation could, and most likely would, deteriorate further. Yet even if the Administration's populists force the Fed to keep on buying, at some point they'll have to stop. There's only so much money the government can print -- if for no other reason that there's only a limited amount of ink they can create. Whenever the Fed's program comes to an end, interest rates will be poised to jump. Historically, that's been the warning sign for inflation. But again historically, that's occurred because there were a lot of dollars in circulation and a lot of demand for them. That's not exactly the case now, at least not yet. Domestically, consumers put on the brakes on spending in 2008. Although February's household spending rose by 0.5 percent, greater than the 0.1 percent expected, it's still a far cry from it's pre-2009 levels. Many economists don't believe consumers will resume their profligate ways until they're back to work, raising that old question, "What came first, the chicken or the egg?" In this case, what comes first, economic expansion or jobs? In the usual cycle, when a recession ends, pent-up demand sparks a flurry of activity. This allows businesses to liquidate inventory and raises the need for more production. Additional workers are hired to meet the increased demand. With more people back to work, more are in a position to step up spending, helping to fuel the (at least initially ) virtuous cycle. But 2009's recovery wasn't top-line driven. Profits didn't come from rising sales but rather cost savings, a large portion of which coming from layoffs. Not only that, unlike the end of most recessions, there's relatively little pent-up demand aside perhaps, from tech spending at the corporate level. Without demand spurring production, businesses have little reason to hire additional staff, which brings us full circle. Rather than enjoying the fruits of their new jobs, unemployed workers are still afraid to spend. Low demand and spending are not the source of inflation. Instead, rising rates may signal a return to 1980's style stagflation rather than inflation.
Stocks on the Sidelines Nevertheless, investors are taking a more defensive posture. As opposed to 2009 when the lowest quality and most badly beaten up (e.g., financials) led the way up, investors are now seeking the relative safety of value stocks. At the same time, many of last year's individual and sector leaders are now in the red.
At this point, the bluest of the blue chips still offer not only higher quality, but relative value as well. Large cap dividend payers are fairly -- if not under -- valued and can form the core a a solid portfolio. Of course higher taxes could scuttle this approach, but even that threat may have been somewhat diminished. Although President Obama campaigned on allowing the Bush tax cuts to expire, his position seems to have softened as his populist rhetoric has increased. Perhaps even more importantly, the will to increase taxes -- even on "The Rich" -- will wane as November 2010 approaches. Equities and the overall economy will eventually recover. This will happen with or without government's intervention. The key to recovery still lies with jobs and quite honestly, the government cannot create jobs. Hiring always lags months behind the "official" end of a recession. Still, the sooner the unemployment rate comes down, the stronger the recovery. As well-intentioned as it may be, the government cannot buy a recovery, only the private sector can truly create jobs. On the other hand, poorly planned and executed government intervention -- particularly onerous taxes on "The Rich", the very few who can actually create jobs -- can damage the business environment and paralyze the recovery. Stocks flourished during the Clinton years when Republicans held majorities in the House and Senate. Fiscal policy was in a virtual state of gridlock. Perhaps what happened in Massachusetts was a positive signal for stocks in more ways than one. The market will finally get a buy signal from Washington when politicians step back from the financial markets. Search this site! Just enter you key word or words:
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HAT CERTAINLY DIDN'T TAKE LONG. After only eleven trading days the great 2009 rally came to an abrupt end in 2010. The S&P 500 was up over three percent, but investors were left to wonder if that was the high for the year. By the end of January it was down three percent with perhaps further to fall. At its worst point on February 5, it was off 5.2 percent.
