The broad market was actually holding in there pretty well -- up in the morning and hovering around the opening price level into the afternoon session – until sliding a bit in the final hour. For what it is worth, the Dow closed below the 10K mark for the first time since early February – it has crossed this mark 57 times now since 1999.
Some comments from former Fed Chairman Greenspan on Sunday morning’s Meet the Press may have also had an effect on trading. Greenspan stated that the economic recovery will be “slow and trudging.” He also explained that he’d be very concerned if stock prices continue to fall, more on that below.
Commodity prices rebounded a bit. It’s been a pretty good pullback, down 12% over the past month after hitting post-crisis highs. A move of 12% over this length of time isn’t saying a lot as these prices can swing violently, but it’s the most significant move since June and all about sovereign default concerns – European banks hold a lot of the public debt that’s in question and that gets the market concerned about future credit contraction.
Financials led the broad market lower, followed by basic material and industrial shares. All major industry groups closed lower.
Market Activity for February 8, 2010
Central Bankers and the Risk Trade
Central bankers are keeping a close eye on stock prices, as Greenspan signaled this weekend and we’ve talked about several times now. A key objective of the ZIRP (zero interest rate policy, for new readers) was to get traders and investors back into risky assets – they were running from anything other than cash and Treasury securities early in 2009. When you completely erase returns on cash holdings, as the Fed has done, you will get people hunting, desperately in some cases, for yield and returns – that means a rush of money into stocks, and higher-yielding corporate bonds.
Boosting stock prices is really the only quick way with which the Fed could begin to repair household balance sheets; they can’t do it from the perspective of income as that takes job growth, which takes a considerable amount of time. They have certainly accomplished this goal to some degree as household net worth has bounced $5 trillion since last March. The crushing 57% plunge in stock prices (from the Oct. 9, 2007 high to the 13-year low on Mar. 9, 2009) and the roughly 30% decline in home prices (from the July 2006 peak to the cycle low hit in Jan. 2009) stole more than $17 trillion from household net worth. It hit $66 trillion in 2007 and currently sits at $53.4 trillion.
But the perils behind this strategy are not fully being considering in my view, or maybe they have been recently. When your strategy is to push people into riskier assets, traders push aside their consideration of risk as they myopically hone in on the yield – it’s like throwing chum to sharks, a frenzy results. What these yield/return seekers have forgotten, is that there is another side to this trade – prices can move lower. It is utterly amazing to me how so many have forgotten this just 10 months removed from largest collapse in riskier-assets since the 1930s, but that’s what ZIRP does. We’ve recouped a lot by way of stock prices, half of the losses before this 8% pull back. Yet one gets this sense that too many people expected this substantial rally to continue without abatement. We simply face too many headwinds, and it takes time to forge through these challenges.
Anyway, Greenspan made it clear and for sure Bernanke is keeping a close watch on stock prices in particular. If the market endures a decent sized correction here -- which I think is likely as the market begins to consider weaker prospects for growth in the back half of 2010 and into 2011, the cost of very deep deficit spending, the sovereign debt realities that ensue, and a housing market that very likely has to get past another round of downside – we may not yet fully appreciate the extent to which both Congress and the Fed will accelerate easing strategies over the coming months. That means a return to quantitative easing from the Fed and additional spending from Congress, both of which will cause market distortions and new problems that will have to be worked off over the next couple of years.
I do not wish for this to occur, which is why this letter keeps harping on the need for the Fed to gently raise rates and Congress to slash tax rates across the board. Even mild rate hikes will cause problems for this economy, but the slashing of tax rates will offset that pressure – I can’t emphasize this enough. At some point, you’ve got to rein in some of the things we’ve done and force the market to stand on its own. If we don’t, I’m sure additional problems will arise – at which point the Fed won’t have to worry about a short-term correction to this rally from the March lows, but a mired stock market for a longer period of time.
Coming Data
We were without an economic release yesterday but get back to it today with the NFIB Small Business Optimism Index and wholesale inventories (December).
On Wednesday, we receive Mortgage Applications (week ended February 5), the trade balance (December) and the monthly budget statement (size of the budget deficit during January)
On Thursday, and I’ll be out off the office the final two days of the week, we get retail sales (January) and jobless claims.
The retail sales and jobless claims figures will get most of the attention, but NFIB and mortgage apps will be important to watch as well.
Next week things get very interesting with the following releases:
Housing starts, industrial production, Philly Fed and CPI. The market will want to see some bounce back in housing starts after December’s 16% plunge (we’ll see how weather-related that drop was) and industrial production will need to post a good reading (December’s results were all on cold weather as the utility component accounted for the entire increase).
Have a great day!
Brent Vondera, Senior Analyst
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