Tuesday, October 26, 2010

Thoughts For Monday

GS raised C to a Conviction Buy with a target price of $5.50.

The countdown begins as the dual impact of the results of the November midterm election and the scope of the Fed's QE 2 announcement make the next week an interesting market setup.

In the political arena, the stakes loom large. The Democrats appear to be headed toward a House loss, but the Senate majority remains in the balance and probably won't be determined until the wee hours of the morning.

After spending like drunken sailors during the Bush administration, Republican legislators have acknowledged that it will block even the most sensible stimulus programs, and the Democratic administration and its legislators have lost the will to fight their adversaries. As a result, the responsibility for turning around the domestic economy now lies squarely on the shoulders of the Fed. So, on the monetary front, the stakes, too, loom large. While some internal Fed discord appears present, I expect the QE 2 arsenal to be something slightly more meaningful than the consensus $500 billion over six months.

And, almost more significant than the results, will be the market's reaction to the news.


Will the market greet gridlock favorably as it has historically? Or will investors conclude that in light of the profound local, state and federal fiscal imbalances and other challenges that we face, solutions, not gridlock, are in order? Will the administration move toward the center in an attempt to reach agreement on fiscal policy? How strong a role will the Tea Party play in the GOP as we move closer to the Presidential election in 2012?


The bulls argue that "these are the good old days." They opine that QE 2 will stimulate domestic economic growth and that the risks and costs associated with further easing are justified in light of the risks of deflation and the current elevated unemployment rate. They further argue that more easing is better than nothing and that the bubble risks are outside a relevant investment time horizon.

The bears argue that we are just "chasing after some finer day." They suggest, as I do, that QE 2's ultimate efficacy should be questioned, that the unintended consequences and costs (i.e., screwflation) might be considerable and that the current stall speed of growth, with limited impact/influence from QE 2, exposes the U.S. economy to policy errors and/or an unexpected jolt to the system. Purposeful and transformative fiscal and tax remedies would trump more easing, the ursine crowd suggests. As a consequence of policy, the savers' class is being penalized, and sectors of our economy are getting hooked on unprecedented low interest rates as we await another Fed bubble.

Other general questions (from both camps) both camps:

* Will interest rates continue their descent, or have interest rates already adjusted to more quantitative easing?

* Will the markets grow increasingly concerned with rising commodity costs and the growing mountain of U.S. debt?

* Beyond the first $500 billion, or so, how much quantitative easing will ultimately be needed to achieve the dual mandate of price stability and maximum sustainable employment?

Spooky Scenarios

Interestingly, to complicate matters further (and to makes things even more spooky), Halloween arrives this Sunday evening, only days before the QE 2 announcement and the election returns.

"I dabbled into witchcraft. I never joined a coven. But I did, I did. I dabbled into witchcraft. I hung around people who were doing these things. I'm not making this stuff up. I know what they told me they do."

-- Christine O'Donnell on "Politically Incorrect With Bill Maher" (October 29, 1999, unaired) and "Real Time With Bill Maher" (September 17, 2010, aired)

Perhaps the one thing I can be certain about, is that Delaware Republican Senatorial candidate Christine O'Donnell will receive a lucrative contract for her own show from Fox News within weeks following her loss to Democrat Chris Coons a week from tomorrow!

That said, while corporate profits have beaten expectations (a lagging indicator), over the last two months, a series of tentative and even downbeat (especially on the housing and jobs fronts) domestic economic releases have accompanied the QE 2 optimism, leading me to conclude that the U.S. stock market might be disappointed and could be in the process of topping out for the year.

Recommended Reading

Run, don't walk, to read Ray Ozzie's blog on the challenges that Microsoft faces.

Commodities Are Soaring

Cotton prices are now at Civil War levels!

The remarkable rally in commodity stocks continues apace today.

There is no fear of screwflation on the part of market participants -- for now.

Dallas Fed Releases Poor Manufacturing Data

The components of the Dallas Fed Manufacturing report were poor, and equities dropped modestly after the release.

Curb Appeal

The stock market's initial positive response to housing sales was unjustified, in my view.

September 2009 sales were 468,000. September 2010 sales were only 379,000.

Moreover, this year's sales were buoyed by the tax extension to Sept. 30, 2010.

In addition, September 2010 activity was 7.3% below September 2007 and and 13.2% below September 2008 (two awful years of housing activity!).

Finally, prices plunged.

Whatever positive spin put on the release by housing bulls will likely evaporate in next month's release -- just as it did in July 2010.

More on Dallas Fed Manufacturing Index

Both October orders and employment components weakened, though the six-month order outlook increased to the best figure in four or five months.

Weakness in Financials Cannot Be Ignored Much Longer

Any more commodities strength raises the specter of lower corporate profit margins, which are already at record levels.

Recommended Reading

Run, don't walk, to read John Hussmann's 'Bernanke Leaps Into a Liquidity Trap.'

Amazing -- a five-year TIPS auction with a negative current return!

Sign of a Bond Price Top?

Goldman Sachs is pricing a 50-year, $250 million debt issue at a bit over a 6% interest rate.

More evidence of a top in bond prices (and a bottom in bond yields) comes out of Goldman Sachs, which is pricing a 50-year, $250 million debt issue at a bit over 6% interest rate.

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