Tuesday, December 13, 2011

In reality, the statement should not unsettle markets.

Let's review the FOMC statement.

1. The federal funds rate will be kept between 0% and 0.25% until the middle of 2013.
2. The assessment of the jobs market and of current economic activity was increased slightly.
3. Core inflation will stay below the Fed's target.
4. There remains economic risks chiefly associated with the condition of Europe's economies.

There was one dissenter, Chicago Fed President Charles Evans, who wanted more cowbell.

The flight to safety continues -- the 10-year U.S. note auction was very firm.

The yield was more than 2 basis points below the when-issued yield, the bid-to-cover ratio of 3.53 was well above the average of 3.05 (and the best coverage in 1½ years), and direct/indirect bidders took down the most in 10 months.

The National Transportation Safety Board has recommended that states ban the use of cell phones and other electronic devices by all drivers (except emergencies).

I expect cell phone suppliers like PLT and others to be vulnerable to this news.

This is option expiration week, when December options and futures contracts expire. Over the history of the S&P 500 futures, the week of December option expiration has been positive 83% of the time (24 out of 29 years), averaging +1.4%. The contract has never lost more than -0.9% on the week. If Monday started with a loss of more than -1%, then the rest of the week was positive 3 out of 3 times, averaging +3.2%. If Monday started with a loss of any amount, then the rest of the week was positive 8 out of 8 times, averaging +2.4%.Only once did the futures lose any more than -0.9% at their worst at any point during the rest of the week, but they gained more than +1.3% every time, and more than +2.0% every time but once.

I expect a large asset allocation out of bonds and into stocks sometime in the next six months.

Here is what Merkel said on Friday:

Germany opposes adding to the firepower of Europe's permanent rescue fund.... I've made my position quite clear that it won't be topped up.... [W]e can only move towards our goal when we tackle the root causes of the crisis through budget limits and the fiscal compact.

The world's economies are imperfect, as structural headwinds are governors to growth, and a relatively weak trajectory of growth is exposed to all sorts of exogenous shocks.

Arguably, the stock market has been discounted in reasonable valuations and little, if any, expectation of more positive news. With stocks trading at only 12.5x projected 2012 S&P profits and a 2.05% yield on our 10-year U.S note, this compares favorably to a 50-year average of over 15x during a time in which the yield on the 10-year U.S. note approached 6.70%.

With investors either materially in cash or heavily skewed toward low-yielding fixed income, any market recovery could feed on itself in an environment where individuals are uninvolved and hedge funds have multiyear low (i.e., bear-market low) net long exposure and run the risk of being caught offside.

Low expectations and an underinvested investment community are all conditions that have historically formed the foundation for a better market setting, as bull markets typically emerge out of periods of bad news. (And bear markets typically emerge out of periods of good news.)