Fears about the intensity of the global recession and renewed skepticism regarding the beleaguered financial sector fueled a flight to safety during the past holiday-shortened trading week. President Obama’s inauguration offered only a brief respite from the dreadful economic and earnings data and pounding of the stock markets.
Commentators were in agreement that Mr. Obama commenced his tenure against the worst economic background in living memory and had his work cut out to resurrect America from its economic morass. I wish him well with this daunting task.
As investors piled into the perceived safety of gold (+6.9%), the U.S. dollar (+1.8% in the case of the U.S. Dollar Index) and the Japanese yen (+2.1% against the U.S. dollar), global stock markets recorded a third straight week of losses. West Texas Intermediate Crude (+9.2%) also ended higher, joining a broader rally in commodities (+2.1% in the case of the Reuters/Jeffries CRB Index).
The MSCI World Index and the MSCI Emerging Markets Index declined by 4.7% (YTD -10.3%) and 5.7% (YTD -10.5%) respectively. Bucking the downtrend, the Shanghai Composite Index rose by 1.9% over the week and, with a gain of 9.3%, is also the best-performing global stock market since the start of 2009.
Elsewhere, the yields of long-dated government bonds in the U.S., U.K. and Eurozone rose sharply as large issuances of sovereign debt looms. For example, the yield of the U.S. ten-year Treasury Note jumped by 28 basis points to 2.62% and that of the 30-year Treasury Bond by 40 basis points to 3.32% - the highest weekly points rise since April 1987. On the other hand, short-dated yields in a number of European countries declined as a result of expectations of further rate cuts.
The U.K. was a case in point with the two-year Gilt declining by 12 basis points to 1.0% on doubts about the government’s new rescue plan for the banking system and a deterioration in the country’s public finances. The pound crumbled to a 23-year low against the greenback and an all-time low against the yen.
The financial turmoil and the various actions by central banks reminded me of a quote from 1867 by Karl Marx:
Owners of capital will stimulate the working class to buy more and more expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism.
TARP has been an abject failure. I compare the situation to a fire on a Savannah plain: Let it rip and burn, and the market will rejuvenate so much faster - try to control or impede it, and there will be more and longer suffering before renewal. Japan experienced two decades of economic paralysis by experimenting with fire control of a similar unproductive sort.
Shrink the government radically, cancel all bailouts immediately, take plenty of tough medicine, and let the free market do its job - however harsh it may be for, say, autoworkers in the meantime.
According to Sheila Bair of the FDIC, as reported by The Wall Street Journal, there will soon be a new government-banking agency, the Aggregator Bank, to buy troubled assets from financial institutions. For a bit of fun, I tried to register this domain last week. Alas, another aspirant banker pipped me to the post. His reselling price? $100,000! Needless to say, I swiftly terminated the negotiations.
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Next, a tag cloud of my week’s reading. This is a way of visualizing word frequencies at a glance. Key words such as “bank”, “government”, “economy,” “market,” “financial,” debt” and “crisis” topped the list.
The graph below shows the performance of various S&P sector SPDRs for the year to date. With Financials having declined by 28.2%, the market’s weakness was quite strongly concentrated in one sector. In addition to Financials, only Industrials (-11.9%) and Consumer Discretionary (-8.8%) have underperformed the S&P 500 Index (-7.9%) since the beginning of the year.
During prior declines during this bear, losses were broad based and once they become more concentrated (as they are now), it’s a sign that the market is beginning to separate the eventual winners from the losers.
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Considering the outlook for the stock market, Richard Russell, 84-year-old author of the Dow Theory Letters, said:
Recently, the Transports broke below their November 20 bear market low. The Industrials have refused (so far) to confirm the Transports. Will the Industrials break down and confirm?
No one can possibly know. But the longer the time elapses that the Industrials refuse to confirm, the more hopeful the situation. As a rule, the closer in time the two Averages, Transports and Industrials, break through preceding levels, the more authoritative the signal. The Transports broke to new lows on January 20. The longer Industrials hold above their November 20 low of 7,552, the better the odds that they will not confirm.
Key resistance and support levels for the major U.S. indices are shown in the table below. The immediate upside target is the 50-day moving average, followed by the early January highs. On the downside, the December 1 and all-important November 20 lows must hold in order to prevent considerable technical damage.
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