Avoiding the Momentum Pony, Painful as It Is

I have been scanning the New Year output from a variety of Wall Street strategists, not as a source of predictions about 2008 but as a source of data that might give some perspective as to where we stand. Here are some of the observations that I have found interesting:

-The "TED Spread" has recently been at an all time high of nearly 2% (at least since 1990), although it has narrowed over the last few days. This is a measure of the difference between LIBOR rates and Treasury rates; LIBOR being the rate at which banks lend to each other. In other words, banks are demanding higher rates from each other than at any time in recent history. Therein lies the so-called liquidity crisis. From what I hear, there is actually tons of cash sloshing around out there but it is mostly sitting in short-term Treasuries. Maybe if banks would stop giving each other the "stink eye" and get on on with business, there would be no crisis.

-Mutual funds, in general, outperformed their benchmarks last year. Jonathan Golub of Bear Stearns attributes this to a few factors. First, many US managers strayed from their benchmarks and invested in emerging markets. 2nd, anyone "riding the momentum pony" was rewarded in 2007. Investing based on what worked over the past 6-12 months may have been last year's best strategy according to Golub. This likely partially explains why so many value managers had a tough year, and why all mutual fund value categories underperformed the market. Taking risk in emerging markets and following the herd worked, being a contrarian didn't. In my opinion, these strategies will come to an ugly end. By their very nature, they work until they don't - when the momentum shifts, look out below.

- If you want to know what sectors had negative momentum last year, look no further than financials and consumer discretionary stocks. While the S&P 500 returned 5.5% including dividends in 2007, every sector returned more than that except financials at - 18.6% and CD at -13.2%. Energy was up 34.4% materials were up 22.5%, and utilities, normally reserved for widows and orphans, were up 19.4%. Where do you think the greater values lie now?

- Are we headed for a recession? Beats me. One interesting observation though is that real fed funds peaked at 300 bps (i.e., fed funds rates less year over year change in CPI was 3%), whereas they normally approach 500bps before a recession. One typical leading indicator of recessions is an overly-restrictive Fed, and another is an inverted yield curve. While we did have an inverted curve early last year, we don't now and we also don't have a restrictive Fed. While this doesn't guarantee we won't have a recession, if we do, it will be unusual.

I continue to avoid the mo-mo pony, as painful as it is in the short-term, and I am sticking with the slo-slo tortoise. Hmm, I seem to recall a similar story from my childhood...