The following is part of Pivotal Events that was published for our subscribers February 11, 2010.
SIGNS OF THE TIMES:
"White House staff have taken direction and control of programmatic areas that are the statutory responsibility of Senate-confirmed officials."
- Senator Robert Byrd, Politico, February 25, 2009
"Bankers to Obama: Stop trashing us."
"Mr. President, of over 8000 banks in this country, very few ever made a sub-prime loan, and they did not engage in the highly-leveraged activities that brought down Wall Street."
- Politico, February 27, 2009
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"Picking the Pearl of Stocks"
"Six names to consider as we enter a stock picker's market."
- Financial Post, January 20, 2010
"Survey: All 54 Economists Expect GDP Growth Through Every Quarter in 2010."
- Wall Street Journal, January 30, 2010
"Climate-change legislation buried under record snowfall in capital."
"Sen. Bingaman (Dem. N.M.) said that blizzards have made it difficult to argue that global warming is an imminent danger."
"Where's Al Gore when we need him?"
- Senator Mitch McConnell, The Hill, February 10, 2010
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Last week we noted that crude oil and copper had been trashed enough such that it was time to look for a relief rally. This would lift most stock markets as well.
So far the low on the S&P has been 1047 on Monday and the market is attempting to stabilize as doom about European sovereign debt commands the front pages. This phase of the sovereign crisis is in the news and it is appropriate to review market conditions.
In December we considered that the market was setting up for a rounded top from where an intermediate decline would follow. Then when the gold/silver ratio (GSR) rose strongly through 65 and copper got hit we concluded that an important top had been accomplished. A more severe decline could follow.
This would be accompanied by the resumption of credit problems, with widening credit spreads, weakening commodities and a firming dollar.
But, as the opening paragraph notes opinion makers have suffered a sudden discovery of problems. The stock market and copper became oversold as the DX and the GSR became overbought.
Relief is happening.
However, the main problem - too much debt against precarious collateral and a precarious economy - won't go away soon. What's more, mounting demands of an extremely ambitious governing class are finally being met by mounting taxpayer common sense and resistance. This makes for a political storm that may not be constructive to most markets.
Stock markets have suffered an important hit and could recover for a few weeks. It is prudent to keep in mind that severe slumps can start within oversold conditions.
The long bond has been expected to trade between 118.5 to 119.5 for a while. This generally worked with one slump to 117.3 on February 3 and today it slipped to 117. The first was in response to crude ending its plunge and today's to a recovery in crude as well as in base metal prices.
The main thing is that the trading range is broken and the bond could decline to support at 115.
On the other hand, some of the price decline could be due to diminishing liquidity. High-grade and junk also declined, but the lesser fool kept buying the investment grade high-yield. Albeit at a lower price than when the greater fool was buying.
Corporate spreads continued to widen. This started the week of January 12, with the Baa at 38 bps, high-yield at 382 bps and junk at 723 bps. These are now at 50 bps, 469 bps and 844 bps, with yields increasing by 122 bps for junk, for example.
This represents not just increasing cost of borrowing, but it is beginning to put late players to the carry trade offside. Mother Nature has been changing the game and Mister Margin is sharpening his axe.
Clearly the corporate market has taken a turn for the worse, and prices are close to breaking down. However, there is the possibility that crude and base metals could rebound for some weeks. In which case corporate bonds could also recover.
On the bigger picture, late in the year it looked as if the corporate bond market, which has been fabulous since March could be accomplished, a "turn-of-the-decade" top. Previous examples include gold and silver in January 1980 and the Nikkei on the last trading day of 1989. The latter was celebrated in the January 1990 Outlook by Sanyo Securities:
"Japanese firms' massive equity financing will push up stock prices. Instead of causing oversupply they will invest the newly raised funds in the stock market. The Nikkei target is 46,000 at the end of the year."
As recalled, that famous bubble was fueled by essentially zero-cost funds raised in Europe through debt plus warrant issues. Zaitech, otherwise known as financial engineering, at its best.
The term Zaitech may not be as frequently used as twenty years ago, but today's financial engineering is again stretched to the limit.
Currencies: The Dollar Index reached our initial target of 80 a week ago, generating the usual astonishment when something happens contrary to conventional wisdom. More specifically, the high was 80.5 a week ago, the low was 79.8 and today the test seems to be failing.
A correction into March is possible which could assist a relief rally in formerly hot games.
The Canadian dollar: Last week we thought that stability could be found at 93, which was the support level. The low close was 93.1 last Thursday and the pop to 95 has been a bit of a rush. If this runs for a few weeks without the test it could again become vulnerable.
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That credit market convulsions begin in lesser countries and eventually afflict the financial capital has been around for a long time.
"If some lose their whole fortunes, they will drag many more down with them ... believe me that the whole system of credit and finance which is carried on here at Rome in the Forum, is inextricably bound up with the revenues of the Asiatic province. If those revenues are destroyed, our whole system of credit will come down with a crash."
- Cicero, 66 B.C.
(Translation by W.W. Fowler, 1909)
Link to February 12, 2010 "Bob and Phil Show" on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1555