January Effect for Credit But Not Equities

Good Evening: 2009 has put seven trading days into the books, and it already bears a passing resemblance to the opening days of 2008. Falling stock prices, rising bond prices, a strong yen, and slumping commodities represent moves that could have been plucked from the headlines during January (or almost any month) of last year, thus giving the casual reader a sense of Deja vu. But while there are indeed similarities, there are also important differences. Last year a financial crisis was ahead of us; this year we are dealing with one of the economic variety.

With no economic data out this morning in the U.S., the early drivers of price action were a further digestion of Friday’s payrolls report and some weakness in equities overseas. The more one looked past the positive surprise generated by the headline number (524K jobs lost in December), the harder it became to view the U.S. labor situation with any sense of the optimism that prevailed during the minutes following the release. The unemployment rate (such as BLS measures it today, 7.2%) was higher than expected, and the work week was smaller than expected. And, as the BAC/MER report you see below points out, the downward revisions to previously reported monthly totals caused the total losses of “full-time jobs” since the November 2007 employment peak to be much greater than the 3.3 million most analysts cite. David Rosenberg points out that “we actually have lost 5.5 million full-time jobs, which is not only off the charts but is more than double what we see in a typical recession. Double.”

So, if the data looked shiny on the surface and scruffy underneath, how did the stock market react? The “down, sideways, and down again at the bell” action on Friday gave us at least a small clue that market participants are, in this post-Madoff era, willing to look past the headlines and dig a little to get at the truth. A very weak labor market is not a truth most business models prosper under, so the extension of Friday’s decline in equities into today’s session should not have come as a surprise. As is also discussed in Mr. Rosenberg’s piece, corporate earnings will be harder to generate in this environment. What did cause eyebrows to tilt skyward, however, was today’s accompanying weakness in commodities (see story below). Corn, soybeans, and wheat all traded “limit down” today in response to a report that stockpiles of each are on the rise. Crude oil dropped 8%, also on fears that supply is still out-stripping demand.

The trio of weak employment, falling commodity demand, and poor earnings prospects weighed on stocks all day today. Opening just a bit lower, they sold off steadily throughout the session. A half-hearted bounce during the final hour lessened the damage somewhat, but the major averages retreated between 1.5% (Dow) and 4.1% (Dow Transports). Treasurys enjoyed another up day, with yields falling between 2 bps and 8 bps. As for the dollar, the yen may have been the strongest currency today, but the greenback finished a respectable second as the dollar index gained 0.7%. There is no need to further describe the damage visited upon commodities today; the CRB index fell 4%.

Will this two day reaction to Friday’s employment data be a harbinger of things to come in 2009, or is an expectation for a redux of 2008 simply too facile? The biggest similarities are that housing is still on its ear and that financial stocks are still leading fairly broad-based declines, but the differences might be more important. The economy may have been entering a recession during the early days of 2008, but the biggest worries back then were the inflationary effects of rising commodity prices and the commensurate fall in the value of the U.S. dollar. Credit spreads were much narrower (though widening), but credit — excepting most leveraged loans and all leveraged mortgage structures — was still generally available. Those of us who wrote about an imminent financial crisis still had no way of knowing just when it would arrive (in March, with Bear Stearns), how bad it would get (on the edge of collapse after the demise of Lehman Brothers), or what policy-makers would do in response (open both the public purse and the monetary floodgates wider than at any time in history). With the benefit of 365 grueling days worth of hindsight, we now know the Federales will not let the financial system fail.

But is avoiding a huge negative (a financial meltdown) necessarily a huge positive? Perhaps, but only if the U.S. economy regains its footing at mid year, as is still widely expected. JP Morgan’s Jamie Dimon has been a decent economic forecaster since a wayward “the worst is now behind us” call in Q2 of last year. He turned quite bearish on the economy soon afterward and still thinks it stinks (see below). Mr. Dimon sees the current malaise extending at least two additional quarters, but I wonder just how he can know the prognosis for the patient known as the U.S. economy in the wake of what he describes as last year’s “cardiac arrest”? Certainly Citigroup seems to have been wheeled back into the ICU, since TARP funding and a special bailout have not been enough to prevent C’s contemplated “sale” of their prized Smith Barney unit. Citigroup’s troubles are symptomatic of a banking system that is too weak to lend enough to be of much help.

Bulls will point out that, despite Citi’s troubles, credit spreads have started to come in since December. This improvement, though, surmises a friend who’s fund is on the front lines of credit, is likely due to certain investors deciding to throw good money after bad as some new capital has entered the space. This “January effect” in credit has certainly not been matched (as of yet) by a likewise rise in equity prices. This seasonal bump grows more overdue with each passing day, and it pays to remember a down January in 2008 set the tone for what I’ll charitably call a tough year. Thus, while it may be too soon to tell if there is still room for a rally from here, it does seem that both the economy and the markets are hinting there is still unfinished business to the downside in 2009.

— Jack McHugh

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