Good Evening: Now that the Fed has morphed into the world’s largest hedge fund, all eyes are turning to the capital markets to see how they will respond to the Fed’s promise to buy whatever needs buying in order to forestall the Great Depression II. Ebbs and flows in stock prices aside, the vital question is whether or not the Mother’s milk of capitalism — lending and borrowing — will resume any time soon. Adam Smith’s invisible hand has thus far been able to duck and dodge what PIMCO’s Paul McCulley calls “the visible fist of government”, but the FOMC’s promise of yesterday to soon don Superman’s cape and finish this battle will be fascinating to watch. As we are now entering uncharted waters in terms of governmental response to what 19th century financiers might call an old fashioned (and well charted) “panic”, 2009 promises a virtual clash of titans as these forces compete for the upper hand.
Searching for answers to the above questions, market participants seemed to be more in the mood to listen rather than act. Overseas markets were cautious in reaction to yesterday’s news out of the Eccles building, and U.S. stock futures pointed to a lower start as we approached the opening bell in New York . Analysts and strategists, CIOs and CEOs all held forth on the implications of the Fed’s policy shift. Little notice, therefore, was given to the day’s economic stats. Mortgage purchase applications remained moribund, and the Q3 current account deficit retreated back to Q2 levels. Into this relative vacuum of important news, Bloomberg offered up a story about how banks have yet to restart the process of borrowing and lending in the wake of the Fed’s dramatic moves yesterday (see below). I have no doubt that the Bloomberg reporter is on the mark with this story, but let’s try to resist the pangs of instant gratification and give the Fed’s new policies more than 24 hours to succeed.
Still mulling over the thoughts of various pundits (or, more likely, devouring the latest tidbits surrounding the Madoff case), investors eased back from the buying seen yesterday afternoon. Stocks opened down some 1% before rallying back and settling into a fairly narrow range. Reaching their highs (up 1% to 2%) with two hours left in the trading session, the major averages proceeded to head back down into the close. The final tally was mixed, with the Russell 2000 (+0.75%) leading the way and the Dow’s 1.1% loss trailing the field.
The Treasury market, too, was mixed. The short end saw some profit taking (yields were up 8 to 10 bps), but the long end continued to benefit from the interest of duration seekers (yields were down 6 to 9 bps). While the stock and bond markets couldn’t seem to reach firm conclusions about the Fed’s new new policy approach, the global currency and commodities markets reached decisive, if opposite, verdicts (see below). Fearing dollar debasement, currency investors smacked the greenback for another 2%+ loss, but some commodity market participants worried the Fed might not be stronger than the markets. Crude oil was the best example, since it fell 8% in the face of both a looser Fed and a tighter OPEC (see below). Precious metals investors sided with their currency brethren, but not even nice gains in gold, silver, and grains could repair the damage wrought by falling energy prices. The CRB index slipped 0.5%.
The editorial portion of this daily comment is normally reserved for analysis and predictions, but rather than sharing my own, I thought I would simply present the views of those who I think take a thoughtful and long term approach to interpreting yesterday’s moves by the Fed. The first views are those of Mohamed El-Erian, co-CIO/CEO of PIMCO. As you will see in this video clip from last night’s version of “Fast Money”, Mr. El-Erian thinks the Fed did the right thing. He cautions investors, however, to wait to see if the private sector believes the Fed’s actions will work. On this score, let me relate that a longtime veteran in high yield told me today that he is seeing the first faint signs of customer demand for junk bonds. It should further be noted that Morgan Stanley let the world know this morning that its leverage ratio against its common equity has fallen from around 30x to around 11x. As for Mr. El-Erian, he advises us all to wait and see if these new policies out of Washington (and he’s including Mr. Obama’s likely stimulus package) will 1) restart the process of borrowing and lending, and thus, 2) pave the way to higher consumption by individuals. Agreed; patience will indeed be a virtue in 2009.
The next set of thoughts to consider come from Merrill Lynch’s David Rosenberg. His crystal ball has been clear and spot on these past two years, and the piece you see below represents his first attempt to imagine what issues might impact the markets in 2009. He doesn’t offer a quarter by quarter guess for GDP, instead choosing to think about what the crowd might be missing about what lies ahead. His top choices, in no particular order, are protectionism, geopolitical conflict, and a commodity rally. I do his arguments little justice by recounting them here, so please enjoy this brief read for yourself.
Finally, the folks at Credit Suisse have put out a new “Market Focus” (see attached PDF). Entitled, “Overwhelming Force”, the London-based fixed income team at CS attempts to truly handicap the battle between the markets and government policy I depicted above. In preview, let me say that the CS team forecasts a year long struggle between these forces, one that will bring us to either of two polar extremes — S&P 1200/1300 or S&P 650. Like Jim Grant, CS believes that each outcome should cause the thoughtful equity investor to reach for the equity-like returns in the world of credit. Credit should outperform in either case, says Credit Suisse. And, good prognosticators that they are, the CS fixed income team does not cop out with an economist’s “on the one hand…”. No, they honestly think and persuasively argue that the overwhelming force of unprecedented policy action will ultimately lead to financial healing before 2010 arrives. The best way to sum up the position of this venerable Swiss bank is to borrow a phrase from them that they borrowed from the former junior senator from Illinois : “Yes, we can”.
— Jack McHugh