Jim Welsh Investment letter – April 3 2009

Jim Welsh of Welsh Money Management has been publishing his monthly investment letter, “The Financial Commentator”, since 1985. His analysis focuses on Federal Reserve monetary policy, and how policy affects the economy and the financial markets.


Investment letter – April 3, 2009

In the last three weeks, three significant policy announcements have been made. The Federal Reserve stated it is firmly committed to Quantitative Easing and will double its balance sheet before the end of 2009. Treasury Secretary Geithner announced a plan to get toxic assets off of bank balance sheets. And yesterday, FASB announced it is going to give bankers the discretion of valuing their toxic assets. Although the market initially responded favorably to each announcement, it did subsequently sell off after the Fed’s and Geithner’s announcements in the following days. This indicates that there is still a fair amount of selling pressure in the market.

The market has also been responding to economic news that has been viewed as being ‘positive’. On Tuesday, consumer confidence went up from 25.3 to 26 in February. Yippee! Too bad that the 25.3 in January was lowest number ever recorded since they started keeping records in 1967. On Wednesday, construction spending was reported down .9% in February, rather than the -1.5% expected. Good news!
But if one bothers to look at the data a different picture shows up. In January, non-residential construction was down -4.3%, largest drop in 15 years. In February, non-residential spending was up .3%, which is why the overall number wasn’t as negative. In effect, it declined 14 times as much in January as it rose in February, and that’s good news?

This morning the Labor Department announced that another 663,000 jobs were lost in March, bringing the total job losses since December 2007 to 5.1 million. The average work week dropped to 33.2 hours, a new record low. In the next six months, the economy will lose at least another 2 million jobs, and the unemployment rate will exceed 10%. The jobs decline and lower personal income will cause default rates on every type of credit to increase, which will increase bank losses, and curb consumer demand. This will continue to be a very difficult environment for most companies to generate earnings.

The announcements by the Fed, Treasury, and FASB will provide some incremental help for the banking system. But they will not keep home prices from falling further, credit card default rates from climbing, commercial real estate values from declining either, and another 2 million jobs will be lost in the next 6 months. The charts below show that the credit markets for residential and commercial real estate have not improved despite these announcements.

As I wrote in the March 23 letter, “Between 1966 and 1982, the absolute price low was made in December 1974 when the DJIA traded at 577, even though the secular bear market ran for almost 8 more years. My hope is that the March 6 low will be the low for this secular bear market.” The odds have increased that the March 6 low will hold for an extended time. However, the challenges are still so great that preservation of capital should remain the primary goal. Bull markets climb a wall of worry. But can this market jump the crater that persists in the banking system, credit market, and real economy? Not without a correction. My guess is that the initial rally off the March 6 low is just about over, since there are no more policy rabbits to be pulled from the government’s hat. I don’t think the S&P will get over 860, without first undergoing a correction. Although the market may hold up for a week or two, a pullback to 760-775 is coming. And if those rabbits prove to be scarecrows, and fail to deliver the help needed and now expected, a decline to lower levels is not out of the question.

-E. James Welsh

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