It’s a Start

Good Evening: Investor complacency, a market hallmark in recent months, received a stern test today when a series of unrelated news items combined to jostle market expectations in almost every asset class. Stocks went down, Treasurys went up, the dollar shot higher, and commodities buckled. Today’s primary market drivers included poorly received earnings releases from IBM and CSX, renewed credit concerns in Greece, and an attempt by officials in China to reign in the breakneck pace of bank lending. That Massachusetts voters elected Mark Brown to fill the late Ted Kennedy’s senate seat may have been the story of the day, but the news had only a tangential effect on our markets. Pundits and strategists will debate the meaning of the message sent by the electorate in Massachusetts, but I hope his success augers a return to some semblance of fiscal sanity in Washington. It’s a long shot, one that the special interest groups from both parties will fight, but Mr. Brown’s election may just be a hopeful start to the 2010 election cycle.

IBM joined other companies (e.g. Intel) that have kicked off the Q4 earnings season by posting an earnings “beat”, only to see their stock prices get pummeled in response. Many individual stocks also suffered a similar fate during the Q3 reporting season last October/November. This recent trend of seeing companies sell off on good news stands in stark contrast to the reactions to the Q1 and Q2 reports during the middle portion of 2009. From April to August, poor earnings were often shrugged off, or even bought. And yet, though the market reactions in each period have been opposites in terms of direction, the same force was at work each time. The news was priced in. Low expectations and low stock prices gave individual names the room to rally for much of 2009, while higher expectations and higher stock prices have led to profit taking since late last year. We’re only 10 days into the latest batch of earnings news, so it’s probably too soon to tell if this trend implies a correction is coming. But it bears watching.

Of more immediate concern to investors were the news dispatches bearing overseas datelines. The fiscal situation in Greece looks to be going from simmer to boil, and credit default swaps on sovereign Greek debt blew out to new highs today (see below). How the politicians in both Greece and the EU react will determine the ultimate outcome, but the knee-jerk reaction among global investors has been to buy the dollar and sell the euro. The euro’s future trajectory will likely depend on whether Greece voluntarily imposes budgetary discipline, gets an EU bailout, or gets kicked out of the euro altogether. The only certainty is that, like California, Greece cannot continue its previously profligate ways.

The dollar also received a boost today when word came from China overnight that a select number of banks have been told to curtail their lending practices. Judging by the sudden drop in global risk appetites for stocks and commodities, one might think that all lending in China was given a “cease and desist” order. A careful read, however, reveals that officials in China simply want banks to stay within their required capital ratios. Since even somewhat responsible lending oversight is a concept foreign to U.S and European investors, they probably should be forgiven for misunderstanding the situation in China. It will take months of continued tightening to slow down the supertanker known as the Chinese economy, but the change in policy direction from easy to less easy certainly snapped Mr. Market out of his winter hibernation.

Stocks in Asia and Europe were hit to varying degrees, but the speed of the selling in the U.S. took market participants by surprise this morning. After opening 1% lower, the major averages were down some 2% after 90 minutes of trading. The indexes then bounced around near the lows for a couple of hours before staging a rally into the closing bell. The late upticks almost halved the early losses, but the averages still declined between 1.1% (S&P) to 1.5% (Russell 2000). Treasurys were firm, but while yields on government securities fell by 2 to 6 bps, credit spreads actually widened a bit. Why shriveling risk appetities should cause investors to seek the U.S. dollar is still a mystery to me, but the greenback did advance more than 1% against its major competitors. Wednesday’s biggest losers were the precious metals and energy-related commodities. The twin specters of a warming dollar and a cooling China were too much for the CRB index. It coughed up 1.4% today.

It may be too soon to gage the real impact of Mark Brown’s ascension to the U.S. Senate, especially since it is very hard to isolate the variables that go into a single ballot decision. Punching a hole next to the name of any one politician can be linked to positives (for the candidate as a person, their policies, or their party), but votes can also be negative (against the other candidate, their policies, or their party). A single punched hole can even represent a protest vote about a specific issue, or against the powers that be in Washington, D.C. But an inability to know what Massachusetts voters were truly thinking yesterday won’t stop the pundits from trying to tell us what it all means.

“It’s a repudiation of healthcare reform, a rejection of the Obama administration’s agenda, and an endorsement of the Republican platform”, partisans on the Right will thunder. “The election means very little”, will begin the tight-lipped response by partisans on the Left. “Martha Coakley was a weak candidate who ran a poor campaign. It’s a sign of how far the Republicans have fallen when they feel happy about occupying a mere 41% of the Senate”. I have a more hopeful, non-partisan take on Brown’s win. I think the voters in Massachusetts may have instead sent a two-fold message, one that combines a plea for fiscal sanity with a “throw the bums out” mentality that rejects lightning rod partisanship on both sides. Official Washington expected Bay Staters to rubber stamp any Democratic candidate who supported the adminstration’s agenda. Voters apparently didn’t like doing what many in Washington took for granted, and they sent their first Republican to the U.S. Senate in 32 years.

I’ll hazard a guess that few readers know just which Democrat ousted that Republican, one Edward Brooke, way back in 1978. It was Paul Tsongas. I bring up the late Senator for reasons other than trivia. Mr. Tsongas ran for the presidency in 1992, and, despite being a less than dynamic speaker and a poor money-raiser, Mr. Tsongas gave Bill Clinton quite a scare on the way to Mr. Clinton’s eventual nomination that year. Mr. Tsongas may have lacked political guile of the spouse to our current Secretary of State, but he won over large groups of voters by promising to tackle what was then a large U.S. budget deficit. When asked why he refused to support a middle class tax cut or multiple spending programs that other candidates offered up, Mr. Tsongas replied, “I’m not Santa Claus”.

In stark contrast to those on both sides who would pander for votes, Mr. Tsongas told would-be voters to brace themselves for the medicine that would restore fiscal discipline in Washington. This form of straight talk didn’t win him the Democratic nomination, but it tapped into resevoir of fiscal conservatism on both sides of the aisle that the major parties continue to ignore. What’s more, the appeal of Mr. Tsongas’s basic message was no fluke. Ross Perot recognized this wellspring of antipathy and used to garner 20% of the popular vote during the 1992 presidential election. Given that our deficit situation is far more perilous today than it was 18 years ago, we need more candidates than ever who are willing to tell voters they won’t be Santa Claus.

I’m not saying that Massachusetts voters were somehow trying to honor Mr. Tsongas’s memory by electing Mr. Brown. Far from it; such irony rarely exists outside of literature. But if Mr. Obama’s initial reaction is any guide, then this election may start to affect policy in positive ways (see below). Scaling back healthcare legislation so it focuses more on efficiency and cost reduction is a more sensible approach than the monstrosity laboring through Congress. Then again, as Mr. Tsongas once said in 1992, “If anyone believes the words ‘government’ and ‘efficiency’ belong in the same sentence, we have counseling available”.

I wonder if the voters of Massachusetts were sending a message to Washington that the business-as-usual, red-stained budgets from both parties would no longer be tolerated. I have no proof, but I do have hope. Imposing fiscal discipline before our nation hits the funding wall now facing Greece is change I can believe in. But I’ll settle for a “throw the bums out” attitude toward entrenched incumbents in both parties. The fear of losing tends to make politicians better listeners. Either way, it’s a start.

— Jack McHugh

Stocks, Commodities Slide as Dollar, Treasuries Gain on China

Greek Bonds Slide on Concern Investors May Shun New Debt Sales

China Asks Some Banks to Limit Lending as Loans Surge

Senator-Elect Brown Calls Himself a ‘New Breed of Republican’

Obama, Democrats Signal Readiness to Limit Health Law

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