December 13, 2008

The S&P500 lurched upward by 0.4% this week, not much of a December rally.  The Dow, by comparison, dropped a bit.  Several factors point to the possibility of more upside.  One major indicator was the ability of the equity market to disregard a torrent of bad news, including horrible jobless claims, deflationary PPI numbers, and weak retail sales.   The argument is that the market’s low prices have already discounted such bad news, so a short term bottom might have been established, providing bulls with confidence to push prices higher.

On a daily basis, an uptrend seems to have been established on November 24.   But this past week’s performance showed evidence of weakness, with the low of the week being made on Friday.  On a weekly basis, the market is still somewhat oversold, but much less so than it was on November 21.

Longer term, from a weekly and monthly perspective, the bear market and downward trend is still firmly intact. 

Fundamentally, the bad news continues to flow.  The Tribune and KB Toys filed for bankruptcy.  GM and Chrylser will live beyond 2008 only if the White House decrees that it will be so.  Other large firms are teetering:  Nortel, GMAC, XL Capital, General Growth Properties, most of the large newspaper publishers, and many others. 

Many firms need to roll over their debt in the upcoming quarters.  Unfortunately too many will need to pay an arm and a leg to get this financing; many others will not get it–at any price.  More defaults and bankruptcy filings are imminent. 

Earnings warnings are cropping up again:  FedEx alarmed the optimists (who were hoping for a boost from lower fuel prices) that decreasing shipments will mean much lower earnings in 2009.  And as a bellwether for the overall health of the economy, FedEx’s revelation is an ominous signal.  Although market analysts have slashed their estimates for Q4 and early 2009, they may more work to do revising estimates downward.

As corporations slash jobs and capital expenditures, as consumers slash spending (and borrowing), and as our trade deficit remains stubbornly high, the only entity available to take up the slack is the U.S. government, through fiscal and monetary stimulus.  And most economists agree that these efforts, at best, will only partially offset the massive reduction in the three other components of aggregate demand.  Total U.S. indebtedness of $55 trillion must come down by approximately $20 trillion to return to a more normal, long term relationship to GDP.  So even if our government throws $2 trillion (or even $3 trillion) at this problem, it still does not come close to replacing the potential reduction in spending that would result from the massive deleveraging already underway.

We have a long way to go in resolving our economic crisis.  Those who proclaim that the final bottom has been put in (in the U.S. equity markets) are being highly optimistic.  A miraculous V-shaped recovery to our recession would be nice, but a long and painful L-shaped outcome is more realistic.

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