Posted by Davy Bui on January 5th, 2009 in Market Commentary
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As evidenced by last week’s thinly traded rally and action this morning, the stock market doesn’t want to stay down. By its nature, the winter holidays and the New Year imbue folks with a sense of optimism (except for those who get increasingly depressed during holidays, but I digress). I wouldn’t get too caught up in any rally in equities at the start of the year.

Credit markets are also recovering, which I don’t discount as readily as the stocks rally. While the economic situation is likely to worsen, corporate spreads widened well beyond record levels. My simultaneous worries have been

• a) things deteriorate further, spreads widen more and I get in too early
• b) things deteriorate further, spreads tighten anyway and I miss the record bargains

Both situations present a solid case against market timing.  As Ben Graham writes, market timing is ill-advised unless it is tied to price levels. And there is really cheap debt available still.  The problem is choosing the survivors and for this, I highly recommend heeding Graham’s advise regarding junk debt: treat them as stocks, not bonds.  The risk/reward characteristics are much closer to equities than debt.

The Dow Jones news offerings have been interesting these past few days.  I enjoyed the WSJ piece on Bruce Berkowitz [$] and must state that I too have been trying to start a band these last few months.

The Journal also ran their Cassandra prognisticators piece, with the usual not-so-subtle barbs at these bull-market infidels (Bob Rodriguez, Jeremy Grantham, Peter Schiff). Reading the piece, the authors implied that these guys were merely broken clocks due for their rare moment. Of course, they do not mention that over 10 years, Rodriguez’s FPA Capital fund has beaten the S&P 500 by 7.6 points. In the graphics section, they list other Cassandras like Marc Faber, Paul Kasriel of Northern Trust, David Einhorn, Mr. 2x Irrational Exuberance Robert Schiller, James Grant, and new Master of the Universe John Paulson.  Of the financial world, half of the handful of people worth paying attention to were just listed.

I found other interesting articles relevant to navigating the present markets.  Barron’s ran a cover story, imploring everyone to flee the Treasury bubble. I don’t really have problem with the sentiment but is it another case of missing the big picture? If the Treasury bubble pops, what does that do to mortgage rates?  Can you realistically expect a 30-year Treasury at 4% and a 30-year mortgage at 5% or 4.5%? After all that’s happened, anything is possible but why would anyone go from “risk-free” to housing-dependent in this market? The article mentioned none of this possible fall-out.

Also, consider this article [$] discussing Visteon’s cutting their white-collar work hours and salary by 20%. I’ve seen an increasing number of articles detailing major cut-backs in salaried pay and/or work hours, in what could be described as “wage deflation.” Non-exempt (hourly) employees are less subject to this as I think there are barriers to cutting hourly wages; instead, these employees are simply furloughed or laid off and likely to have their wages deflated by moving onto a lower-paying job.

Obviously, Visteon is part of an auto industry that is hurting globally but this wage deflation is not limited to that industry. Enterprises ranging from FedEx (supposed economic bellweather) to the state of California (another supposed bellweather) have been reducing worker hours and pay. Bernanke should finally congratulate himself on slaying that fearsome beast, wage inflation…oh wait, the economy is 70% consumer spending and these consumers are losing their jobs or taking home smaller paychecks? Way to think that one through, Helicopter Ben.

I make no forecasts but simply try to keep my eyes on the various moving parts. A burst bubble in Treasurys, by definition, leads to higher long-term interest rates which would retard any housing recovery. Wage deflation combined with rising unemployment and weakening demand across the board means any economic stimulus is facing a stiff resistance. I am more convinced that the situation leans more toward the worst-case scenario than the best. And despite my anti-timing bias, I cannot shake the feeling that at least the equity market has further to fall.

And the budget crisis in California suggests that crisis flashpoints (Wall Street banks, GSEs, the various corporate paper markets) have not been exhausted.

As always but with more feeling than ever before, be careful out there, my friends.