The Markets 2-17-11

Feb 17, 2011 | Blog, Blogs, Daily Financial, In the News, Market Commentary

Terrry Sawchuk Financial Advisor Terry Sawchuk
Founder & Chairman

I don’t know about you, but I for one am ready for winter to move along now. Give me sunshine and warm air. Speaking of warm, or should I say “hot” air, there seems to be no shortage of it when it comes to opinions on where the stock market is heading. So it only seems right that I make my monthly contribution to global warming, which by the way, seems to affect every other state except Michigan. As for the markets, I honestly have no idea when they are going to turn, but I suspect it’s probably not too far off now. Why do we think this way? This chart is one small reason:

We have seen a major retracement (recouping of market declines) in most of the index averages now. This alone is no indicator that the market rally is over, but it gives you a sense of how far we have come. In my opinion, the major reason(s) to think the market rally will end has nothing to do with how much we have recovered, but rather a change in tone in Washington. Some people think that the Federal Reserve Board is made up of clueless idiots that simply want to print our currency into banana republic status. There are only two reasons to suggest such nonsense. Either you really have no clue as to what you are talking about, or you have a vested interest (like scaring people into buying gold) in a particular outcome. Neither argument is a particularly valid one. The way I see it, the Federal Reserve Board is preparing us for their eventual exit from the latest Treasury Purchase Program (quantitative easing). At this time, we believe it is very unlikely that the Fed will quickly engage in another round of Treasury Purchases. The markets will be left to function on their own, and only then will we truly see how far the economy has come.

There are other headwinds to prepare for. The political climate will be more challenging, as the Republican Congress may be more critical of the Fed than the previous Congress; making life a little more difficult for Mr. Bernanke should he choose to continue to follow a policy of artificially low interest rates and increasing the National Debt. There is roughly $770 billion dollars in negative equity in the residential real estate market here in the U.S: source, Rodney Johnson, President of the HS Dent Foundation.. That means that there are a huge number of homes that are worth less than the debt that is owed on them. If history is any indication, an unfortunately high number of these homes will be foreclosed on, and that means more write-offs for the banks. You can do the math, if hypothetically 20% of those homes were to be foreclosed on, the amount of capital the banks would lose would be staggering. Speaking of debt, let’s not forget our friends across the pond. We believe that it’s likely this year that Greece will default on some of it’s debt, seeing as they can’t make their upcoming debt payment on bonds that were restructured less than a year ago! The thought of falling dominos comes to mind, however, this is not a foregone conclusion at this time.

On the bright side, there are some things to be more optimistic about. The labor market seems to have stabilized (meaning the job losses have slowed considerably) and the economy has improved over the last year. Corporate profits have been pretty solid and certain sectors of the economy continue to look promising. The third year of the presidential cycle has been the best from a stock market performance point of view and companies seem to have learned how to live on less. One area of concern however, is the rising commodity costs. If prices stay at current levels or move higher, we think it will put pressure on margins at the corporate level, and that could lead to some downside earnings surprises later in the year and that would not be very good for the markets.

For now, we are content that our current models are situated properly. We do anticipate the continued rising of interest rates, which is why we recently modified our bond positions. We see the balance of risk versus return in the very short-term as being close to equal, which means our current models have both stocks and fixed income and should hold up reasonably well either way. We were a little more bullish earlier in the year, but as time has progressed we have become a bit more cautious about the future. While the beginning of the year has been very good for the stock market, we believe by the end of the year, things could look quite a bit different. Stay tuned.

Best regards,
Terry Sawchuk

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