Many Thanks for the Holiday Market

What a pleasant start to the Holidays, a 10% increase in the market. Granted, most of us are pretty bummed over the 50% - 70% drops in our accounts, but gains are gains.

Several key points are in front of us. First, we're FINALLY going to head into a recession. After 16 months of battering from the press and neophite politicians claiming we were already in one, we might just fulfill their prophesy. We've had one quarter of declines and this shopping season did not start well enough to keep another quarter at bay. Expect Q4 to show some contraction which means we technically enter a recession. On more fundamental grounds, the market has already priced in the financial markets weekness and a major turnaround isn't expected until mid 2009.

However...

...two points need to circle this grim forecast. First, the market pricing ALWAYS preceeds events, even if the preface is only a few hours. The market volatility has been extreme in past weeks. Further, most of the market is oversold due to investors pulling their money from stocks and some (albeit limited) short selling. In terms of the DOW, the market has shown some resiliency at 7,500 and 8,200. Unfortunately, each new low has been in succession which could mean another dip in the near future. But, I digress. Without getting into too much technical babble, it is important to realize that the lows aren't holding. I believe that 8,000 is a support level and represents a good entry point for new money. However, when the bulls start to right this ship, the bears will jump in a hurry causing very volatile up spikes. If the fundamental health of the financial system is stabilizing (as indicated by the interest rate spreads) and swings into healthy numbers by mid next year, the markets will probably start pricing these bits of good news in the next month. In other words, don't try to time the market.

The second point is a bit more somber. The incoming administration makes no bones about the intent to increase government. While most of the "bail-out" money isn't a real cost and will probably be repaid, increases in the social security net (unemployment, medicare, social security, etc) will only push up spending and encourage Congress to increase taxes. Basic economics suggest that taxes are repressive and will further stall the economy. Assuming the feds can combine their cranial masses into at least half of one functional brain, California is sure to spoil to mood. I'm certain the California State government is the product of our failing schools. When the largest state in the country has unemployment 10% higher than the rest of the country, the highest sales tax, the highest income tax, and nearly the highest business tax, the last thing the economy needs is MORE TAXES. Apparently, the legislature has run out of fingers to count on, because more taxes appears to be on the table.

While the markets appear to be stabilizing, the government looks poised to mess it all up. If the tax burden is increased, the recovery will probably be at least one year further out. Paying the unemployed to stay unemployed is not going to create jobs. Taxing the corporations more is not going to create jobs, paying the farmers not to grow will not create jobs. Bailing out the automakers WILL NOT create jobs. Limiting the ability of energy companies to build more refineries, more oil exploration, and more nuclear plants hampers job creation.

Unfortunately, it apperas that the recovery might be getting pushed back by our incompetent governments. Obama appears to be continuing the spend now, ask later mantra of the Bush administration. US markets usually succeed despite the well intentioned blunders of US governments, so I'm still bullish for 2009. Unfortunately, I think we'll have to wait a few years before we see some real growth unless somebody in Washington, New York, or California figures out how to limit the politicians spending habits.

Change of the Guard

Needless to say, the market wasn't thrilled with our new choice for Commander In Chief. Further, across the country, voters agreed to more tax increases (mostly sales tax), and 100's of billions in bonds (debt) across the state and county measures. All three branches are run by the Democrats although they don't have a filibuster proof majority. Regardless of your political leaning, higher taxes and higher debt infer a slower recovery and potentially long recession. The market thinks this government might ignore economic laws and simply pass around the currency feedbag. 

Certainly, if the governments (fed and state) increase taxes even further, we will most definitely slip into an official recession. Job losses will likely increase, and further pressure on corporate valuations will hold back a solid recovery. On the off chance that our "leaders" come to their senses, we might still avoid a recession or, at least, keep it short. 

The financial crisis appears to be over. Some smallish banks will still fail and several corporate bankruptcies are likely to surface. However, the shrinking of the LIBOR indicates some level of stability arriving with the credit markets. 

Most equities appear well beaten down and while volatility will stay high for months to come, the general direction will not likely fall much more. Now is the time to research healthy companies and buy into the market. A dollar cost average into your choices will avoid a major timing risk. 

Next week appears shaky and similar to this week so hang on...