Wednesday, January 21, 2009

Stock Market -- Position Overview

Our previous newsletter, dated December 15th, stated that US money-center banks and financial institutions, using the spirit and intent of the accounting reform act, Sarbanes-Oxley, became gigantic hedge funds, leveraged 25-to-30 to 1 on net tangible assets. The deleveraging process could continue for awhile and force the stock market to remain under pressure; however, in the near-term, the stock market is due for a period of consolidation, before continuing the decline. We anticipated the DOW to have a trading range between 8,100 and 10,250, as the major stock indices remove the oversold condition that exists in the marketplace. The actual result did see a period of consolidation, but with a narrower DOW trading range than expected, between 8,118 and 9,026.

We stated that the Federal Reserve's balance sheet has expanded by $1.3 trillion in the past year. The US Treasury has backed banks and money-market funds, has taken in the government-sponsored mortgage companies and is toying with bailing out the big auto makers. Eventually, this monetary expansion will push prices higher; however, in the near-term, the US Treasury suggests prices will decline before they expand. The break-even inflation rate between inflation-protected US Treasury Notes and fix-rate US Treasury notes is nearly minus 0.5% for the next five years. We further stated that investors should brace for transitory deflation in the continued near future that will give way to inflation for the long-term. The near-term result could see the US treasuries be price supported, with the US 10-year Note having a peak yield for the month of 3.25%. The actual result was as forecasted, with the US treasuries being price-supported, causing yields to inversely decline, producing a 10-year Note yield-range for the month between 2.55% and 3.26% -- a very accurate forecast.

We anticipated that the US dollar, at least for the near-term, could decline in value. We projected a euro fx equivalent trading range for the month between $1.26 and $1.43, as the Federal Reserve, through their Federal Open Market Committee Meeting (FOMC) was likely to cut the prevailing fed funds rate by 50 basis points (0.50%) to a new level of 0.50%. This could cause the US dollar to decline in value, as the US would now offer the one of the lowest loan rates in the world. We could see the US dollar carry-trade in the future, instead of the yen carry-trade, which has been used for the past decade. The actual result saw the euro fx equivalent produce a trading range between $1.2605 and $1.4590, and the FOMC cut the prevailing fed funds rate by 75 basis points (0.75%) to new level of 0.25% -- a very accurate forecast.