Train Kept A-rollin'

There is a belief among many investors that the markets always accurately represent the fair value of asset. We know that to be untrue. If stock and bond prices were always correctly valued there would very little market volatility. There would be no bubbles or corrections. We would have never has a tech bubble and severe correction. There would have been no real estate bubble and catastrophic retrenchment. There are times market prices are based on value. However, we are in markets driven by momentum traders.

There is an old saying among traders which states: "The trend is your friend". In other words, one may not agree that market prices are based on fundamental values, but if the trend is moving in a particular direction (up or down), one has to trade accordingly. Remember, there is a difference between a trader and an investor.

An investor looks for long-term value or income. He or she will seek vehicles which address particular financial needs and tweak their portfolio as necessary. Risk, yield and fair value are very important. A trader does not care whether or not an assets should be priced at a particular level. A trader only cares which direction the price of said asset. A trader may view a stock priced at $50 as being over valued, but if the momentum appears ready to push the stock to $60, the trader climbs aboard. If momentum is poised to push the stock lower, a trader may flatten his position or even go short. No matter how much momentum may be present during an asset's or market's most frenetic period, calmer heads will eventually prevail and say enough is enough.

When the value of an asset or market rises or falls well beyond what fundamentals indicate to be fair value, the prices moves (corrects) to reflect fundamental valuations I.E. tech bubble and housing bubble. Given the economic data we have seen in recent months, the severe bear market which troughed in March 2008 may have overshot to the downside (hindsight is 20/20), but the data doesn't bear out further increases in equity prices or tightening of corporate bond and preferred security spreads. Fixed income market participants and experts have been very vocal about their tempered forecasts for economic growth.

The other day, Fed Chairman, Ben Bernanke warned that although the recession may be technically over, growth will be tepid during the next several years and inflation pressures will be subdued. Today, former Fed Chairman and current presidential economic adviser, Paul Volcker gave his less-than-thrilling assessment of forthcoming U.S. economic growth. At a financial conference held in Beverly Hills, California, Mr. Volcker had this to say:

There is “long way to go” before economic growth returns to normal (whatever that is going forward).

“It will be a long slog -- a matter of years -- with the risk of some relapses along the way.”

Mr. Volcker also warned that it will be along time before it is business as usual and he favors trading and risk restriction on banks deemed to big and important to fail. You go Paul!

Bank of America Chief Economist, Ethan Harris told Bloomberg News:

"We have a deep hole to dig our way out of." He believes the U.S. labor market is "in a severe bleeding mode." He predicted that unemployment would peak at 10.2% in the first quarter 2010 before moderating very slowly.


Let's be clear, the economy's recovery prospects are limited unless jobs come back and these jobs pay well enough to promote discretionary spending. I think this is highly unlikely. Why? First; business do not hire proactively. They hire reactively. This is why the Fed has, for nearly three decades, to spark spending by lowering rates during recessions. The thinking is that those who have cash or (especially) access to credit spend, generating demand and jobs. Those days are gone. Rates are near their historic levels. There is not much spendable income available among U.S. consumers and those who have access to credit has fallen as lenders require more than a foggy mirror to obtain a loan or credit cards.

No, this economy is mired in an economic swamp, one which will require much time from which to emerge. Asset prices among corporate credit prices are (by and large) fairly priced or rich versus fundamental. Corporate bond and preferred investors should be looking toward the treasury market and not the equity market for guidance on where the economy is going.

Inflation should remain subdued, making most TIPs unattractive. Some believe that printing of money and issuance of debt will cause inflation. Although government actions such as these could put upward pressure on prices, but wage stagnation (or worse) and a poor labor market will keep many consumers on the sidelines. This makes the 10-year area of the corporate credit curve attractive, but mainly in the acquired subsidiaries of larger banks).

Instead of a V-shaped recovery, we could have an O-shaped recovery. Round and round she goes.