Department of Correction

Did we all have fun today? Look folks the correction is for real. This is because the problems are for real. Some pundits pondered if the selloff was overdone. Truthfully, with all the soft and somewhat disturbing economic data, trouble in Europe and a possible slow down in China, it appears as though the stock market recovery of 2009 / 2010 was overdone.

The recovery was all about government stimulus and optimism, maybe irrational optimism. Foreclosures hit a new high. Consumer prices are not rising much and deflation fears pervade. Jobless Claims data disappointed today as firings continue to be uncomfortably high.

I have written previously that the "vigilantes" are in the markets and they want real fixes, nit government rhetoric, promises and the printing of money. Former Fed Vice Chairman Alan Blinder agrees. He writes in the Wall Street Journal:


"Remember the bond market vigilantes, that frightening band of financial marauders who once roamed the earth like a fearsome herd of Tyrannosaurus rex? They were so scary that in February 1993, as President Bill Clinton struggled to reduce the federal budget deficit, James Carville quipped that he wanted to be reincarnated as the bond market so he could intimidate everybody.
Well, they're baaack! Not in the United States, though. Here, the Treasury Department continues to borrow brobdingnagian sums of money at extremely low interest rates-about 3.5% for 10-year Treasurys and under 1% for two-years lately-even though everybody knows that the federal budget deficit is on an unsustainable path toward the stratosphere. (Could it be that not everybody knows?)
But the bond market vigilantes have landed in force in Europe. Their beachhead, of course, is Greece, which all but invited them in with-how shall we put it?-a certain lack of fiscal probity. The ensuing roller-coaster ride of ups and downs that have roiled stock, bond and currency markets around the world is apparently not over. As you read this, the markets may be either sinking or soaring on the latest news out of Europe."


A little disinflation may be in order here. Remember, home prices reached loft heights due to free-flowing and ever cheaper credit. Well, the Fed can't make it any cheaper and investors want collateral which actually has a chance of paying off. I don't think the equity markets will descend into a free fall, but weakness could be with us for awhile. There should be little upward pressure on long-term interest rates and the Fed will be on the sidelines until at least next spring.

Credit spreads have been widening in recent weeks. Where a few weeks ago bank and finance preferreds were a bit rich, now 8.00% is possible in names like Morgan Stanley and Goldman. Now may be a good time to modestly add some to income oriented portfolios (high coupon issues please). Ten-year financial bonds are also more attractive with spreads again wide enough to absorb a good amount of interest rate rising (not that I think they will rise much), as credit spreads tighten during a fundamental (read slow and gradual) recovery.


Have a great weekend.