The Fed's all in; but will it work?
Steve Cook on Disciplined Investing

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Economics

   This Week’s Data

    The November consumer price index (CPI) fell 1.7% versus expectations of a decline of 1.3%; the core CPI was flat versus estimates of a .1% decrease.
   
    The headline item yesterday was the Fed meeting or more specifically the formal policy statement made at its conclusion.  It stated all economic sectors are weak, financial markets are under stress, inflation is not currently a problem--all of which aren’t news.  What was significant (today’s story) was the Fed intends to use all available policy tools including sustaining an enlarged Fed balance sheet in order to create an environment conducive to economic recovery (recall the linked article in yesterday’s Morning Call which emphasized the importance of a focus on the quantitative measure of money).  Specifically, it:

(1)    lowered the Fed Funds rate and stated it will now target a range of 0.0--0.25% versus a specific rate.  This basically acknowledges that the present Fed Funds rate does not accurately reflect Market realities and setting a range will allow more flexibility to get the Fed Funds rate back in line with Market conditions,

(2)    would buy government agency and mortgage debt.  Much has been made of late of the yield spread between US Treasury bills/notes and all other debt reflecting investors’ unwillingness to take risk.  By buying non Treasury debt, the Fed is saying ‘we are going to take the risk, so should you’; the point being to encourage investors to start assuming risk by purchasing agency debt, then corporate debt then equities,

(3)    intended to keep interest rates at a low level for as long as necessary to insure increased risk taking and economic recovery.

In summary, the intent of this statement was to convey the message that the Fed will by any means necessary work to insure that the credit markets return to normal.

    For those interested, the text of the press release:
    http://www.ritholtz.com/blog/2008/12/fed-cuts-to-00-25/

    Now the question is, will it work?
    http://article.nationalreview.com/?q=MjQ2MTMyNmQxMmM1MjM0ZGI0M2VhOTIzNWQyN2Q1NDU=
    http://www.capitalspectator.com/archives/2008/12/staring_at_the.html#more

   Other

    W’s economic legacy:
    http://www.forbes.com/opinions/2008/12/14/bush-economy-policy-oped-cx_jt_1215tamny.html

    An encouraging quote from Larry Summers:
    http://mjperry.blogspot.com/2008/12/quote-of-day-let-economic-energy-bubble.html

    One more observation about the wisdom of an auto bailout:
    http://mjperry.blogspot.com/2008/12/lets-not-spend-our-money-to-avoid.html

Politics

  Domestic

  International War Against Radical Islam

    And the good news is:
    http://www.dickmorris.com/blog/2008/12/15/the-impending-collapse-of-our-enemies/#more-510

The Market
    
    Technical

    There were a number to technical positives yesterday: (1) both indices [DJIA 8924, S&P 913] bounced back and closed above the lower boundary of the November to present uptrend and (2) the volatility index fell below the lower boundary of its November to present uptrend [a declining VIX is a plus]. 

So I am now looking at the November to present trend lines (circa DJIA 8728, S&P 878) for short term support; and (1) the last high in the November to present move up (circa DJIA 8996, S&P 913) and the highs since November 19 (DJIA 9707, S&P 1062) as resistance. 

    Note that the Averages are very close to the 8996, 913 level, so resistance is upon us.  If the pin action today takes prices above those levels then it looks like stock prices have the potential to rise another 9-15%.  
   
      What to do?  First, assuming that stocks are in a trading range roughly defined by the 10/10-11/19 lows and the November highs, it is too late to buy.  In retrospect, as soon as I heard the Fed announcement, I should have put some money to work.  However, given that our Portfolios were already at 17% cash in a trading range of 15-25%, I didn’t see the necessity.

    Our focus now is on when to start taking some money off the table.  Certainly, if the Averages can’t penetrate the DJIA 8996, S&P 913 (see above) level, some selling will likely be done.  At the moment, it looks like a down opening; but I think that that is to be expected after a huge up day like yesterday.  I want to watch stocks for the first hour, then make a decision on whether to sell.  On the other hand, if stocks continue to rally (which is my gut feel at the moment), our Portfolios will start to re-build their cash position by approximately 1% for every 100 DJIA points.

   Fundamental
    
    Street forecasts for year end 2009 value of the S & P.  I guess that makes me very bullish, though I should point out that Fair Value as determined by our Valuation Model is not exactly a market price prediction.  It is a value based on the long term earnings capacity of corporate America, an expected rate of inflation and psychological factor (mine).
    http://bespokeinvest.typepad.com/bespoke/2008/12/strategists-2009-sp-500-price-targets.html

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    From a fundamental standpoint, yesterday’s Fed announcement has the potential to be a game changer.  Certainly, it is pulling out all the stops to alleviate the turmoil in the financial markets and providing the liquidity to avoid a depression.  There are two potential problems: (1) the Fed can put the money out there, but it can make neither banks or investors take risk nor consumers or businesses spend  money.  In short, if this move isn’t confidence inspiring, it will in the end be a futile gesture. (2)  because the policies being promulgated by the government/Fed have never been proven to have worked in stemming deflation, (a) we don’t know if they will work and (b) even if they do, we have no clue what the unintended consequences are. 

    I make these points not to throw cold water on or be critical of the Fed’s attempt to deal with our economic problems.  Indeed, I applaud them.  But that doesn’t mean that the worst is over--which is why I want to stay disciplined about sticking with our current strategy of managing our cash position between 15-25%.





Posted 12-17-2008 8:36 AM by Steve Cook
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