On the other hand last night the Fed raised one of the two interest rates it controls. This is the rate that the central bank charges for emergency loans to banks. It went from .50% to .75%. This is a sign that the Fed sees enough improvement in the financial sector to start tightening money though this is one of the most benign tightenings it could undertake.

Inflation and the Fed’s action is good news both for the economy and the stock market. Inflation is not a problem yet and the Fed has signaled a willingness to fight future inflation by making a move, albeit a minor one, early. It is also a sign that the dollar may not be as weak as feared. Of course this is only one small first step. Still the battered dollar is faced with a massive spending program which will continue to push its value down.

All and all this was a good week for the stock market and the economy. Only time will tell us if the correction is over.

Good Trading
Steve Peasley

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The trend in the DOW is certainly down and breaking down to new lows. The other indexes are not far behind though they have not fallen below previous lows made last year. Everyone is feeling that the economy is not going to recover anytime soon and the stock market has been leading the charge in that sentiment. There certainly has been no bounce from the new administration. President Obama’s stimulus package has hit the public with a loud thud. When the President himself expresses little confidence in it working how you do think the rest of the public, including the stock traders, are going to feel?

On another note, the government has said that they stand by the big banks and are not interested in taking ownership. At the same time Citigroup is in talks with the government in which Citi would give up to 40% ownership to Uncle Sam in exchange for a cash infusion. That may not be outright ownership but it certainly would constitute controlling interest.

Uncertainty and fear reign and until that changes there will be no sustained rally. We will likely have a relief rally from an oversold situation, but when and how much is a difficult call.

On a brighter note, the economy will recover and there are some small signs that the recession is lessening its grip. Small signs are much better than none. The turn is coming and the stock market is looking for any sign of it.

Good Trading
Steve Peasley

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On Monday we had some economic statistics which were not as bad as expected and that helped to move the market off of weakness. These numbers continued to show a weak economy but maybe not a weakening economy. In other words, have we hit a short term bottom in the economy or is this a pause before more bad news comes out? The traders were asking themselves those same kinds of questions. On Tuesday buyers were attracted into the stock market with no economic news and some decent earnings reports.

On Wednesday the ISM report for the nonmanufacturing sector for our economy showed an increase in January over December. The number came in at 42.9 when the estimate was for 39.0. The reading for December was 40.1. Again these are weak numbers as any reading below 50 means our economy is shrinking, but the rate of shrinkage is slowing. It’s like having pain but less pain. Is that good news? On Thursday Factory Orders for December came in with a drop of 3.9% from a revised 6.5% drop in November. Also, productivity for the 4th quarter of last year was up strongly, more than expected at 3.2%. Real income was up 15% and hours worked were down 8.4%. Jobless claims rose sharply again. Overall it is economic pain.

This morning it was the jobs report for the month and at 598,000 jobs lost it was more than expected which was 525,000. No one cared as the market continued to gain strength. Today it appears traders are focusing on the stimulus package which is close to passing and the announcement that the new secretary of the treasury is going to tell us what the plans are to save the banking system.

Last week we hit important support levels for the DOW and the S&P 500 and the market held and bounced up. No one knows when the next rally will begin or when the recession will finally be over. The stock market will start to rally inside the recession, on average between 2 and 9 months and normally about 6 months before the recessions ends. Normally the first run up in stock prices has always been steep. Still, if we break down from these support levels we must exit the market and move to the short side.

This little rally is one to sell in to, not to buy. You should have already bought. Use this small rally to lighten up. Resistance as seen on the DOW chart is around 9,000. This morning it is at 8,200 but you also must look at your individual stocks and if they have risen sharply this week to their own resistance levels, sell.

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This has been a week of earnings reports and important economic statistics. We started the week with good news. MacDonald’s earnings were better than expected, but more importantly was the existing housing report which showed an increase in sales for December, not a reduction as expected and it showed a significant reduction in inventory from 11.2 to 9.3 months from the month before. Also, the leading economic indicators report, which gives us a gauge of future health for our economy, was up when the expectation was for it to be down. The beginning of the week gave us some hope.

That hope extended into mid week because of President Obama’s spending package and talk about setting up a good bank/bad bank to buy toxic loans and get them off the back of the banking industry. That hope faded on Thursday as we had a number of poor earnings reports, unemployment claims rising, durable goods sales falling and new home construction falling sharply with an accompanying spike in inventory of unsold homes.

It is obvious that foreclosures have pushed home prices to such a low point that sales that would normally go to new homes are going to used homes. This week’s numbers tell the story clearly. Builders are not going to recover in 2009 even though sales in housing might. The raw data for new homes was that 331,000 new homes were sold for December down from 399,000 in November. Inventory for new homes stands at 14.7 months up from 12 months. As this is the opposite of the existing housing numbers out earlier in the week the conclusion is clear.

Last Saturday at our conference in Berkeley we reviewed the reaction of the stock market in each recession going back to the Great Depression. The conclusion is that the stock market ‘will start’ to rally long before the economy recovers. The average lead time is 4 months with some stock market recoveries starting only a month or two before the economic recovery and some as long as 8 months. The average stock market rally for those few months is 23%. That does not include the continued rally after the economy continues to strengthen. The 23% is only from the start of the stock market recovery to the start of the economic recovery. That is a sharp move up that most people will miss. Also, we will not see the recovery in the economic numbers for at least 6 months past the start. These statistics mean you are not going to be able to look into that crystal ball and determine ‘when’ the stock market recovery will start. There will be bad news everywhere and the stock market will be ignoring it.

Finally, in last Saturday’s conference we looked for the economic recession that most closely matches the current one with a similar fall in stock prices. It appears the 1973-74 recession closely matches in many ways the problems we are having today. In that recession the stock market fell 45.1% from the start to the end of the recession, the stock market started to recover 2.8 months before the economy begin its recovery and the net change up in those 2.8 months was 33.0%.

The question is ‘when’ will this recession end? It is already one of the longest recessions on record if you count the start being that of when job losses began. It is very likely that we will have at least 4 quarters in a row of falling GDP and of course it could be longer since no one knows. Most count the start of a recession with two quarters of falling GDP in a row. Once that happens you are in a recession. So by any definition we are in a recession. This morning GDP numbers for the last quarter of 2008 were reported and it fell 3.8%. That was in sharp contrast to the expectation of at least 4.5% and some were expecting much higher. Most experts are saying that we will see two more quarters of shrinking GDP before the end. Of course most experts are wrong as well.

Since none of us know when the recovery will start you have to make a decision. That decision is all about ‘when’ not ‘if’. Once it starts it is going to be fast and very large if history is any guide. The pain will be in the waiting.

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This week was dominated by the new President taking the oath and grabbing the reins of power. The day of the inauguration the stock market had its worst day in history for that first day of a new administration. I don’t think that means much at this point but it is an interesting fact. More important is that the market tested support levels that day and the next day bounced up sharply from those lows. What will be important is the follow-through.

On the day the market fell it was because of bad news in the banking industry. That news was replaced with good strong earnings reports from IBM on Monday night and some very good news from different large banks that had earnings rather than losses. That was a surprise. After hours on Tuesday Apple reported numbers that were very good but before the opening on Thursday Microsoft reported poor earnings. That scared the market badly, so down it went to retest the lows it bounced off of the day before. The market is very nervous. It is looking for something from Obama. The banking sector is searching for something to help it. I think we need the same thing we needed in the dark days of the Savings and Loans bank crisis of 30 years ago and that is setting up a separate entity to take the troubled loans off the banks’ balance sheets. That is the solution. Also, that does not mean necessarily it will ultimately cost us much. Those assets have value if you wait long enough to realize a good price for them.

We are past the middle of earnings season with good and bad numbers being reported. On balance, at least so far, you have to be fairly pleased. I think there was wide expectation that earnings were going to be terrible. They were poor but overall they showed that there are companies growing their incomes even in the current poor economic conditions.

Now it’s up to confidence building by our new President and his team. Will the spending package be a net positive and when might that happen? What will they spend the second half of the TARP money on? Will any of this massive spending help? One thing is certain: there will be massive waste. Whenever the government spends money there is a lot of waste. Don’t buy in that there will be no pork spending. If there isn’t, as Obama promises despite his best intention, it will be the first time in history. Just like pet projects the Republicans spent on, the Democrats will do the same. Let’s just hope the net results will be good for our economy.

Frankly, I think our economy will recover on its own. We are in a normal deep recession. One in which we will see unemployment reach 8 to 10%, where the GDP will shrink for several quarters and where prices for all things go down. This will be a health restoring event- it’s just very painful to live through.

When can we expect the banking crisis to end? That is what the stock market is trying to determine. Once they know, or at least when they think they know, stock prices will begin a long recovery. For the near term we are looking at very choppy waters. There will be rallies and retests of lows. Every stock market bottom acts this way. So far the lows made in October and November are holding. This is the real test. As long as they hold and the longer they hold the more positive the prospects. If the lows do not hold then we are in for a down stroke in equity prices. If we go lower we are looking at history making events. 2008 was the second worst year in history and you have to go back to the Great Depression to make comparisons. The 1973 to 1974 market is a close third, both for the market and the economy. In fact that market is a very good comparison with this market. What happened in 1975? The market rallied strongly.

If you own stocks hold them unless the stock market breaks the low. If that happens exit and wait for another bottom to be put in. If you have cash slowly invest it. The bottom is close if not already in. Also, keep your stops close. Let them take you out of the market if need be. Caution is the word that should describe your approach but long term this market is going to go higher; it’s the short term that is the worry.

One final word. The U.S. economy ‘will’ recover. It always has and always will.

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This week was the start of earnings season as Alcoa posted over a billion dollars in losses on Tuesday. On Monday, anticipating that the report might be worse, the market sold off. It came in at about what was expected, so on Tuesday the market tried to hold up. Selling pressure intensified on Wednesday with 90% of the volume for 90% of the stocks on the down side. That was a very strong sell off as the market appeared to want to retest the lows. A retest is normal though tough to handle if you are the one who is experiencing the fall in your asset value. Still, it is normal and a successful retest is very positive. On Thursday the low was not broken and the market turned around in mid day ending on the up side after an intraday slide of almost 300 points on the DOW, a positive sign that maybe we have seen the low in this mini cycle.

The market this week was dealing with some tough economic reports. Though most of the news was expected, the retail sales report for December showed a fall of 2.7% which was more than expected. However, I think it was the news about the banks this week that pushed the market down. Citigroup is selling assets to try and improve its balance sheet and Bank of America announced that they are in negotiations with the Fed for more money and then got it early this morning. This uncertainty is not what the stock market wants to hear.

Economic news not so well reported as the retail sales this week, was inflation which has fallen off a cliff. On the producer level for December it came in at a -1.9%. No one is talking about ‘deflation’ which is what we have at this time. The reason no one is talking about deflation is because almost every expert expects inflation to come back at some point. That will depend on the FED and when it starts to raise rates again. That is not going to happen for a long time.

Foreclosures are up strongly, especially in California. This recent spike is nothing more than a result of government interference. The government forced banks to postpone notices of foreclosures to try and work out loan defaults and all that did was push back the time line. The good news is not in the foreclosure rate. That is going to continue to be a problem long after the housing market settles down. Any good news will be in mortgage applications which were up last week another 25%. That was on top of the 25% increase the week before. Annually, applications are up 50%. Of course 85% of those applications were for refinancing, but with 30 year fixed rates falling to below 5% this bodes well for future sales of properties. As I have said before, look for a recovery to start in refinancing and sales of homes. Don’t expect prices to rise or foreclosures to fall for a while but sales are the important aspect at this time. Without an increase in sales a recovery is not going to happen.

Import prices fell in December by 4.2% and that is on top of a 7% drop in November. I wonder what this means when you consider the retail sales report? Net of auto and gas, retail sales fell 1.5% not 2.7%, but what have lower prices on everything done to the sales report? Maybe it is not as bad as we all think. Still it is not good.

It appears the market is marking time. It has established a range and is testing the low of that range. There is no great urgency to buy stocks at these very low levels as fear makes investors worry about going lower while at the same time everyone is waiting for the new president to take office and see what his stimulus package is going to look like. A huge amount of money is sitting on the sidelines paying zero to 1% interest rates. Traders are waiting for something. They just don’t know what that something is.

Maybe they are waiting for more clarity in the economy. We shall have to wait and see. Meanwhile, stock prices are at historic low prices. The market will rally but maybe it’s one to sell not buy as we struggle in this trading range.

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At a final look at 2008, Fidelity Magellan, the largest and long established bellwhether mutual fund, lost 49% for the year. The CGM Focus Fund which was the best performing mutual fund in 2007 lost 48% in 2008. The average mutual fund loss for last year came in at 39%. There are a couple lessons to be learned. One is don’t blindly buy the largest mutual fund thinking it is safe and secondly don’t chase performance. Last year’s winner does not mean it is going to be this year’s winner.

But we have to look forward. What will 2009 bring us, both in the economy and the stock market? The big economic news this week was the jobs report out this morning which showed a loss of 524,000 jobs with an unemployment rate reaching 7.2% in December. Earlier in the week we had the ISM report, factory orders, construction spending and pending home sales. Most of these reports were for November and across the board they were weak. That was and is expected. It was October when the financial system collapsed and we are going to see several months or more of follow through of weakness before all the efforts to re-inflate the system start to show any result. Expect bad reports for a while.

However, the stock market has already priced in a very weak economy. It has started to rally from its depths and though many do not believe this is a sustainable rally, only a bear market rally that will weaken and roll over, a bottom has been put in. Of course it is a possibility that we could go lower. However, since very dire predictions for the economy have been built into the prices of most stocks it is normal to have at least a strong bounce in stock prices. A return to normalcy would suggest that a rally might last for several months before losing steam and give us some kind of retest of the lows. In October of 2002, in our last recession, the market bottomed and retested that bottom in March 2003. This market will not be the same as this economic slump is much deeper but so was the speed and depth of the market collapse. So the scale is sharply different in the two recessions but the pattern of the stock market lows and recovery so far is very similar.

The question that the experts are all asking themselves is will the Paulson and Bernanke efforts coupled with the Obama stimulus plan work? Will our politicians get it right? I have some serious doubts, but at the same time there is great hope.

I like the infrastructure improvement spending; the U.S. needs that and has needed it for some time. Also, tax breaks for individuals and small business are a good idea. These things will help as will cheaper gas and food prices. But then again- will it be enough?

No one can tell us. There are some hopeful signs that the economy is working its way through the problem; cheaper mortgage rates and interbank lending is starting to improve, but those are baby steps and the new rules the lenders are implementing appear to be very Draconian. Banks at some point are going to have to begin lending. That is the only way they can make money. Right now they are frightened thus they have tightened up standards to such a degree that loans are difficult to come by.

Looking past the current economic recession, inflation will likely return. It is a lot more familiar to deal with than the current deflation we are facing today. Inflation is an old friend, one which we know well, but if inflation gets out of control because of the liquidity we want and need today, then that excess liquidity can destroy the economy a year or two from now. I am referring to all the spending that is going on by our government. Printing money is inflationary and it could be ‘very’ inflationary if the government does not remove the excess liquidity at some point. As in all things it is the timing that is difficult.

Therefore, it is time to be invested not frightened. It will be a bumpy road but as the year unfolds it should be a good one. Keep your stops and be ready to exit at any time but on balance be in the market for 2009.

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