Market Commentary

As noted several times there few absolutes in the markets.
January 12, 2010

As noted several times there few absolutes in the markets.  For example, an inverted yield has a 100% correlation to a slowing economy.  Conversely a sharply vertical curve is 100% correlated to an expanding economy.

At the time of this writing—Monday evening—the spread between the 2 and 10 year treasury is the largest in history…291 basis points.  Consistent comments by Federal Reserve officials that economic conditions continue to warrant “exceptionally low levels” for the federal funds rate “for an extended period of time” is the reason for such a steep inversion.  The data however is suggesting the economy is recovering more robustly than expected.

I believe this week’s heavy release of data coupled by at least six FRB Presidents speaking the above chorus; the curve could steepen even more.

As widely accepted, the Federal Reserve is more reactive rather than proactive.  The yield curve is saying the longer Fed officials keep the federal funds rate anchored between zero and 25 bps, while the economy is recovering and two thirds of the $787 billion stimulus (and perhaps more to come) is to be committed, the greater the chances inflationary growth will occur in the future.

My greatest fear the Fed will act to late, perhaps reliving the 1970s when hard asset values rose at a rapid pace that generated cost push (wage) inflation.  However I guess a possible benefit would be the recovery of real estate values, but would this benefit be worth the price?

Turning to the here and now, Alcoa posted earnings last night that missed expectations.  How will these results be extrapolated?  Later this week both Intel and JP Morgan announce profits. 

I reiterate my long held view because GDP is expanding at a pace greater than forecasted which should generate top line sales growth, amplified by robust productivity gains produced by last year’s massive firings, fourth quarter profit growth could be greater than the 62% expected surge.

How accurate is this outlook?  I will tell you in a month.

Last night the foreign markets were down. London was down 1.15%, Paris down 1.15% and Frankfurt down 1.16%.  Japan was up 0.75% and Hang Sang down 0.38%.

The Dow should open modestly lower on profit taking; fearing stocks are overvalued based upon profit outlook.  I must remind all no recovery is ever linear.  There is backing and filling with inevitable positive and negative surprises.  The 10-year is up 18/32 to yield 3.75%.