Market Commentary

Many times I discuss the “Velocity of Change.”
January 20, 2010

Many times I discuss the “Velocity of Change.”  Not that change occurs but rather the velocity of this change.  Three  weeks ago if I wrote there would be a distinct possibility a Republican could win the seat that former Senator Kennedy held for 47 years, many would think I would be at best nuts.  For the record, like most three weeks ago I was vaguely aware of this election.

Early last spring I wrote the President has reawakened the American electorate and has the possibility to become a great leader if he is able to harness this energy.  At this juncture it appears his Presidency is in great trouble as his poll numbers plunge as the electorate is rebelling against higher tax policies to fund uncontrollable spending.

I have always believed the American voter is smarter than most give them credit.  We did not become the richest and the most powerful country the world has ever witnessed via stupidity and ignorance.

I think the outcome of Massachusetts’s special election is pivotal as today’s events in Washington may have the greatest potential to impact markets/society in over 25 years.

As widely noted the great experiment in Quantitative Easing (QE) begins to wind down by March 31, 2010, the date the government stops buying the vast majority of newly minted mortgages.

As per the Treasury Department, $1.5 trillion in treasuries were sold in 2010.   Foreigners purchased about $300 billion and domestic banks/financial institutions purchased the vast remaining, the primary investment of choice for bank excess reserves which now amount to over $1 trillion. [Note:  Historically excess bank reserves are around $1-$2 billion]

The question to ask will banks continue to purchase treasuries with their excess reserves or will they begin buying mortgages filling the vacuum as the Fed ends this stage of QE?  Banks are historically the largest buyers of mortgage debt.

The Administration intends to sell another $1.5 trillion in treasuries—give or take a couple hundred of billions—in 2010 to fund their progressive agenda.  Who will be the purchaser of choice if banks begin again buying mortgage debt?

I do not think there will be an issue in selling this debt as buyers will emerge but I think the impact of these massive deficits are now beginning to weigh in on the electorate.

Can I make the case that yesterday’s rally in both stocks and bonds were the direct result that regardless of the outcome in Massachusetts the President’s progressive agenda has been stopped in its tracks? 

Absolutely for as stated above the happenings in Washington can have the greatest potential impact upon the markets/society in over 25 years.

What are the odds that instead of tax hikes there is tax stability or actual cuts?  What a radical thought, a thought about as radical as suggesting a Republican could win Senator Kennedy’s seat.

This consistency of this crisis is to expect the unexpected and velocity that these unexpected events have occurred.

Most economists will agree reducing taxes spur economic activity, a thought that at this juncture appears to be lost in Washington.  Maybe this attitude will change because of the outcome of this election. 

A similar change occurred in 1994 following the Democratic loss of Congress that forced President Clinton to move to the center, cut taxes, an event that was the primary catalyst for strong economic growth and stock market advance.

What will occur today?

Last night the foreign markets were down.   London was down 0.92%, Paris down 0.75% and Frankfurt down 1.14%.  Japan was down 0.25% and Hang Sang down 1.81%.

The Dow should open moderately lower on earning and economic concerns.  Bank of America and IBM disappointed the markets with their quarterly results.  China is moving to curb its explosive growth via a potential curtailment in bank lending. The 10-year is up 4/32 to yield 3.67%.