Market Commentary

Treasuries were crushed Friday.
October 12, 2009

Treasuries were crushed Friday.  The FRB Chairman stated Thursday evening “an accommodative monetary policy will be needed for an extended period” but then continued on to say “as economic recovery takes hold we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road.”

Is the Fed Chief offering a warning, stating the obvious or just confused?  I think the former.  The Federal Reserve will likely begin withdrawing reserves via reverse repos…the Fed sells treasuries to dealers for cash to drain money from the financial system with an agreement to buy them back at a later date at a slightly higher price.  As per the WSJ the Central Bank has experimented at least three times since March to use reverse repos to reduce liquidity.

At this juncture Fed Funds Futures, which are only a gauge of market sentiment, is suggesting a 40% chance the FOMC will increase rates by March.  However as written many times, the consistency of this crisis is its inconsistencies and the velocity of change.

Does the Committee think economic growth might be stronger and more sustainable than expected?

As noted several times I think the sustainability of this recovery will be the result of capital spending, spending that is dictated by earnings.  Third quarter profits are expected to decline by 23%, the ninth consecutive drop in profitability. This is the longest drop in profits since at least the 1930s.  Earnings are than projected to rise by 63.4% in the fourth quarter and 26% in 2010.

As noted Friday if GDP really accelerates and given the massive cost cutting that has occurred earnings could go ballistic.  This large increase in profitability could support a capital spending boom similar to the one experienced 10 years ago when all thought we have entered into a “New Paradigm” and the death of the business cycle.

As noted several times the technology laden NASDAQ is posting a 35% year to date return and is almost 30% higher than a year ago.  If the markets are all knowing as some would suggest, the above view of a sustainable recovery via capital spending is indeed probable.

Speaking of earnings, approximately 75 companies post results this week. 

This week is heavy with economic releases.  Retail sales, import price index, the CPI, business inventories, Minutes of the September FOMC meeting, the Philadelphia Fed and Empire Manufacturing Index and capacity utilization/industrial production are all released.

Commenting briefly about equities, stocks rose on earnings and economic optimism.

Last night the foreign markets were up. London was up 1.17%, Paris up 1.37% and Frankfurt up 1.54%.  Japan was up 1.87% and Hang Sang down 0.93%.

The Dow should open moderately higher on earning optimism banks are closed today suggesting bond trading will be lackluster at best.