The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Good Evening: Our capital markets had a lot to chew on today, and different markets may have offered hints with regard to near term direction. Last night came word that the Obama Treasury department is considering a plan to set up a “bad bank” to absorb toxic assets from the financial system, a possibility which sat very well with global equity investors. All the chatter swirling around the bad bank concept made it difficult to assess the impact of the FOMC’s vague announcement later in the day about potential open market securities purchases (a.k.a. Quantitative Easing). Net, net, today’s session can be summed up as one of hope for equities, disappointment for Treasurys, and long term bullish for gold.

CNBC broke the “bad bank” story last night after the close, and stock index futures here and around the world jumped for joy (see below). Details of the plan are still lacking and will probably not be announced until next week, but the desire to hope and believe that a magic bullet can save us from the credit crisis apparently still runs deep. Recall that in the autumn of 2007, stocks rallied to all time highs on hopes the Fed’s easing campaign would stop the subprime mess in its tracks. Well, the fed funds rate is hovering near the zero mark, the Fed has set up numerous lending facilities and has nearly tripled the size of its balance sheet. And yet, some 16 months after Mr. Market’s first post-crisis end zone dance, the crisis is anything but over. The TARP was also hailed as a savior, but the first $350 billion has been deployed only to be chewed up in more credit losses by participating financial institutions. Last month brought a promise of a large stimulus package from the Obama administration and was also hailed as a “solution”, but what it will look like after Congress finishes with it is anyone’s guess. Advice as to what to do next has been flying in from all quarters, but the common bond these ideas share is the hope we’ll soon see the great credit crisis of 2007/2008 in the rearview mirror.

Optimism about the “bad bank” concept caused investors to push stocks 2% to 3% higher this morning before they settled into a sideways range ahead of word from the FOMC. The statement itself was a disappointment, at least to Treasury investors. As BAC/MER points out in their piece below, today’s release hardly differed from the one the FOMC issued back in December. Rather than announcing it would indeed intervene to buy Treasurys, the Fed could only say it was “prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets” (source: Bloomberg article below).

Fearing this 2009 Fed promise would end up filed in the same wastebasket the Fed’s 2003 Treasury buying scheme, Treasury investors registered their disappointment by selling bonds (see below). Rates on long dated Treasury securities rose 14 bps to 18 bps. Even equity market participants were a bit underwhelmed by the FOMC’s announcement, and stocks sold off immediately after the release. Regaining their composure, and with renewed hopes for the “bad bank” plan, investors pushed stocks back to nearly their best levels by day’s end. The major averages closed with gains of between 2.5% (Dow) to 3.85% (Dow Transports). Currency traders who had been hoping the Fed might provide a tailwind to short dollar positions felt the need to buy a few greenbacks instead. Down 0.5% prior to the FOMC statement, the U.S. dollar index finished slightly in the plus column. Commodity prices were up both prior to and then after the Fed text came out, and the CRB index closed with a gain of 1%.

Despite the Fed’s muttered promises, it seems like there is now a decent chance equity investors will dust off and then put on their old rally caps. Sentiment is always swinging from belief to disbelief and back again, but the “bad bank” plan is one investors have been pining for since the dark days after Lehman Brothers slipped under the waves. Toss in Mr. Obama’s stimulus plan on top of it, and “Resolution Trust II” might just goose equities for a spell. Obviously, the details of each plan have to be worked out, but I wouldn’t be surprised to see a “delayed January effect” type of rally that favors whatever has been out of favor (e.g. financials, small caps, etc.). This call may sound like a change in my recent dour outlook, but it’s only a short term switch and one I could quickly abandon. I still think that no matter where a rally takes us in the days or weeks ahead, we are still in for some disappointment later this year when these “magic bullets” fail to find their mark.

Let’s also keep in mind that the “bad bank” plan and Mr. Obama’s stimulus plan will require a lot of Treasury borrowing, and the long bond has been blanching at this prospect of late. Long term Treasurys may end up needing the Fed to buy them to keep the back end of the yield curve from reaching for the sky. Other governments around the world have similar plans for sovereign issuance, so all government bonds look suspect to me in the years ahead. And, should Fed decide to support the government bond market, then the one currency no government can devalue or manipulate should shine. The last article you see below tells the story of how Greenlight’s David Einhorn has finally decided to take the advice of his “Grandpa Ben”. Not trusting governments to do anything but debase their currencies over time, the elder Mr. Einhorn told his grandson decades ago to invest in gold and gold mining companies. Given what Uncle Ben (Bernanke) has done to date, and considering what he might later do to monetize Treasury debt, I will side with Grandpa Ben.

– Jack McHugh

U.S. Stocks Gain, Extending Global Rally, on ‘Bad Bank’ Plan

FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets

Treasuries Drop as Fed Offers Little Guidance on Debt Purchases

Greenlight Founder Takes Grandfather’s Advice on Gold

Minor shifts no real changes.pdf