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

Good Evening: U.S. capital markets were on the defensive today ahead of the imminent first quarter earnings season. As a result, the equity rally off the March lows was once again tested, and stocks sold off for a second day in a row. Whether this nascent decline is simply a correction of the previous up move or a resumption of the primary bear market is impossible to know with assurance. It may therefore be instructive to consider the views of two well-known investors before we each reach our own conclusions.

Stock index futures were down this morning, perhaps in response to some vague stories about the Treasury Department’s recent actions. I could find nothing solid, but rumors persisted that the Treasury plans to hold off on announcing the results of its so-called “stress test” for our nation’s largest banks until late April. The rationale offered is that Treasury wishes not to muddy the waters around the Q1 earnings reports of these institutions, but the darker side of this chatter held that the delay was due to early indications the folks at Treasury do not like the results. Not helping to allay these whispers was a report out that showed office rents in Manhattan fell 6% in the first quarter of 2009, the steepest quarterly decline in at least 25 years (see below). While such a fall in rents in financially dependent New York is not exactly unexpected, it’s notable in comparison to the 1990-91 recession, which had as its centerpiece a crack up in commercial real estate lending. Twenty first century risk management techniques helped to limit the exposure to commercial real estate this time around; our banks instead took on more residential real estate exposure. Nice hedge.

Less a rumor and more a fact is that Tim Geithner’s troops are seeing less interest in PPIC than they had expected. The program’s complex requirements and a fear of future rules changes apparently have caused fewer players to want to join in the fun of bidding for toxic assets with taxpayer-sponsored leverage. I’m sure Treasury will come up with some changes (read: sweeteners), but with banks now allowed to mark their portfolios as they wish, it is quite possible the lack of demand for PPIC will be met with an equally small amount of supply.

Chalk up the lack of interest on both sides as unintended consequences numbers one and two for our newly seated Congress. Pressuring FASB into embracing “Miss Mark-to-Market” accounting will hurt PPIC supply, while It was the retroactive attack on the employees of AIG and other financial entities by our nation’s elected officials that is likely crimping demand. A thank you note from Tim Geithner to the Democratic leadership in both chambers is unlikely to be forthcoming.

These rumors and stories gave stocks an excuse to take back yesterday’s late rally at this morning’s open. Down 2% or so right out of the gate, the major averages recouped almost half those early losses before sinking again. Since Alcoa was slated to kick off the Q1 earnings season tonight (it missed — sales were down an astonishing 41% yoy), a pull back in share prices should come as no surprise. What did raise a few eyebrows among the bulls, however, was a decided lack of energy in the tape. Most of the action was sideways to down and both small rally attempts, including one just prior to the closing bell, failed. The averages went out on their lows, and the damage ranged from a 2.35% decline for the Dow Industrials to a 4.35% loss for the Dow Transports. Lower risk appetites were also evident in the other markets. Treasurys were firm for most of the session, as yields declined between 2 and 4 bps. The dollar rose 1% and commodity prices fell by almost as much as the greenback rose. Even the rally in precious metals seemed to indicate investors were playing defense today, but it was an almost 4% retreat in oil prices that paced the 0.8% decline in the CRB index.

Neither George Soros nor Marc Faber need to be introduced to regular readers, but each proffered their latest views on U.S. stocks today (see below). Both were bearish on U.S. equities for most of 2008, though it should be noted that Mr. Faber did correctly spy a rally coming back in November. In the article, Mr. Faber allows that while equities could give back between 5% and 10% after a 30 day sprint, they are likely to resume advancing into the middle of this summer. For his part, Mr. Soros thinks this move is simply another bear market rally. He thinks we will eventually muddle our way through this mess, but he also believes the economic damage has been too severe to yet venture back in on the long side. And, oddly enough, both could end up being right if stocks dip now, rally toward 900 by July, and then set new bear market lows at some point in the future.

As for how I reconcile these different takes on what might happen, I like to break it down according to timeframe. Traders who like to time the markets can follow Mr. Faber’s advice, while longer term investors should heed what Mr. Soros has to say. But just as important as one’s market outlook or timeframe is how investors plan to deal with outcomes that deviate from the pre-ordained mental roadmap. If you’re unsure about this concept, just ask the Treasury Department. They keep making plans and then submit new ones even before the previous one can take effect. To paraphrase the always eloquent, Jim Grant, “our government may soon run out of kitchen sinks to throw at the problem”. High rates of change and high degrees of uncertainty are not an easy backdrop against which to conduct one’s financial affairs. Invest accordingly.

– Jack McHugh

U.S. Stocks, Oil Retreat as Dollar, Treasury Bonds Advance

Manhattan Office Rents Fall Most in Quarter Century

Soros Says Gain in U.S. Stocks Is ‘Bear-Market Rally’

Stocks May See ‘Correction’ of 10%, Marc Faber Says