Sunday, May 24, 2009

Market preview and outlook as 05 2009

We have bottomed out since March 2009 but it is still early to conclude V-shape economy. Highly probably, we will experience a W-shape economy until the year end. Since the market bottomed out during early March 2009, all sagging markets have rebounded. Credit market have witnessed that interbank lending rate 3M libor rate has tightened below 100 bps to 80 bps. Commercial paper yields have also trending back to normal under the Fed massive liquidity programs and recovery of investors confidence. AA financial, nonfinancial, and asset based 30 days commercial paper rate have dropped below 60 bps from over 5% in 2007. Long term credit market has rebounded. In 2009, Jan and Feb alone have issued more than 174 bil, at the annual rate of $1044 bil, at a pace more than 2008. Funding market in Equity has seen improvements. With stock market rallying more than 30% since the trough in March, more companies sought the opportunity to tap the market sentiment to beaf up their capital vault. Many banks, such as BAC and State Street, have succesfully raised billions of equity capital in private market. Even some junk rated corporations, such as MGM Mirage, have been able to raised funding. It all means that investors confidence for market is improving and risk appetite have come back shoring up marktes. Market fundamentals have registered mixed signs in the past few months. On the one side, high unemployment and declining house wealth continued to weigh in consuming power. On the ohter side, consumers have been holding consumption too long to sustain any longer. Unemployment rate has reached 8.9% in April 2009, the highest since 1983. It might not exceed the peak of 10.8 in Nov 1982 as Government's massive stimulus package and aggresive monetary policies have prevented a systematic collapse in U.S. economy. But lack of growth engine in US economy and weak consuming power have also excluded the possibility of a sharp recovery in the employment market. In the early 1990s recession, the economy recovered fast under the influence of Internet. In the early 2000s recession, US economy was rescued at some degree by the housing bubble. Unlike previous two recession, US do not have such growth engines in place. You might bet on green technology. But green technology is far from being commericalized. Most of the time, the green technology, such as solar and hybrid, requires massive subsidies from the government to sustain themselves. Hence, it seems naive to expect US economy to return back to the pre-crisis level within one or two years. On the housing front, existing home inventory have reduced to 3.7 mil from the peak of over 4.5 mil in June 2008. The housing price has dropped to 143.17 in Feb 2009 from the peak of 206.52 in July 2006, 30% drop. But the YoY change of the index tended to level off by Februry. However, housing permits has dropped to 494k, the lowest point since 1980. Because banks have been holding foreclosures in the begining of the year in reponse to Governemnt request for mortgages modications. It seemed that the policy was not functional well in preventing foreclosure. Now the flood gate is widen open, more banks will forclore properties, further weighing in the housing market in the short term. Consumers have given out mixed signals. Retail sale in April dropped 0.4%, following a drop of 1.3% in March. It dashed the hope of a full recovery caused by two postive growth in Jan and Feb. Unemployment climbed higher from 8.5 to 8.9% in April. This might weigh heavily consumer and housing market. But manufacturing inventories has been exhausted to the limit that any reduction might have to be offset uing new orders. ISM manufacturing report on business inventories dropped to 32.2 in March, the lowest point since 1982. In April, the indicators rose to 33.6, a sign that the inventory level might bottom out. Further reinforcing the outlook of manufacuring sector, ISM advance orders have keeping increasing almost consistently in the first four months in 2009. Beyond manufacturing sector, non-manufacutring sector has spelled out similar signals: inventory level reached bottom in early 2009 and new advance orders started to pick up since then. All these indicators suggeseted that US manufacutring and sevice inventory levels have dropped to the lowest level and have to be refilled. This type of demand might pull US economy back to normal, but it is not strong enough to push the pendulum to high growth. Other secular developments might limit the upside of US economy within the short time horizon. US consumers might no longer overconsume. Consumers used to borrow to consume, living beyond their means. Now they tend to save more. Within a few months, the US consumers saving rate has reached 4.2% by April , a level not seen since 1995. If this consumer behavior persist, it will benefit consumers in the long term, but prolong the recession in the short run. Some funding market are still closed and might no longer be active. Securization markets, especially subprime mortgage and auto markets, are not back to normal. Similar to what happend after CMO market cisis in 1980, some of these markets might be closed forever. Securization market has played an important role in moving money flow. The shut down of these market might slow down the money flow velocity and prevent the economy from recovering to th pre-crisis level. Banks might dodge the bullet of full involvency. But these banks are still in the processes of deleverage. The tight regulation and delverage prevented these banks from engaging an aggressive approach. They might continue to raise and conserve capital until the economy show signs of growth, not just bottom out. Their conservative approach might limit the capital flow into US economy. In sum, the upside and downside risks of US economy until the year end might be limited. Hence the outlook of US economy might warrant a W-shape. To apply outlook into asset management, I strongly suggest fixed income investment if you are long and hold type invetors. High grade will be a good choice. Also if you are a good at timing market, high frequency trading is suggested for equity investors. Also, be aware of regional banks and REITS corporation. Some of these companies are bound for insovlvency due to their expsoure to Commercial Realt Estate. By the year end, some of these companies might file for banktrupcies.

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