BONDS - Pressure is building within the Fed and the investment community for higher interest rates. China, India, Brasil and others have raised rates. The Fed will have to follow in coming months. In spite of the flood of liquidity released by the Fed in recent weeks, both Treasury and mortgage rates are up around 70 bps. Seeing that they now will be held to account, lenders are setting rates according to their judgment of risk, a restraint which was absent when the loans could be passed on to unwitting buyers. A deluge of Treasury debt is coming down the pike, very apt to force rates and the dollar higher.
The monetary and fiscal condition of the U.S. government is in tatters. The government's virtual takeover of financing the entire U.S. housing industry is extremely unwise, placing enormous strain on the very solvency of the country. The taxpayers are being very ill served. The magnitude of losses on mortgage paper has been consistently underestimated. The $400 billion haircut taken so far exceeds the previous estimates of both S&P and Goldman Sachs. The IMF and J.P. Morgan are in the $700 billion range, Bill Gross is at $1 trillion and Bridgewater Associates is projecting $1.6 trillion. If we are less than half-way through this mess, it will not be cleared up until 2010 and the scars will be deep. A record federal deficit is expected for FY '08 and the prospects for improve-ment in '09 are dim. The major economic indicators are exhibiting trends which are not seen outside of formal recessions, but almost all observers are in denial. A problem cannot be solved until it is recognized to exist.
EQUITIES - We are in a full-fledged bear market. Historically these have lasted 18-24 months, recording declines of 30%-40%. Conditions are now so much worse than those existing during previous garden variety cyclical declines that the outer limits of duration and per cent loss may well be tested. The surprising advances of market indices in the past few days and weeks are countertrend rallies which will blow themselves out before long. The S&P 500 and the DJI will encounter strong resistance above 1,300 and 11,750, respectively. These targets are only 20 and 200 points higher than current levels. Multinational companies will be adversely affected by any dollar strength which occurs as interest rates rise. Domestic consumer spending will wane as the stimulus package wears off and the employment figures deteriorate.
William Wright
The search for worthwhile investment ideas in the difficult period we anticipate should start with the question, 'Who can afford to buy this product or service and will they buy?' This leads to consideration of government expenditures on infrastructure, defense hardware and services and subsidies for alternative energy. There are many choices among the subdivisions of these categories. Big oil will be a big spender on all types of services, even though their profits will not be enjoying the huge increases of recent years. The opportunities related to increased consumer spending in developing economies are vast. A variety of companies which produce a unique product for the world market and which have been pressured by high commodity prices should do better when and if these prices decline. Pricing power will be at a premium.