Memorial Day marks the beginning of the slow season for stock markets worldwide, which usually ends sometime after the Labor Day weekend in September. Traditionally, it has been a period where stocks consolidate or even decline hence the saying “Sell in May and Go Away.” In bear markets, over the last 59 years, stocks have done far worse than in bull markets. Last year was no exception. That, however, does not mean that it will happen again this year.
We may, as many economists are now predicting, come out of this recession sometime soon than many expected, either in the second half of this year or the first half of 2010. Certainly, the stock market’s recent 36% run up from the bottom indicate that investors are betting that will be the case. Assuming they are right, I believe it may be time to start looking at the consequences of all the emergency funding that world governments have throw at the financial crisis over the last 18 months.
Inflation is the obvious worry. Many investors (myself included) fear that all those trillions in government spending will cause an inflationary cycle down the road. There is little indication today that inflation is a problem but investors bet on future trends not on the present. Over the last few months commodities, which traditionally provide a hedge against inflation, have stopped going down and just recently have begun to creep up. Although oil demand continues to be slack, for example, the price of a barrel has risen from $35/BBL to $62/BBL in just a few short months. Gold is once again marching toward $1,000/oz. and other metals like silver, copper and aluminum are also making gains.
The dollar is also stalling out. During the credit crisis foreign investors flocked to the greenback as a “safe haven” against financial Armageddon but those days appear over. The fear today is that future inflation, combined with the enormous debt load our nation is now forced to carry and finance will destroy the value of the dollar.
Over in the debt market, our Treasury bonds are also feeling the pinch as prices drop and rates on the 20-30 year bonds begin to rise. Bond players also fear inflation but see a more immediate problem ahead. There is an increasing need by the U.S. Treasury Department to finance our burgeoning debt by issuing more and more bonds. This week the Treasury announced they will seek to raise $101 billion of new bonds (called “paper” by the bond market) through auction next week. Investors see a never-ending supply into the future and are demanding higher rates of interest in order to buy this paper.
In a move that couldn’t happen at a worse time for our bond market, Standard and Poor’s, the international credit rating agency, warned this week that there was a one in three chance that the UK’s top-tier AAA credit rating could be cut as its debt burden approached 100% of the nation’s GDP. Investor’s quickly seized on that information and dumped both the pound and British bonds. Fears that the U.S. might be next were already in the whisper stage when Bill Gross, the much-respected founder and co-head of PIMCO, the world’s largest and most influential bond investment house, stated the obvious. He warned that the U.S. might also lose its AAA rating. U.S. Treasuries sold off immediately and have yet to recover.
Over in the stock market, it has been roughly a dead heat between bulls and bears. The good news: the capital raising by several of the large money centre banks went off without a hitch. The bad news (aside from the above-mentioned dollar/bond issues) was that some of the macroeconomic numbers came in worst than expected. In addition, BankUnited out of Coral Gables, Florida went into receivership on Thursday. There was just enough bad news to keep the bulls at bay for yet another week.
As I wrote last week, I expect the 945 level of the S&P 500 Index to be a battleground between the bulls and the bears. It is shaping up to be just that. We moved as high as 924 on Tuesday before backing off yet again. Next week should be more of the same. Of course, the much-heralded beginning of possible bankruptcy proceedings at General Motors will be a lot for investors to digest and give the bears ammunition for further sell-offs. I’m hoping that 875 holds on the S&P. If not we could be looking at 800 so watch out and have a great Memorial Day weekend.