Insights & Advice

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Stocks Up in Anticipation of a Stimulus/Banking Plan

This Monday investors are betting that the new U.S. Treasury Secretary, Timothy Geithner, will announce a once-and-for-all solution to the nation’s on-going banking crisis. In addition, there are high hopes that the Obama stimulus package will pass the Senate. Rather than wait, the markets have decided to get a jump on the news.

Stock investors are an optimistic lot in general. So this past week they have discounted the continuing stream of bad news on every front and decided instead to focus on the future. To the bulls, the fact that the majority of Americans in the most recent polls are against the passage of the stimulus package, that many Senate Republicans have dug in their heels and even some of the President’s own party have problems with the plan are only minor hiccups in the road to passing the bill.

No one knows the actual details of the new banking plan. Yet earlier in the week there were fears that the government might nationalize a few of the largest banks. By Friday the rumors changed. Now talk centers on some kind of additional capital injections and more lending facilities. I hope not because that would indicate a ‘business as usual policy’ and not a major break from the present practices of the Treasury and Fed (and we all know where those actions have led us).

Clearly something has to be done and soon. Seven states, according to The Wall Street Journal, have just about run out of money to pay for unemployment benefits and more are expected to follow. Banks are not lending money and the housing markets are still falling.

Over in the bond markets there is also trouble afoot. In 2008, government bonds were the last safe refuge for investors after cash. The demand for Treasury bonds was so strong that yields dropped to historical lows. Some talked of a bubble forming in that market. In the last few weeks bond investors began to tally up the amount of money the U.S. Government will need to raise as a result of this continuing crisis. A trillion here, a trillion there starts to add up. Suddenly, it dawned on investors that there are a lot of zeroes in a trillion.

In addition, the need to sell billions of new bonds quarterly will continue for far more years than anyone imagined. In order to attract new buyers for these bonds, many believe the government will have to offer higher and higher rates of interest causing prices to fall (bond prices move inversely to their interest rates). Suddenly there has been a stampede for the exits with some rates rising almost a point from their lows of last year.

It is clear that the government, the markets and we, dear reader, are walking a narrow tight rope and on both sides the floor is a long, long way down. Let’s just hope we can all make it to the other side.

As for the markets, I expect all three—the Dow, NASDAQ and the S&P500– may move even higher in a “relief rally” early next week. But once the package is passed there is a good chance that the markets will fall back as they have in every bear market bounce since this correction began over a year ago. So strap your seat belts on because I expect it will be one wild ride.

Posted in A Few Dollars More, At the Market