Insights & Advice

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Volatility is Back in Spades

Pity the poor fund manager this week. The markets moved up and down like a yo-yo gaining and losing a year’s worth of wealth in minutes. I sense there is a real battle going on right now between the bulls and the bears. Both have a wealth of ammunition and neither side is sparing any prisoners.

On the negative side some of the world’s great companies, the very backbone of American industry, reported disappointing results. Names like Microsoft, General Electric, Advanced Micro Devices and Google reported down earnings for the fourth quarter. The news from overseas was no better: Samsung in Korea, Nokia in Sweden and Sony in Japan reported losses while Spain’s sovereign debt rating was lowered and the British economy contracted by 1.8% last quarter.

Yet there were bright spots as well. IBM surprised everyone with better than expected earnings as did Apple while it appears troubled Chrysler may form an alliance with Italian auto maker, Fiat (that may or may not be a good move).

Tuesday, the day of President Obama’s inauguration (which many hoped would ignite a strong market rally) ended down almost 5%. It now ranks as the worst Inauguration Day in history for the U.S. market. The next day however, stocks gained almost all of that back and then promptly sold off the following day.

Some participants believe that stocks have dropped too much and are near a market bottom. Every time the Dow drops below 8,000 buyers step in and bid the market up again. Sellers on the other hand are convinced that the markets will continue lower because the economy is even worse than people think and any stimulus package from the government will fail. So all week day traders have made and loss fortunes trying to keep ahead of the next hour’s stock movements.

Over in the bond market, however, the bubble in U.S. Treasury bonds appears to be running into resistance. During the last few months investors, fleeing the carnage in the stock markets, fled to the relative safety of government bonds. There was so much demand for government guaranteed securities that the interest on these bonds dropped to historical lows. This week bond prices have begun to drop as yields climbed higher (bond prices move inversely to interest rates).

Given the volatility of the stock markets, I do not believe investors are moving out of Treasuries because they perceive the stock market is a safer bet. The move may instead be a growing recognition that the trillion dollar-plus stimulus package now being debated in Washington will mean a lot more bonds will have to be sold to finance that spending. In order to attract future buyers the government may need to raise interest rates so some investors may be getting out while the getting is good.

There are also concern that the world’s largest customer for our bonds, China, may be pressured by the new administration to allow their currency to strengthen against the dollar. China could respond by staging a buyer’s strike and reducing the amount of U.S. Treasuries they purchase. All of this is supposition right now but I suggest we all keep our eyes on the bond market for further hints on policy developments.

Posted in A Few Dollars More, At the Market