Deleveraging: Round II
By Ryan J. Puplava CMT, March 2, 2009
The last bubble holding up the stock market has burst. The confidence we held in fiscal policy to swoop down and rescue the financial markets from the financial woes of last year – was for naught. I say this because there’s a correlation between the drop in the S&P 500 and the day our new Treasury Secretary advised us that there’s a plan (sold separately and details not included) on February 10th.
Bailout Plan: $2.5 Trillion and a Strong U.S. Hand
NY Times, 02/10/09
...“The stock market, propped up for weeks on the expectation that Washington would finally deliver a comprehensive rescue plan, dipped almost as soon as Mr. Geithner began speaking in the morning. The Dow Jones industrial average fell 382 points, or 4.6 percent, by the time the market closed. Yields on Treasury bills dropped, indicating a flight from stocks to the safety of government bonds”
The jawboning from the Federal Reserve last week did much to rally the banks to stem the falling tide at key support levels in the financial markets, but today was a firm break in that support with a drop in the S&P 500 to 700. Since January, the long-term trend has been down. An accelerated downtrend started on February 10th.
I’m not blaming Timothy Geithner for our financial problems. I’m saying, our confidence in fiscal policy has burst and the deleveraging we saw in September of last year has started round II.
What happens during times of deleveraging in the financial markets? There’s a flight to safety and I don’t mean a flight to defensive sectors such as consumer staples, healthcare, and utilities. Defensive sectors do well at the start of a recession but they can’t weather deleveraging. Take a look at what happened between September and November 2008 in the defensive sectors:
To avoid being hurt in deleveraging: round II, I think Baloo in Disney’s “The Jungle Book” said it best when he instructed Mowgli about the bare necessities of life.
Now when you pick a pawpaw
Or a prickly pear
And you prick a raw paw
Next time beware
Don’t pick the prickly pear by the paw
When you pick a pear
Try to use the claw
If you pricked a raw paw during September to November, Baloo is telling you, “next time beware” and don’t suffer through deleveraging: round II. The flight to safety trade is treasuries and at this point, investors should already be there by now. There are trends and counter trends in the financial markets during a recession and depression, but during times of deleveraging the best place to be is cash or treasuries.
Key technical levels in the stock market were broken last week and today - just like they were broken in September of 2008. Eventually, there will be a trading bounce to play, but I think we’re in the midst of deleveraging: round II. I believe fiscal policy will continue to play a large role in the direction of our financial markets. We need some decisive moves that investors can really wrap their fingers around. One of those could be a suspension of mark-to-market accounting for the financials. Another possible fiscal policy change could be to re-implement the up-tick rule on shorting securities. Yet another idea would be the suspension of shorting financial stocks as they did in 2008.
Fiscal policy is the wild card the market can’t predict, but the market sure is telling us it doesn’t like what it has been hearing from this administration. Some of the measures I mentioned above were discussed last week by Bernanke, but I think investors are tired of rhetoric and they need to see action—and that doesn’t mean frothy stimulus packages with earmarks for lobbyist agendas or projects in the legislator’s home state.
© 2009 Ryan Puplava