Just when a collective sigh of relief was breathed about 2008 ending and a fresh year beginning, 2009 was ushered in by the worst ever index performance in the S&P 500 and Dow Jones 30 for a January. This was certainly not encouraging for those that believe in the adage, “So goes January, so goes the year”.
Outlook not so good
2009 promises investors and traders one thing. Uncertainty. While the market has declined nearly 50% peak to trough, the deleveraging process has not been completed. Banks still have far too much common stock equity vs. assets on book. Usually recoveries in any stock market are led by financials, so this turn around prospect seems bleak until the equity to assets ratio improves.
Inflation prospects seem to be rearing their ugly head again, as precious metals are catching a strong bid. Oil seems to have bottomed. Gas prices are on the rise again for consumers. Treasury bonds are selling off. The baltic dryships index has been recovering based on Asian demand for raw materials. Certainly ZIRP (zero interest rate policy) has created the possibility of a new carry trade.
Recovery, what recovery?
Most predict that the US markets will tread through a slow, “L-shaped” recovery because of the serious damage to credit and stock markets, and most importantly, confidence. Nearly $9 trillion is sitting on the sidelines in virtually zero yield short term treasuries and money markets. That cash has yet to be deployed, and was originally retracted from equities, because of a flight to safety from confidence being lost.
The smart money is watching China and Taiwan, as the markets there have enjoyed a significant recovery from their lows and forming a bottoming pattern. With the US dollar nearly free to borrow for currency traders, the possibility of the dollar becoming a carry trade currency is quite real. Long term prospects for the dollar are weak so traders would not feel as though their principle loan is going to increase from dollar strength.
History in the making or repeating itself?
The possibility is striking because when Japan suffered a similar crisis in the early 90s, their currency suffered this very fate. The carry trade in Japan caused most financial institutions to move money outside of Japan rather than invest in the country and assist its recovery. Infact, Japanese equity markets have never recovered and still thrash around making significant lower highs and lower lows in recent months.
In my opinion, this is indicative of a significant risk to recovery in the US markets. Already gold is more valuable per ounce than the S&P index. Other stock markets are outperforming the US market on their recoveries. Will the trend continue?