The Market's New Years Resolutions?

Happy New Year all, we hope the holidays created some compelling inspiration for your resolutions. Thought we would spend this missive sharing some of the pros and cons we perceive to be looming above the financial markets. What we usually do for this type of analysis is give reasons why to be optimistic about the markets, then list things that could create some concern and finish with my personal take. So here goes.

Why we are Optimistic

1. Accommodative Fed – We think it is clear that they will do whatever they can to keep the economy from falling into recession.
2. Election Year – Is generally a good time for stocks.
3. World Economies and Liquidity – Several foreign entities have been buyers of US assets and it appears to me that will continue.
4. Market Resiliency – With all the bricks that have been thrown at the stock market, we have to admit that it has responded fairly well.

Why we are Concerned

1. Recession – As 2007 the chances of a recession has grown and the consensus is above 50% a recession will occur.
2. Credit Bubble – There has been those who feel that the process with which the sub-prime mortgages were created was also instituted in the corporate bond market. If a recession does occur, there is a chance we could have a similar outcome as we had in sub-prime.
3. Inflation – If inflation gets to the worry level for the Fed, that potentially compromises their ability to lower rates to fight off a recession. A combination of recession and inflation is stagflation and that is not good.
4. Foreign Stocks Correct – Global growth has been strong, but many of the foreign stock markets (Hong Kong, India, China, etc.) have a speculative look to them similar to NASDAQ 2000. A severe correction in those indices could create a collective sell-off around the world.

Those are the most compelling dynamics we see currently. The most worrisome issue we believe on the table is the breadth and depth of the credit bubble with the corporate finance arena. Just as the sub-prime mortgage mess unraveled like peeling an onion (we do not think we have got to the middle of that one yet) the corporate finance arena could be worse? Remember how the market dropped in 2001-02 and as it dropped the misdeeds were revealed (WorldCom, Enron, etc.), we might have a similar scenario in 2008-09 surrounding various forms of financing. The problem with that scenario is that the market drops before the misdeeds are revealed.

We think the market will end up in a trading range. Our belief is that the bursting of the credit bubble will keep a lid on the top of the range and the Fed and global liquidity will keep the market afloat near the bottom of that range. Those foreign entities appear more than ready to buy our distressed assets, although we believe that poses a problem for us in the future.