The Volatility Continues

Yesterday was a day in the market everyone should get used to--Big swings up and Big swings down. Fear was high and the market floundered but as oil prices started to decline new confidence developed that inflation would be curtailed and costs of consumer and industrial products will decline. Gas prices are dropping and consumers may save some money at the pump and use it to purchase some discretionary goods. The markets are not easy to figure out but it is all about reading the Tea Leaves.

The problems we have today relate to a lack of confidence in our financial system, ubiquitous leverage, a sinking housing market, and a weak global economy. The government is focused on stabilizing the banking system and improving the flow of money among banks while hoping to generate new lending to consumers and businesses. There are some positive signs beginning to take shape in the financial system, albeit slowly. Some interbank lending rates are slowly declining and the injection of $125B of equity into banks this week is a big step forward. Bond insurers such as AMBAC and MBIA are working with the government to rid themselves of distressed assets which will be another step in the right direction to improve America's financial system.

The government reported yesterday that industrial production was weak last month while today housing starts dropped more than expected. These numbers point to the recession we are in and the low consumer confidence we have. There is no magic to turn around the economy and the weakness may last a long time. Hence, it is important to continue to see the glimmers of hope on the horizon. Google announced terrific earnings so the advertising market is not dead. IBM met their expectations and AMD solidly beat expectations. The world is not coming to an end. A recession is here but The Great Depression II is likely off the table.

We will continue to see disappointing news everyday as we saw Citigroup take larger than expected write-offs yesterday and rumors that ING Bank may need a cash infusion due to its weak balance sheet. On the other hand, everyday will also produce tidbits of good news. The discussions of a merger with GM and Chrysler would be great news for the auto manufacturers and the corporate bond market. JP Morgan has about $4B of Chrysler loans marked at par on their books. They are in a long-term account and have not been written down. These loans alone could produce a $2.6B loss for JPM. A merger will likely result in a restructuring of all the debt at GM and Chrysler with many losses taken but it will also be one more positive step to improving the corporate bond and loan markets.

We are going to start to see merger and acquisition activity pick up as strong companies prey on their weak competitors. Private equity firms are also gearing up to pounce on financial institutions as the government's $700B basket starts to fill up with distressed assets. As you see this type of activity, read the Tea Leaves. The economy will be strong again and the stock market will forecast that. Keep buying quality in this market. You may not make money today but in a few years, you will look back and be thankful you did.

Today is option expiration expiration day. In normal markets, option Friday usually brings large swings in the stock market. Today should be no different. Weak housing numbers this morning will clearly focus the market on the recession and drive prices lower. News will help create volatility all day as more companies report earnings and oil and gold prices remain a focus for investors.