No Volume Markets

The DOW swung over 100 points yesterday so the volatility isn't gone. However, there wasn't much volume as most Wall Street traders are on a well-deserved vacation. The year may be ending but news still seems to be driving some of the market movement. Israeli attacks on Hamas pushed gold and oil a little higher but its effect seemed to be minimal. The bigger event seemed to be a withdrawn joint venture by Kuwait with Dow Chemical. Dow was hoping to receive $7 billion from the deal but Kuwait backed out. This left Dow in a precarious position to fund its acquisition of Rohm & Haas. This acquisition is fully financed with a $13 billion 1-year bridge loan from banks and an equity investment from Warren Buffett. This transaction will put a lot of leverage on Dow's balance sheet. Perhaps Dow can get Rohm & Haas to cut the price a little while also offering Berkshire a sweetened equity deal if they put up additional money to replace some of the debt. This is a tense situation but should be resolved in January.

The last story of focus is that GMAC became a bank holding company and received $6B from Tarp and the Federal Government. This should stabilize it for now and allow the company to finance automobile inventories at dealers as well as the purchase of new cars by consumers.

Don't expect much more from the markets this year as everybody winds down and gets ready for the new year.

2008 Is Coming To An End

This week should be relatively quiet for the markets as we wind down a dismal year. The new Israeli conflict leaves us somewhat concerned as one of the unexpected risks for 2009 is growing political instability which could lead to unforeseen wars. High oil prices gave Russia, Iran, Venezuela, and most of the Middle East new found economic power. The reversal of oil's price is starting to create new turmoil and financial stress amongst these countries. Civil wars could break out and greater global tension could be a negative theme for awhile. We hope to be wrong about this possibility but it could result in supply cuts for oil, higher oil prices, increased inflation expectations, and soaring gold prices. Stocks overall probably won't benefit and consumer confidence may remain depressed.

We would like to see a quick resolution to the Israeli fighting before other countries become involved. At this point the fighting is limited in scope and the markets should still be focused on the depth and length of the economic decline.

Investing for 2009 and Beyond

We don't know when the stock market will begin to move up but we know it will. There are many stocks that are down 50% or more and plenty of industries that have been pummeled this year. Investing takes time and work and we try to pick stocks that will benefit from the turnaround in the economy but be safe from destruction in a weakened financial system, from overleveraged businesses and from a poorer consumer.

The housing sector has brought the financial system to its knees but the Government has injected capital into many of the faltering financial enterprises while the Federal Reserve has provided enough capital to ultimately stimulate the economy and improve the bank lending system. Housing will bottom and begin to turnaround. We want to be positioned for that occurrence.

Oil prices are down about $100 per barrel but last we looked nobody has discovered any new supply. When economic demand improves, energy sources will be needed. It is important to have a portfolio that is prepared for this inevitability.

Technology drives efficiency and innovation. It is the core to pushing the economic engine forward. Consumers migrate to new phones, computers, and gadgets that make life easier and entertaining. Businesses strive for efficiency and competitive advantages. Technology is the key to solving both consumer and business problems. Every portfolio should own technology companies.

We have been saying that improved corporate credit conditions will drive higher stock prices. Owning fixed income instruments will not only provide good current income but as corporate spreads improve, one will also see capital appreciation in bond prices. Now is the time to own loans and bonds.

Below we will list some of the stocks we own as we prepare for 2009 and beyond. We don't know how well each of these stocks will perform in 2009 but we are pretty confident that within 3 to 5 years most of them will provide very good returns.

Energy- Williams Companies(WMB) and Sandridge Energy(SD)
Both of these companies are primarily natural gas plays. Sandridge is only for those
who want to take more risk.

Housing- Masco(MAS), USG Corporation(USG), Temple Inland(TIN)
Each of these companies are building products enterprises.

Technology- Oracle Corporation(ORCL), Cisco Systems(CSCO), EMC Corp(EMC)
Each of these companies focuses on helping companies run efficiently.

Internet- Google Inc.(GOOG)
We view this company as a play on the advertising environment but it is a virtual
monopoly for search on the internet. This company is innovative and a cash cow.

Software/Utility- Microsoft(MSFT)
This company has a virtual monopoly with all computers. It is in the enviable position of having $20 Billion plus of cash to take advantage of distressed market opportunities, buy back stock or increase its dividend. Its 2.7% dividend is better than treasury bills and it is as safe as a utility.

Industrial/Consumer- Owens Illinois(OI)
This company is the world's largest glass bottle manufacturer serving
the beverage and pharmaceutical industries. This company produces
free cash flow, benefits from low oil prices and a weak dollar, and has
a relatively recession resistant customer base.

Defense-Alliant Techsystems Inc.(ATK)
This company produce advanced military weapons. It has a huge backlog and will
produce strong earnings in any economic environment.

Financial- Bank of America Preferred E(BACpE)
We have limited our direct investment in most financial companies. We are
concerned with the consumer loan problems Bank of America will likely face
in 2009 but the preferred stock has an 11.25% current yield and trades at 35%
of face value. If it were not for the structure of the Citigroup bailout, we would not
own this security.

Special Situations-Icahn Enterprise(IEP), Loews Corporation(L), Leucadia National Corp
The three companies have a few characteristics in common. They are
all run by leaders who have been through many economic cycles. Each
views themselves as a distressed buyer of assets and we expect they will
take advantage of the weak real estate market, soft energy prices,
impending corporate bankruptcies, declining commodities, and the
cheap values in the credit markets.

Commercial Real Estate-Forest City Enterprises (FCE/A)
We believe 2009 will be a very difficult year for commercial real
estate companies but Forest City's stock has dropped about 90%
this year. This is still a very risky investment but we believe the
company will be able to refinance the few loans they haven't been
able to restructure. The company has very experienced
management with a long history of real estate cycles.

Loans-ING Prime Rate Trust(PPR)
This closed end fund is a way to invest in the leveraged loan market.

Corporate Bonds-ISHARES IBOXX $ High Yield Corporate Bond(HYG), PIMCO Corporate
Income Fund(PCN), PIMCO Corporate Opportunity Fund(PTY)
HYG is a an exchange traded fund with a portfolio of high yield bonds with
an 11% current income trading at 74 cents on the dollar.
PCN is a leveraged closed end fund of corporate bonds (many are
investment grade financial institutions) with a current income of 12.7%.
The focus of this fund is high current income.
PTY is similar to PCN except its objective is to maximize total return
through a combination of current income and capital appreciation. Its
current income is 13.84%

Gold-SPDR Gold Trust(GLD)
We believe that inflation is on the horizon as the Federal Reserve has flooded the
economy with liquidity and the Government will need to raise a significant amount
of debt to pay for all its stimulus programs enacted and forthcoming. GLD is an
investment fund holds gold bullion and it is a proxy for the price movement of gold.
Holding gold will be a good hedge for the portfolio if the value of the dollar declines
over time and inflation resumes.

The Holiday Swoon

The economy is weak and getting weaker. Jobless claims are rising and durable goods orders are contracting. There is no good news anywhere we look and negative fallout from the Madoff affair. Stocks have been drifting for five days when investors have been hoping for the Christmas rally. It may not be coming this year but on the positive side, the volume on the stock exchanges has been very light. Perhaps a big buy order will come in and bully the traders to let stocks rise. Either way, the year is almost over and it will soon be on to 2009.

Too many people are expecting a January rally which makes us a little nervous. At Wall Street firms, traders typically use this time to sell all unwanted inventory of stocks and bonds while also making sure their remaining inventory is priced very conservatively. 2008 produced losses for everyone so it is the time to take as many losses as possible to give one the fighting chance of maximizing profits next year.

Corporate America is likely following Wall Street's lead as they cut expenses and payrolls as fast as possible. Everybody is trying to forget 2008 but be ready for better times in 2009. Unfortunately, exogenous events always appear to try and spoil the good intentions. The auto company restructurings will be a big concern for the first three months of the year. The bondholders won't roll over easy and we expect a major battle for the majority of the equity of GM. In fact, the government may have to compromise and give the bondholders some of their 20% of the company.

At some point investors will begin to ignore the bad news and look to the future. It is holiday season so let's hope it happens soon so we can all enjoy the new year.

Merry Christmas, Happy Chanukkah, and Happy New Year

The Top Ten Reasons For a 2009 Market Rally

At this point, it is very uncertain as to the direction of the markets for 2009. Earlier we penned the Top 10 dangers for 2009 and now we will attempt to outline the events that could propel the market higher.

1. Low mortgage rates have finally appeared. Declining housing prices, falling housing starts, fewer house sales, and growing inventories have made 2008 a dismal year for anyone watching the destruction of value for the nations housing stock. The Federal Reserve has orchestrated a lower interest rate environment which has led to 5% and lower mortgages. It looks like the refinancing market has picked up considerably. However, should spring awaken with a zest from new buyers willing to take the chance of purchasing a very cheap house with an historically low mortgage rate, the housing market could get a long awaited lift. Such an event, will be positive for home builders, building products companies, real estate agents, and retailers like Lowes and Home Depot. This would clearly bring some excitement to the markets.

2. The auto Industry is clearly a mess. It is over levered, has a bloated cost structure and currently lacks enough viable products. The Government gave GM and Chrysler a life line with many contingencies. If these two companies can successful exchange the bulk of their debt into equity, renegotiate a competitive labor agreement, and relieve themselves of some legacy healthcare and pension costs, perhaps profitability can return to this industry. An impactful restructuring will be viewed very positively by the markets.

3. The corporate loan and bond markets have seen some life recently. If this trend continues, the capital markets could reopen and companies can begin to borrow again. This would clearly benefit the stock market which will take its lead from the credit markets.

4. The Federal Reserve is growing the monetary base and has pledged to do whatever is necessary to stimulate our economy. It is very concerned about deflation and was willing to drop rates to zero. The dollar subsequently began to lose its value again to the yen and the euro. If the Fed suddenly determines deflation is not a risk anymore, the dollar will stabilize and any fears of a depression will dissipate. If the Fed is ready to raise rates, growth will be on the horizon and markets will be moving up.

5. The financial crisis is not over. It appears that many of the weak financial institutions have been fixed but one never know when a Madoff event could appear. One big concern we still have is the stability of Citigroup. The Government truly bailed out Citigroup with a bad deal for taxpayers but a good result for creditors and stockholders. However, we believe such a move is the precursor to an acquisition of Citigroup by another financial company. Citi can not survive in its current form by itself. It needs to dismantle its pieces or sell itself. An announcement of a Citi transaction will be very positively received by the markets.

6. AIG finally sold an asset today but the proceeds hardly put a dent in the loan owed to the Government. This company has become an albatross on the taxpayer's back. Additional sales of assets which will meaningfully reduce the Government loan will please Congress and be perceived by investors as a positive sign that the financial crisis may be moving in the right direction.

7. Unemployment is rising each week and there is no slowdown in sight. Eventually, companies will pare their workforces down to levels needed to remain in business. A slowdown in the growth of unemployment will be a good sign that an economic bottom is around the corner. If the market hasn't risen by this point, it certainly will become a raging bull.

8. The announcement of Mergers and Acquisitions have been sparse. As financially strong companies peruse their competitors, value is being seen everywhere. It is hard to execute an acquisition in these markets even if both parties come to an agreement because stock prices are too volatile. As the volatility declines, the pace of acquisitions will pick up. Investors will start to sense there is plenty of value in the market and they won't want to miss the opportunity.

9. China's growth is clearly slowing but its government is not sitting on its hands. A huge stimulus package was implemented to keep the economy moving. Most investors expect the country to continue to grow but at a much slower pace than the last few years. If the Chinese Government can figure out a plan to propel its economy back to the double digit growth, the global economy will get a jump start and markets will follow.

10. President-Elect Obama is gearing up for his own stimulus package. His economic team is well versed in economic history and the financial markets. A creative plan could clearly give a boost to our souring economy.

There is no right answer to when, how , and why the markets will finally start its upward march again but the above ideas can prove to be some of the factors that drive the markets higher and bring smiles to investor's faces.

The Pre-Christmas Blues

After rising last week, the markets started off poorly today. The S&P was down 1.8% while the DOW was down .7%. There was plenty of negative news starting with Toyota's forecast of losing money this year. If Toyota can't earn a profit, how can GM, Chrysler or Ford. Next came the Wall Street Journal article discussing the commercial real estate markets. Leaders of this industry have been petitioning the Government to provide a life line of $200mm to refinance the maturing debt coming due in 2009 and 2010. Commercial real estate properties are heading lower as the over levered industry faces declining rents and a scarcity of lenders. Met Life took a dive as investors fret about the $36 billion of commercial real estate they own. Finally, Walgreen's, the cream of the drug store industry, reported lower than consensus earnings as their sales slowed down. The management expects a weak 2009 and is curtailing new store expansion next year.

The trend of bad news continues and earnings reports for the next few months should be just as dismal. The weak will get weaker and the strong will survive and pick up market share. Although the VIX fear index continues to fall, the Dow still had over a 100 point swing today. Volatility is here for a while as the uncertainly prevails. Investors are praying for a Christmas and New Year's rally but so far it has not arrived. Hope is usually not the best form of investing.

What are the Top 10 Dangers for 2009?

It is unlikely that 2009 can be worse than 2008 for stocks. If it is, we probably are in a depression. The housing market still holds the keys to a recovery but there are many potential obstacles to a better economy and global prosperity. Investing in these markets requires one to analyze many markets both domestically and globally. Where does trouble lie ahead?



1. 2009 should be the year when commercial real estate values decline. Refinancing risk will result in some bankruptcies, weak corporate earnings, and stretched consumers. This should result in higher vacancies and lower rents.



2. Lower oil prices may be a good sign for consumers but what about the oil producing countries. Russia, Iran, and Venezuela will be in focus as their oil riches, which led to their bold political statements and aggressiveness, are now reversing. Those countries could create instability in the emerging markets while magnifying the global economic problems, political dangers, and the financial crisis.



3. Corporate bankruptcies will dramatically rise in 2009. The past decade had unprecedented growth in leveraged lending and non-investment grade bonds. The LBO era may be over but the fallout is just about to begin. We expect to see bankruptcies in the range of 10-20% of all non-investment grade companies. The result will be more unemployment, some liquidations, and a pick-up in mergers and acquisitions.



4. The consumer has been weakened but the full effect has not been seen yet. We anticipate a large increase in late payments or defaults for credit cards, student loans, home equity loans and auto loans in 2009. This will not only be bad for the consumer but many financial institutions will have to focus on this new battle ground. Banks have been suffering for over a year and BankAmerica, Wells Fargo, and J.P. Morgan have distinguished themselves from the pack. However, the consumer loan problems will clearly be a challenge for these stronger entities.

5. China is the engine driving global growth. It is clearly slowing but most optimists believe it will maintain a good growth path. What happens if China only grows 2-3% or worse, flattens out? This would create a new shock to the global economy as exports would dry up in the U.S. and most countries would see a weaker economic environment.

6. The weak economy in the United States is causing tax revenues to fall off a cliff. States and Cities around the country are facing rising deficits. The red ink and weak financial profiles could lead to downgrades of their municipal debt. This debt is already trading at attractive historical yields but weak capital markets and a desperate need to raise new capital could lead to another leg down in the municipal bond market.

7. The aftermath of the Madoff scandal has yet to unfold. Will investors globally become more cautious in doling out their money? We believe diversification of money managers is going to be the trend of the future. Many hedge funds may see a new wave of withdrawals as investors set limits of investable assets given to any one professional investor. The concern for new Ponzi schemes as well as poor risk management will lead to increased due diligence by investors and perhaps a new more conservative style of investing.

8. The dollar had a big rally in the fall but has shown some weakness lately. We believe the increased liquidity created by the Fed, government support through Tarp, the other government bailouts, and the forthcoming stimulus package will result in a much weaker balance sheet for the United States. Will the rating agencies have the guts to lower the ratings on U.S. Treasuries? Unlikely, but the government will need to issues trillions of new bonds and foreign investors will need to buy them. The ratings may say Triple-A but the U.S. balance sheet is anything but. The dollar will remain weak, gold will rise, and long-term bond yields will ultimately have much higher rates to entice investors to buy them.

9. The recession is getting worse every day. At this point most economists and strategists expect the economy to hit bottom in late 2009 or early 2010 but what if housing remains weak, unemployment approaches 15%, new banking troubles abound, and corporations anticipate more weakness in their businesses? This would result in higher savings rates, more bankruptcies, a steep contraction in GDP, and a recovery that doesn't appear until late 2010 or well into 2011. The stock market will take a turn for the worse and the best stock pickers will be the only winners in 2009.

10. Corporate loans and bonds have seen a little bit of a rally in December. We believe this market is one of the keys for stocks to improve in 2009. The best value is in these markets but what if this rally is just a result of short covering and there is no follow through into 2009? A drop off in the price of loans and bonds results in higher yields and less liquidity. The economy needs strong businesses to prosper. These companies need access to the capital markets but a weak corporate bond market and limited liquidity in the loan market will forestall the growth in the economy and keep the United States in a deep recession.

2009 is an uncertain year for investors. A long-term view will no doubt produce solid returns but there could still be much pain in the short-term. It is essential to be cognizant of the potential pitfalls ahead and the best portfolios will be diversified in many markets. Continue to only own highly liquid companies with minimal debt requirements. Include loans and bonds in your portfolio as well as gold. A loss in one market can hopefully be made up with gains from another.

The Energy Two-For

President-elect Obama loves to focus on solving problems and getting 2 benefits for his actions. It is time to fix the energy problem in this country. The best time to do this is when oil prices are at their lows not when they are skyrocketing. Oil is at $42 and could go lower as global economies remain weak. Gasoline prices in the United States are finally under $2 again after almost reaching $5 this summer. These lower prices benefit consumers as they increase one's disposable income during the holiday season.

We believe it is important to limit the demand for oil until alternative energy sources can be developed. Oil prices will not stay low forever and are likely to hit the summer highs again in the not too distant future. It is time for Mr. Obama to propose a gas tax. This is the best way to get the two-for for his energy policies. The tax will help to limit demand and also provide a new source of revenue he can use to fund his alternative energy policies.

Government spending is out of control as all the initiatives to cure the financial crisis and stimulate the economy have left this country in poor financial shape. Income taxes are not in the cards for 2008 but a gas tax could alleviate some of the pain while driving some benefit to the United States in its road to becoming energy self-sufficient.

The Road to 2009

Last week we saw the VIX index of fear continue to decline. 2008 had plenty of volatility in the markets and each new crisis brought on new fear. The year seems to be ending a little calmer as oil has declined, the dollar has dropped, interest rates have headed toward zero, the credit markets have rallied a little, and stocks are well off their November 21st lows.

We expect this week to be relatively quiet as many traders on Wall Street will be happy to close the books for 2008 and take some time off from the fury. If credit spreads continue to tighten, the stock market may also bring some holiday cheer.

We are still quite concerned with the fragility of the financial system, rising unemployment, weak housing, soft commercial real estate markets, and a weak business environment. Unemployment will keep rising and the consumer savings rate will also dramatically increase from very low levels. Higher savings means less consuming. This is a viscous cycle that needs to run its course. The stock market will eventually see the light at the end of the tunnel but the tunnel is very long this time. Expect some bear market rallies but not much good news on the economy. In three to five years, large, liquid, well capitalized companies will be stronger, larger and produce good stock market returns but the short-term could be a rocky ride.

The Government to the Rescue

President Bush announced a $17.3 billion bridge loan to GM and Chrysler. The is a bridge to an organized restructuring which is the true medicine these companies need. All stakeholders will participate in this reorganization of the most important manufacturing industry left in the United States. The unions will need to redo their contracts, including pension and health care benefits, so these companies can compete effectively with their foreign rivals. The banks and bondholders will need to fix the capital structure which should wipe out the stockholders. The suppliers will likely need to consolidate more to remain viable and the auto dealerships will shrink dramatically along with the manufacturers.

This process is going to be painful for all stakeholders but it is necessary if the United States wants to keep this industry a vital part of our economy. The inefficiency of the auto manufacturers has cost them market share over time and this process will invigorate the industry to compete against foreign auto manufacturers as we struggle through these weak economic times.

The Credit Market Tea Leaves

We have been watching the credit markets closely to see when signs of liquidity reappear. The Federal Reserve has dropped the Fed Funds rate to zero and the 10-year treasury is approaching 2%. Such low rates are intended to help unfreeze the credit markets. The stock market ended down about 1% today but there seemed to be more calm as the VIX fear index dropped below 50 after reaching heights above 80 not too long ago.

Mortgage rates are now quoted below 5% which should spur some more activity in the housing market. The home builders are still seeing weak sales but low rates are the medicine needed to get consumers to purchase homes and reduce this nation's unsold housing inventory.

As we have been saying for a while, the stock market cannot consistently move up until the loan market and corporate bond market show some life. Today marks such a moment. Macy's announced they were able to get a new credit agreement from their banks and so did Tyson Foods. The banks are garnering better terms for themselves but perhaps now they are beginning to show some willingness to commit capital to business lending.

As we perused the leveraged loan market today, we noticed a big rally. Loan prices rose and their yields dropped. The same phenomena occurred in the credit default swap market and in the high yield market. There was aggressive buying by investors today but much of it appeared to be a short covering rally. This could be the start of a credit rally which extends to the end of the year but until long term investors start committing their capital to these riskier assets, we will not be fully convinced that the credit crisis is truly thawing.

We believe today had many positive tea leaves and as stock investors become more comfortable with the improvement in the corporate credit markets, the bottoming process will end and the beginning of a new bull market can finally begin.

2009 Is "All About the Company"

2008 has been "All About the Economy" It didn't seem to matter what stock you picked because they all went down. However, some sectors did far worse than others. We believe success in 2009 will be "All About the Company". It is a stock pickers year. The financial crisis will hopefully become yesterday's news at some point in the next few months and the financial stability and growth of companies will dominate one's success in the stock market.

This morning, General Mills reported earnings which slightly dropped on higher food-hedging costs but its sales seem to be charging ahead in this weak economic environment. Consumer staples such as basic food is clearly defensive and General Mills is outperforming most companies in this regard. On the other hand, Morgan Stanley announced weaker numbers than expected as they booked large losses and experienced weaker business trends in the capital markets. The contrast of these two companies will likely be a scenario we discuss throughout 2009.

Yesterday, the markets rallied across the board as investors cheered the Federal Reserves interest rate cuts and its desire to do what is necessary to jump start the economy. All sectors rose and many pundits viewed the rise in stocks as the beginning of a Christmas rally. The markets seem to ignore bad news these days which is a good sign for a market bottom but we are not convinced that the recession won't be longer and deeper than the markets are assuming.

Will there be any fallout from the Madoff affair? All the details are not out and the effects on the financial markets are not known. Are there other disasters lurking in the weeds? Perhaps. Can Morgan Stanley, Goldman Sachs, and Citigroup right their ships? Hopefully. Will Apple surprise everyone with a slowdown in their great business? These are just a few topics to ponder which might keep the volatility in stocks, commodities, and interest rates. We do believe the markets are in the bottoming phase but it won't be straight up from here. The stronger companies will become stronger and the weak will wither away or eventually get bought.

Goldman and Best Buy Lead the Way

Goldman reported a $2.12 billion loss and the market was thrilled it wasn't much worse. The stock immediately jumped four points and lifted the broad indices also. Good news only seems to last a short time as Moody's lowered Goldman's corporate ratings and cut the stock's gain to 2.25 points. Best Buy also reported much better than expected third quarter earnings which lifted its stock 10%. They seem to be gaining market share but the key quarter is the fourth quarter. Management is still being cautious as it is offering buyout packages to most of the corporate staff and aggressively cutting costs and capital expenditures.

On the economic front, housing starts were only 625,000 which was less than expected. It wasn't long ago when housing starts were 2.2 million. The deflation scenario continues to pick up steam as consumer prices declined 1.7% in November when compared to October prices. We have said for months that it is all about the economy and weak data keeps pouring in.

The markets are rallying but the day won't be complete until the Fed cuts rates and lets investors know how much they will grow its balance sheet. It certainly seems like we are in a bottoming process as the market is rallying on good news and shrugging off bad news.

Madoff, Autos, and More

Most people never heard of Bernie Madoff until last Thursday but by now his name has been splashed around the world in every home. The man built an empire by convincing wealthy individuals, hedge funds, and banks globally to participate in his grand Ponzi scheme. The fallout is massive as some ordinary individuals as well as the wealthiest woke up on Saturday to realize they may be poor now. This is a crime and the reverberations could be massive. The surprising news is that the markets don't appear to be too troubled by the massive amount of wealth that just vanished. We anticipate some shocks to the system will be felt as more information about this financial scandal becomes known. Stay tuned!

This week the markets will also continue to focus on the auto bailout. It looks like the government is pursuing some bridge loan but the devil is in the details. At this point, we don't know what the Bush Administration is proposing but we hope they force all the stakeholders at GM to move in the direction of a delevered balance sheet and a lean cost efficient manufacturing operation.

Tomorrow, the Federal Reserve will let us know if rates will be cut again but until we get their statement on the economy, the markets should leave stocks in flux for the next day and a half. Of course we will get enough economic data before the Fed's big moment as we find out about industrial production, consumer prices, and housing starts but we don't expect to see any news that says the economy has bottomed and the economy is ready to turn positive.

We still maintain a negative bias on the markets until all market experts expect the worst and it is apparent a bottom to the economy is in sight. This still may be three to six months away from now. Volatility will continue for stocks, commodities, and currencies and fear and anxiety amongst investors is still evident. Professional investors are tiptoeing through this path of danger and so should you. Stay liquid and only buy quality.

A $50 Billion Fraud Adds to Market Concerns

Bernie Madoff owned a trading firm that made money year in and year out for investors. Yesterday he was arrested as it looks like his $50 billion empire was a Ponzi scheme that crashed like a house of cards. About 15 or 20 years ago we were asked by someone who had an opportunity to invest with Mr. Madoff whether he should do it. At the time, we had never heard of this firm but it seemed odd that this individual who had an insignificant amount of money was given this opportunity to invest in this firm as a special favor to a friend of his. After a quick review, it appeared to us that Bernie was not really investing clients' money but using investor's money as capital to build his trading firm. In our opinion, we said this operation was too risky. Of course, our investor friend couldn't resist the consistent high returns Bernie produced every year and invested anyway. For years we were proved wrong as Mr. Madoff yielded very consistent returns for his clients.

If it seems too good to be true, it usually is. We don't know the details of how Mr. Madoff's firm came crashing down but the global credit crisis and volatile stock market has claimed another victim. Investors most likely started to withdraw their capital and this leveraged entity could not manage the dwindling liquidity. Game over.

Look Out Below

The Senate is not going to pass the Bailout Bill for the Automobile Manufacturers as the dispute over union worker pay could not be resolved. We have been saying for weeks that the unions need to have competitive wages with the foreign car companies but it is a little too late to demand it in the last hour. No bailout will mean a Chapter 11 bankruptcy for GM, Chrysler and maybe even Ford. There isn't enough time to reorganize with a prepackaged bankruptcy. We didn't want a bailout initially but the slow process undertaken by Congress has left GM with minimal liquidity and only a bankruptcy option. Such an event will mean massive unemployment, additional bankruptcies by auto suppliers, and a huge drag on the economy.

The stock market is going to tank in the morning and this recession will be even longer and deeper than we have been saying. The chances of a depression have just increased. The only hope to save the economy and global markets is for President-Elect Obama to call a meeting over the weekend where all relevant stakeholders of the auto industry and the Senate can sit down and resurrect a deal. If not, this country is in big trouble and liquidity will be at a premium. Hopefully, the Government can act responsibly and not let the economy spiral out of control.

How Can the Markets Keep Going Up?

It can't except for the Bear Market Rally. The news about the economy and individual companies just gets worse every day. We know the story about GM and at this point, some rescue package needs to be offered by the government as the prepackaged bankruptcy cannot be orchestrated over night. There may be a fight in the Senate but a bridge loan is likely to be offered. The markets will probably like to see this saga end in the next few days so it can breathe a sigh of relief. The real work to restructure the company must begin immediately which should still propel a restructuring of the debt, labor contracts, and cost structure for the industry.

This morning the economic picture didn't get good news as the trade deficit was weaker than expected and initial jobless claims were higher than anticipated. The deflationary environment also continued with import prices dropping 6.7% from last month. Oil was probably a big factor in that decline.

As for corporate news Costco is seeing some weakness, Boeing is delaying the production of the 787 once again, Cummins Engine is lowering their expectations, and P&G said sales may be slower for the quarter. Most companies are seeing business slowing down and if the pace accelerates the recession will last longer.

The dollar is also very weak against the Euro and the Yen. This should bode well for Gold and other commodities. The Russian Ruble continues to be devalued. This is a story we will likely see across the world. The Yen looks to be the strongest currency and the Euro is seeing some new strength after dropping precipitously.

Fear is still high as the 3-month treasury is yielding zero and people just want to make sure their cash is safe even if they have no return. The is no place to hide as an investor and it is important to stay in stocks with no near term debt maturities and plenty of liquidity.

The Bond Market Leads the Stock Market

Yesterday the markets were down about 2.5% as the wariness of weak economic news and poor corporate earnings punished stocks. Stocks continue to be very volatile and the markets are anxiously awaiting the resolution of the Auto bailout. We note that Chrysler loans are trading at 35-37, Ford at 42-43, and GM at 46-48. 100 represents full value for a loan. Discounts this large usually indicate a restructuring is needed and will occur.

As we peruse bond and loan prices for all corporations we continue to notice the steep discounts in these prices. Historically, bond prices cannot trade at big discounts to full value while stocks rise to new heights. The credit crisis will continue for awhile and a new bull market will likely need to first see improvement in the credit markets. The market may be in the bottoming process but an extended period of positive stock price movement now can only be a bear market rally. When bond prices move up significantly so will stocks and we will then be ready for a new bull market.

Time To Test The Market

Companies continue to reduce earnings forecasts every day and bad economic news never seems to stop. However, the market seems to take everything in stride. Yesterday, the DOW was up 298 points as the promise of a large Obama stimulus package drove infrastructure related stocks up significantly. Most industries followed along.

Last night Fedex and Texas Instruments cut earnings forecasts and this morning Sony and Wyndham Hotels announced layoffs. Can the market continue to ignore the bad news and charge ahead? The market has been up nine out of the last eleven days and perhaps we will see a few more positive moments but we still believe the economic crisis will be longer and deeper than most investors believe.

The auto industry looks like they will get some help from the Government but such a band aid will not solve the structural problems of this industry. Many other industries are also suffering and the Government's balance sheet is already stretched. The bankruptcy process is desperately needed to delever the corporate sector, not public funds. Managements across America thrived when borrowing was unlimited but the party is over and it is time to take the medicine. Congress is right to debate giving frivolous loans and the auto manufacturers won't be the last industry to ask for help. The Federal Reserve and the Government need to be focused on systemic risk and let the private sector work through the problems created by themselves in the glory times.

The Markets Love the Bad News

Friday's employment number was as bad as we could have expected. The markets responded accordingly by being down for most of the day but a strong rally reversed the decline and propelled stocks higher as we entered the weekend. Congress continued to debate the fate of the auto companies on Friday and throughout the weekend. It seems like the Government will bail out the auto industry in some form of a loan. Congress is also looking to change management of GM and perhaps Chrysler also.

As we have said in the past, we believe a restructuring of the debt and labor contracts is needed to go along with the loan. Any new management will spend some time analyzing the operations of these companies and realize there is too much debt and the cost structure is too high for General Motors to become profitable and deleverage. On Friday, General Motors' outstanding loans were trading at fifty cents on the dollar. This implies that a government loan of $10 billion to General Motors will be worth $5 billion on day one. Taxpayers will not like that loss. Hopefully, Congress will figure out additional compensation to make up for those losses.

President-elect Obama once again produced some weekend magic as he promised a very large stimulus package to jump start the economy. Infrastructure companies and commodity producers will certainly love that plan. Markets overseas were thrilled to hear the news as will the U.S. markets which look to be up strong in pre-market trading. This market continues to be volatile and good news brings plenty of short covering and a pop in stocks. The economic news should continue to get worse and the markets will continue to evaluate each dour report.

The bottoming process will work its way through the market and it may be painful but in time, we look to see the light at the end of the tunnel. We fear that this process may be longer than some pundits think but the misery will end at some point.

Auto Day

The CEO"s of GM, Ford, and Chrysler will appear in front of congress again today to plead for government financial support. Ford may not need money but GM and Chrysler are in dire need before the year is out. As we have said in the past, the best help these companies should get is a government loan once they file for a prepackaged bankruptcy. Time is running out but the unions and the creditors need to work with the auto companies as they downsize and focus on becoming more efficient. The consumer needs to understand that bankruptcy does not mean cars won't be produced but that the company is being reorganized to become stronger and better in the future. The government should not loan GM money today with its current capital structure. It will just be throwing taxpayer money away. The government can provide loans in bankruptcy where it becomes the senior creditor. It can also ease consumer concerns by guaranteeing warranties but it is up to management to present a formidable plan to become profitable in the future.

Even The Gems Can Get Hurt

Research In Motion, the manufacturer of the Blackberry preannounced weak numbers for the November quarter. Their products are still in demand but perhaps consumers are slightly delaying purchases. Their new Storm model is in high demand but has been getting poor reviews as users have been complaining about typing messages on the newly introduced keyboard. RIMM is still a great company but its stock price is adjusting to a slowing economy. The key question now is whether Apple will also be hit by the cautious consumer.

More bad news was reported this morning as ADP forecast much weaker payrolls in November which also led to stronger worker productivity. The declining commodity markets have forced Freeprt McMoran to suspend its dividend and cut production of copper. This continued negative news will keep the markets weak this morning as it reflects the slowing economy.

The Recession Is Here

The Government let us know yesterday that the recession started last December. Most keen observers of the market and the economy figured that out a long time ago. However, that news and the presence of Mr. Paulson and Mr. Bernanke on TV gave the markets the usual result. It swooned with the biggest drop since the Great Depression. Most stocks on all exchanges dropped and half of the gains from last week were erased quickly.

The market will bounce back a little this morning but we would expect the downward trend might continue during the week. Auto sales numbers will be reported today which will likely be weak. Sears already announced weaker numbers this morning as did MMM. GE is broadcasting to investors and analysts this morning that they will keep their dividend for 2009 but their numbers will be at the low end of expectations for 2009. The company expects to resume 10% growth in 2010. The stock is up a little on the news.

Expect volatility to stay high as we saw with the soaring VIX yesterday. As we have been saying, it will take time for the markets to adjust to the economic climate but we are in the bottoming process and in time (perhaps a few months), the market will start to move in the right direction.

The Holiday Season Has Begin

In September we began to focus on how the markets would ultimately turn its attention to the weak holiday sales that were coming. It is now December and it is still all about The Economy. Black Friday appears to have shown sales increases from last year in the range of 3% to 7%. While on the surface that is a good sign, in reality the profit picture must be bleak. Shoppers came out in droves to find the bargains on Friday and they did. Huge discounting occurred at most stores and if an item didn't have a huge reduction in price, it didn't sell.

The bulk of the buying this weekend was done on Friday; and Saturday may represent the weak retail environment we can expect for the rest of the Christmas season. It may also lead to merchants cutting prices even further. It doesn't really matter as it is clear that margins will be lower and profits will be awful. Has the market discounted these expectations enough? Last week stocks exploded on the upside for five days so we can expect somewhat of a reversal to start off this week. As stores start reporting their holiday results, the market will evaluate them. We think the bear market rally last week will ultimately come back down to life until it is clear that the economy will bottom in the foreseeable future. We continue to be cautious and will buy quality stocks as the market settles down to more realistic levels.