January 8, 2009 Edition

Good Morning All,

Way back in November after markets had given in to the 20% pre election rally, this letter suggested that a year end rally would see indexes recover as much as 50% of their 2008 losses. So far, so good as the move, which has been largely made in the past 10 days or so, has seen a 20% pick up. We have now reached the crisis point in the market rise, the point at which the big money will decide whether they are more afraid of being out or being in. What we know for sure is that the intensely watched credit markets have shown some positive signs of late with the TED spread now receding to levels not seen since the summer. Once again it bears repeating that the stock market and the economy are two distinct entities which rarely if ever operate in tandem. The economy is a mess and is unlikely to show significant improvement for at least two quarters; the question at this juncture is to decide how deep the discounting of bad news has already been and at what level will the market trade in order to find its present fair future value. And always, always remember the lesson recently revisited that markets, stocks, bonds and commodities will always exceed the highest or lowest of expectations by a factor of X plus 10.

There has been much concern of late that the great expectation of the Obama Presidency has been overdone and some are worried that the stimulus package will be delayed or watered down to the point of ineffectiveness. What has been set up here is a classic battle between the largely Republican Freidman school of monetarism and the fiscally conscious Keynsian Democrats. To describe this confrontation as simply as possible you must return to your Economics 101 textbook, (likely written by Paul Samuelson) which defines the terms if not the politics. The Republicans are a one mantra party that ostensibly believes that everything can be solved by cutting taxes and cutting spending, while maintaining a tight control over the money supply. Well folks, one out of three is all they have ever mustered and yes it is the tax cuts to the already wealthy. As for spending and a conservative monetary policy, this has been the party that has twice debased the currency as it recorded the highest deficits in history under Reagan in the 80's and Bush ll in the recent decade. There is little doubt now that Obama will exceed his predecessors' records but the bulk of his problems are hereditary. We now need a massive fiscal stimulus of epic proportion, let us hope that he does not waver in the face of right wing nonsense.

If the market reverses off its early retreat we can watch out for this hope rally becoming a panic rally. They can happen too you know.