What Obama Bounce?

by Will Swarts
www.smartmoney.com

Inauguration week brought plenty of pomp, but didn’t change our economic circumstances. In a jagged week for the markets President Barack Obama’s inauguration failed to spur a rally, and some of our pundits believe a true recovery won’t arrive soon. The Dow Jones Industrial Average plunged 4% as the new commander-in-chief took the oath of office, the worst inaugural day performance on record.

“Investors were boldly and swiftly annihilating whatever value was still left in bank stocks,” said Ed Yardeni, founder of Yardeni Research in a recent note.

While a one-day performance is no barometer for the rest of the year – J.P. Morgan strategist Thomas Lee called current conditions “range-bound” in a Jan. 20 note – there’s a split in thinking about what is on the horizon, especially since it looks like the new administration will engineer a series of legislative initiatives that could have profound impacts on the economy and stocks.

“Following on the heels of the inauguration the next 100 days will likely be a flurry of legislative activity that is likely to impact the markets,” LPL Financial strategist Jeffrey Kleintop wrote Jan. 20.

Kleintop echoed a cautionary sentiment about just how effective some of the moves would be and how investors would react to more government regulation. “The uncertainty and potential for negative consequences as a result of new policy actions may weigh on the market,” he said.

Other market watchers are saying the same thing, making it difficult to gauge when they think the economy will recover. “While the general consensus is for a second half recovery, the data show a clear lack of conviction in that belief,” Citigroup’s Tobias Levkovich wrote Jan. 16.

Adds Ed Hyman, co-founder of ISI Group: “Lagged impacts of policy moves and lower oil prices will eventually get the upper hand, in addition to house prices and inventories finally hitting bottom.” But, he added in a recent research note, “it may not come until 2010.”

David Rosenberg, North American economist at Bank of America Merrill Lynch, wrote Jan. 16 that deflationary pressures created by the collapse of credit markets and sharp cuts in consumer spending will take years to reverse, making a conservative investing strategy the wisest course.

“It will literally take years of fiscal and monetary pump-priming to bring these measures of economic slack to levels that will precipitate the next inflation cycle,” he wrote. “In our view, that is too far beyond the forecasting horizon to be concerned about right now and we expect long Treasurys and any fixed-income instrument with both duration and relative safety attributes to be very compelling at this juncture.”

Can the Obama administration do anything to soothe those concerns and jumpstart the stock market? There is the notion of a so-called “bad bank” that would pull toxic assets out of crippled financial institutions.

Andy Laperriere and Tom Gallagher, policy analysts at ISI Group, point out that valuing these crippled securities is the key to success, and to a credible, well-capitalized banking system that doesn’t have to keep writing off more losses. The government should pay a premium on these assets to avoid a piecemeal approach to nationalization, they said, something a politically strong administration could accomplish in the country’s long-term interests.

“The point of an aggressive policy response,” they wrote, “is not to generate a second-half 2009 recovery as much as it is to avoid a lost decade.” Sphere: Related Content