WEEKLY ECONOMIC ANALYSIS: August 28th, 2009

Provided by TEAM Financial Services

"In the school I went to, they asked a kid to prove the law of gravity and he threw the teacher out of the window."
- Rodney Dangerfield (Back to School 1986)

Items for discussion

After a one week hiatus, we are back to answer the questions to all the world’s problems….or at least attempt to figure some financial stuff out. We chose a good week for our hiatus, as not all that much happened price wise over the past two weeks, as the major indexes finished within 1% of where they were two weeks ago.

One of the major news stories in our world over the past two weeks was the reappointment of Ben Bernanke to the post of Federal Reserve Chairman. The widespread and intense accolades Mr. Bernanke received throughout the media was interesting to us since we view Mr. Bernanke to have been “Robin” to Alan Greenspan - aka “Batman” for our analogy.

The accolades showered upon Mr. Bernanke were largely centered on the fact that he “saved the financial system from collapse”. We find this humorous and ironic. We believe this would be like congratulating a reckless camper who left all kinds of fire hazards in a dry forest and is then congratulated as a hero for helping fight the inevitable fire.

Overall, we don’t view the reappointment of Mr. Bernanke as a huge development, as we suspect the alternatives would have been cut from the same cloth. However, the timing of the announcement is/was curious. His term was not to expire until January and the President interrupted his family vacation in order to make the announcement. What was the big hurry that couldn't wait until September?

One thing we’ve noticed is some strange behavior in currency and commodity markets in the past few weeks – particularly the past two weeks. One theory we heard floated this week by some savvy investors/traders is the potential for the Chinese to announce some kind of change in their pegging of the yuan to the US dollar. That would certainly make sense based on some of the weird market action of late, but it is obviously pure conjecture at this point.

It does highlight a critical long term issue we believe will be addressed – either by conscious political maneuvering or forced by markets. Due to the yuan-dollar peg, China “imports” our monetary policy to a large extent. To date, they’ve decided that doing so has been in their best interests, but we expect that to change at some point, and potentially in a significant way.

If/when the Chinese make a move, we expect it to be a positive catalyst for our significant overweight position in client portfolios to commodities and related equities. We continue to hold significant allocations to broad commodity indexes with additional concentrated exposure to agriculture. Our equity-related exposure continues to be very significant in precious metals stocks, and we recently ramped our energy equity exposure to a significant stake.

We own these positions for long term fundamental reasons, but we certainly wouldn't be upset if the Chinese create a catalyst to move things along.

Market/Economic Climate

ECRI’s Weekly Leading Index growth rate reached a 38 year high this past week, which suggests that the risks of a traditional “double dip” recession are extremely low. Ironically, TEAM believes that a stronger than expected economic outlook will eventually be much more bearish for stocks than a flat to modest recovery. It may be very difficult for the government to continue to prop things up in our “Weekend at Bernie’s” economy if things begin to show real signs of strength, as we expect to occur by the 1st and 2nd quarters of 2010.

Mr. Bernanke has written and spoken about the mistake the Federal Reserve made in 1936-1937 by raising rates and contracting monetary policy “too fast”, as the economy bounced off the 1933 lows. Given Mr. Bernanke’s view, we suspect the Fed may be VERY hesitant to take actions they believe could stymie the recovery. Such hesitance could leave the speculation and inflation genies out of their bottles, which we believe could eventually result in a dramatically weaker US dollar and higher long term interest rates.

Our current view is that this entire process could take some time to play out and will most likely be reflected in financial markets late this year or, more likely, some time in 2010. 2010 also just happens to be the infamous “2nd year of a presidency”, which has historically been the “kitchen sink” year for administrations to dole out any painful medicine (think MAJOR tax increase this time, in our opinion) in time for political recovery for reelection.

On a short term basis, we continue to carry some modest portfolio hedges to protect against the potential for a trap door. This insurance has cost clients some in performance this year, but we believe it remains prudent given the historic nature of how extended the market currently is technically. Such markets tend to persist for longer than most think, but then surrender much of the momentum driven gains in the “final move”. A comparable move at present would result in a correction of about 5-7% in the major stock market averages, which would be a typical correction even if the cyclical bull market is to extend to new highs.

Humor for the Weekend

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.