The market response to the new Treasury plan yesterday was interesting. The majority of the talking heads, even Krugman, settled against it while market participants appeared to applaud it. Who's right? The cop-out answer is time will tell. From what I could gather, it has positives and negatives and whether it works or not will be dependent on which trumps the other.
I do like the intent to allow experienced managers to run the 5 PPIPs. Yes, this introduces the fox into the hen house, but frankly, that's what's needed at this point. While the Fed continues is quantitative easing strategy, which appears to be helpful, we need a better effort from Treasury. Allowing pros to determine what assets to auction and what the valuation would be is a credible approach. Obviously, in light of the AIG bonus debacle, the pro's will rightly expect Treasury to allow them to make money on the deal and to stay out of their compensation strategies. Let's not forget we're in a capitalistic Democracy still.
The downside to this approach is that there's little motivation for banks to bring their assets to the table. Keep in mind, this group wants mark-to-market eliminated because they claim they can't properly value these assets. If they bring the assets to this market and the PPIPs value the assets, now they have a fair market value at which they can reasonably be expected to mark-to-market. The problem arises when these assets are valued BELOW the bank's current assessment of the assets. Such as scenario would result in the banks marking down these assets which could create solvency issues. Hence, those banks that know their current valuations are too high will have to be dragged to the table as they won't go willingly.
As I mentioned Sunday, I think the best action so far has been taken by the Fed. I believe we need to continue to let the Fed pursue its course of action and bolster it with better action by the Treasury. This plan is superior to the "Stimulus" bill in innumerable ways. Consider the following chart,
Clearly, there is a causal link between government spending and inflation. The stimulus bill will lead to inflation. Unless we're in a period of severe deflation when it kicks in, it won't be pretty. The Fed actions, which have many people worried as well, can be reined in more effectively and more quickly when the economy recovers. As it does, the Fed can gradually sell off its balance sheet and retire the cash it receives. Japan did this effectively and I have no reason to believe our Fed can't do so either.
Finally, the rally of the past several weeks is welcome relief. It appears we haven't had such a rally since the end of September 2001. The challenge is determining if this is truly the beginning of a market recovery or simply another step. We still have, at best, mixed economic signals. We have much good news but still appear to lack confirmation. For example, Citi, JP Morgan, BofA and Wells have all suggested 1Q09 is looking good, however, commentators such as Meredith Whitney have noted, they haven't marked-to-market yet and won't do so until 3/31. These commentators believe that that event will be decidely negative and will result in a negative surprise for market participants as these banks announce earnings in April/May. Additionally, we haven't seen a consistent pattern of good consumer related news to demonstrate that consumers are fully confident in their near futures. Continue to be cautious, continue to consider dollar-cost-averaging into equities and continue to research alternatives such as commodities and TIPS. The skies may appear to be clearing but remember the weather looks great in the eye of a hurricane while the front and back ends ain't so pretty.
