Weekly Markets Commentary – November 24, 2008

David Joy — Chief Market Strategist, RiverSource Investments

Another Bank Bailout

Despite a late day rally on Friday, the fate of Citigroup weighed on investors minds heading into the weekend. If ever the notion of an institution being "too big to fail" was applicable, certainly this was it. But there were quite a few who thought the same about Lehman Brothers, which created more than a little uncertainty surrounding the fate of Citi.

Fortunately, a weekend injection of $20 billion in new capital from the U.S. Treasury, on top of the $25 billion Citigroup received a few weeks ago, along with $306 billion in new loan guarantees, would seem to be enough to stabilize the bank and its share price which closed Friday at $3.77. Its 52-week high was $34.77 on December 10, 2007.

Investors also liked what they heard over the weekend from President-elect Barack Obama regarding an economic stimulus program. It was reported that the new administration's first priority would be a new program involving infrastructure, public services and green technology spending as large as $500-$700 billion in scope. Aides also suggested that there might be no attempt to repeal the Bush tax cuts on the highest marginal income tax brackets before their expiration date after 2010.

After enduring back-to-back declines in excess of six percent on Wednesday and Thursday, stocks staged a late-day rally on Friday to close up six percent on the day. The catalyst for the afternoon turnaround was attributed to the news that New York Federal Reserve Bank President Timothy Geithner would be named U.S. Treasury Secretary. One of the key players in helping to resolve the credit crisis, the selection of Geithner ensures that there will be no learning curve for a new Secretary to get up to speed upon taking office.

As it was, the S&P 500 Index fell 8.4 percent for the week, its worst decline since the 18.2 percent drop during the week ending October 10. The unsettled fate of the auto industry bailout contributed to the prevailing anxiety about the economy.

The VIX Index rose to a new high of 81 on Thursday. The small cap Russell 2000 Index fell 11 percent last week, and has now shed 40 percent since the start of the quarter, compared to a decline of 31 percent for the S&P 500.

It wasn't only stocks that slumped to new lows last week. Crude oil fell $7.11 a barrel to $49.93, its lowest price since May 2005. The same was true for copper and aluminum, while nickel fell to its lowest level in five years. Agricultural commodities fell to their lowest levels of the past 12 months.

The yield on the two-year Treasury note fell below one percent for the first time ever and the rest of the Treasury note curve established new lows. The 10-year note closed at 3.02 percent on Thursday, before ending the week at 3.20 percent. The yield on the three-month bill closed 0.015 percent, an annualized return of $15 on a $10,000 investment.

Credit spreads also continued their record ascent. The option-adjusted spread between the 10-year Treasury note and the Merrill Lynch High-Yield Master II Index widened by an incredible 272 basis points just last week alone to a spread of 2039. These levels imply a default rate next year of approximately 16 percent or higher, according to some estimates. Last week, the rating agency Moody's Investor Services forecasted the rate would be 11.4 percent in the U.S.

General Motors bonds are selling at 16 cents on the dollar, with a current yield of 50 percent. The spread on the investment-grade Merrill Lynch A-AAA 5-10 Year Index widened by 55 basis points to close at 580 – just 14 basis points shy of its recent high on October 13.

The Week Ahead

This holiday-shortened week's economic calendar is full. Scheduled reports include new and existing home sales and the September S&P/Case-Shiller Home Price Index. Other reports include durable goods orders and personal income and spending results for October, along with the personal consumption expenditure (PCE) deflator. The November Chicago Purchasing Managers Index also is scheduled.

Lastly, the Sunday New York Times reported that psychics say their business is thriving as clients turn to them for stock tips. Was it just coincidence that the adjacent column was announcing the "Death of Irony?" How ironic.