With the change in the winds of regulatory reform for the banks and financials I expect that 2010 will be a particularly brutal year for the stock market and the major indices including the Dow 30 and the S&P 500. I also predict that the highs for the Dow 30 and S&P 500 that were hit on Tuesday January 19th will prove to be the high water mark of the breathtaking 10 month rally which began after the market traded to eleven year lows in March of 2009.
Investors should be extremely cautious. I am already reading and hearing that the decline in the stock market, which began in the middle of January 2010, is likely to be the 10% correction that everyone has been waiting for. I am still of the belief that we have not yet seen the lows for this bear market which began in October of 2007. It would not surprise me one bit to see the major indices, which have not experienced even a 10% correction over the last ten months slice right through a 10% correction point like a hot knife through butter. I would avoid buying on a 10% correction and would certainly recommend having 80% of a portfolio in cash equivalents or U.S. Treasury bills.
For those investors who have been lulled by the “magical” ten-month rally into believing that the bear market is over I suggest a review of my December 2008, Equities Magazine article “A Super Bear is Upon Us”. It explains in detail as to why I believe that we are currently in a bear that will continue on until at least 2015. I also recommend that investors watch the two videos in the Video Library at http://www.bearmarkettracker.com/. The stock market experienced one of the sharpest rallies ever during 2009, instead of continuing on with the decline, which began in the Fall of 2008. There are two reasons why. The first is because of the initiatives, which were taken by the Federal Reserve to keep interest rates low. The second and most important reason of the two was due to the “lack of enactment” or even the introduction of proposals for “serious” regulatory reform by the U.S. government for the banks and financial companies. The investment public had anticipated that serious regulatory changes would be made for the banks after they had caused the biggest financial meltdown for the global economy since the Great Depression. As 2009, went on and drew to a close it became clearer and clearer that serious financial regulatory reform did no appear to be a priority of the Obama administration. I believe that the lack of any serious action taken or even the discussion of regulatory reform for the financials is why the market did an about face and experienced one of its biggest rallies ever in a single year. Thus, I believe that if action had been taken on this issue the stock market would not have rallied and instead would have experienced lower levels than it did during 2009.
The driver of the significant blood letting that I am predicting will occur for the stock market over the next several months is the recent announcements by President Obama regarding his administration’s newly proposed taxes and regulations that they intend to slap on the banks and financial institutions. The posture that Obama only recently adopted signals a radical shift in his behavior toward the big banks. I believe that most investors do not yet understand the significance in how this behavioral change can and will have a dramatic impact on the equities markets over the near term.
After being inaugurated in 2009, it became clearer as the year went on that Obama’s priority was not financial regulatory reform. Based on his initial behavior towards the banks it appeared as though he was coddling them. I myself was somewhat befuddled that it was not the top priority of a new Democratic Administration to make bank or financial regulatory reform the number one issue. This was especially since only months earlier the U.S. banking system had faced and had narrowly avoided Armageddon. As health care reform captured an increasingly larger portion of the spotlight many in the electorate and the media began to believe that Obama wanted a major overhaul of healthcare to be his “legacy”.
As 2009, passed with barely a mention of bank regulatory reform many investors were increasingly lulled into investing into the shares of the recovering financial companies because they believed that the banks had escaped the wrath of having to face draconian regulatory reform. This false sense of security that investors had regarding financial regulatory reform, or the lack thereof, is why the major indices were able to experience the likes of a 10 month bear market rally in which the S&P gained more than 60% off of its lows of March 2009.
I now believe that the melancholy approach that Obama and his administration took with the banks in 2009 was by design. There is little doubt in my mind that this strategy was mapped out by former Fed Chairman Paul Volcker, who is one of Obama’s economic advisors. After the October 2008, financial upheaval Volcker knew that banks needed the time lick their wounds or generate the liquidity that they were desperate for. The Obama administration purposely decided to leave the banks alone in 2009, so that they could go along their merry ways. The administration wanted the banks to use the TARP monies to generate profits and wanted the shares of the banks to recover so that they could raise additional capital by issuing and selling new shares to build up their coffers.
In hindsight, I now believe that the strategy mapped out by Volcker and the Obama administration was brilliant. They pulled it off with perfection. The limitations on executive compensation, which were put in place for those banks who owed the U.S. government repayment for TARP was shrewd. If those restrictions had not been put in place I doubt that many of the banks would have voluntarily diluted their shareholders to pay the U.S. government back. All of the big banks with the exception being Citigroup (NYSE:C) diluted their shareholders by raising additional capital to pay all of their TARP monies back. They had no choice but to pay off the TARP otherwise they could not continue to pay the exorbitant be allowed to pay the exorbitant bonuses that their executives had become accustomed to. Even with the significant dilution the shares of financial companies were among the top performers in the stock market during 2009. Finally, the bank stocks led the entire stock market to one of its best performances ever and the major indices such as the S&P 500 and Dow Jones 30 Industrials right back to the levels that they were at in October of 2008.
There is no doubt in my mind that if the banking regulatory reform proposed by the Obama Administration had been announced and enacted during the first half of 2009, the following would have happened:
The big question now is what will be the consequences for the stock market and economy that stem from the enacting of the financial regulatory reforms proposed by President Obama?
The recent announcement by the Obama administration that they were going to cap the size at which a bank can get to (10% of all U.S. deposits) and eliminate the ability for banks to trade for their own accounts is a major game changer. If the changes occur as proposed they will have a significant long term negative impact on the share prices of financials which represent a significant portion of the U.S.’ equity markets. Thus, with the news I expect that the major indices are now much more susceptible to a significant increase in downside volatility and a severe downturn than they were only a week ago. All bets are now off. Investors and traders should expect the dramatic to now happen until the major indices can establish a secure footing. The reasons why are as follows:
For the duration of our lifetimes the glory days for the banks and financials and their shareholders are over. With the new regulations financial companies and the performance of their shares are destined to go back to the days that they were considered as stodgy investments. That was the sixty-six year period between 1933 and 1999, which began the last time that the banks had to undergo regulatory reform due to their risky practices, which led to the Great Depression which started in 1929.
Now that Obama and his administration are now taking drastic action to institute regulatory reform for the banks and financial companies, I expect that the stock market pick up where it left off in early 2009. I expect it to resume the downward course that it was on one year ago in January. On January 23, 2009, the S&P 500 index closed at 831.95 and the Dow 30 Industrials closed at 8077.00. One year ago both indices were 20% lower than their present levels. Those investors who missed out on getting out of the market in October of 2008 should breathe a sigh of relief and take advantage of this opportunity to do so with the Dow 30 above 10,000 and the S&P 500 above 1000.
