Will It All End In Tears?

Charts: The S&P 500 closed at 1006, up 1%. Emerging markets recovered and American tech took on leadership. The broad index outpaced emerging markets, so for today the leadership change we’ve been hoping for is working.

Fundamentals: The Federal Reserve said that economic conditions are leveling out and that it will keep interest rates low for a long time (bullish). It also said that the program to buy treasuries (Quantitative Easing or QE) will be allowed to expire after $300 billion has been spent (bearish). This could have rocked the market since investors are begging for super loose monetary policy and it did at first. However, the real QE is coming from the Fed buying $1.5 trillion of Fannie and Freddie debt and mortgage backed securities. The Fed made reassuring noise on this score; that mullified investors after the first bout of panic. Not to mention that Ginnie Mae now holds a trillion dollars of freshly minted subprime mortgages. So the government is using deficit spending and loose mortgage standards to massively support the housing market. It is working for now, which is great. It can’t keep working without overall spending constraint from the government at some point in the next year or two. That’s not going to happen, so long term conditions are similar to 1975 with a recession ending and structural problems remaining unsolved. The market generally only looks 6 months into the future, so fundamentals look okay for now and the rally should continue for a few more months. Watch for yield on the 10-year note going above 4%, because if that happens it could all end in tears.

Geopolitics: Russia has ended its war against Islamic radicals in Chechnya and America has ended its war in Iraq. The two conflicts are very similar and since the big powers have declared victory the course of the bad guy insurgencies have taken similar paths. Neither region is at war anymore but the insurgencies have kicked back up to a very hot level that will probably require increased involvement from the respective big powers. Russia is going to have to put troops back into Chechnya and America is unlikely to really wind down Iraq operations the way civilians back home are hoping. And so goes the Long War. It is a very stubborn, nasty, and permanent fixture to the new century. From an investing view point there are opportunities. My biggest single stock holding is ITT, a defense company that makes gear for infantrymen. And Raytheon (RTN) for missile offense and defense.