Credit Spreads at 800 Basis Points

The spread between Baa credits and 10 year US Treasuries reached 800 basis points.



The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.

MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.



Here is the raw data.

2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.655
2008-10-22 1174.106
2008-11-05 1265.015
2008-11-19 1506.539
2008-12-03 1502.872
2008-12-17 1689.661
2008-12-31 1728.184
2009-01-14 1773.924

Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.

REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.

In California the number of homes sold last month increased nearly 200%.

As this trend continues, the housing market will stabilize.

However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.

SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.

Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.

Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.

New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.

However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.

TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.

Do not run a mis-matched book.

Avoid commercial real estate.

Expand prudent residential real estate lending and sell all long-term assets in the secondary market.

Balance sheet lending is extremely risky.

STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.

Cooperate with regulators to understand their concerns and allay their fears.

Markets at Major Turning Points

Gold at Major Support










Most of the evidence suggests the bounce will be small, and prices will continue to drop. But, traders don't bet it that way.

Bond Refunding Successful
US Treasury sold $27 billion of notes and bonds following the largest increase in CPI since the Volcker years.

Treasury Note Futures









Treasury Bond Futures









Note that ond prices surged following a successful auction.

Corporate Bond Spreads Falling











Stocks finding Support

NYSE Composite











S&P 500











Russell 2000











SUMMARY
10 years from now this time will be seen as a major turning point in stocks. With inflation banished, and the bull market in bonds ended, only stocks will have the investment potential for the future.

Remember, stock prices rise when interest rates come down and stay down.

Stock Market at Support

Investors will be watching the stock market closely for the next few weeks at prices approach support levels seen twice before in the last 6 months.

NYSE Composite


S&P 500


Russell 2000


Technical traders will be buying the Index here, and selling if the market trades below these levels.

SUMMARY
The usual rule is to buy the market when the situation looks bleakest.

That certainly is the case here.

Inflation and the Bond Market

Bonds sank through support this month and are now back at May's support levels, now resistance for this instrument.



The question now is how low will prices go, and how high will long rates rise?

To answer this question we look at the money supply and the dollar. The first causes inflaton, and the second makes inflation worse.

MONEY SUPPLY
The monetary base is growing, but growth has been slowing for years.



This is a good sign for inflation, showing the Fed's commitment to control the supply of high-powered money.

In recent months, however, growth has accelerated slightly, but not enough to cause inflation.



Bank generated money has grown substantially in the past years, as businesses work their way through the recent Fed-caused disaster.



In recent months, growth in this leading indicator has slowed, leading to renewed confidence in the Fed's management of interest rates and the money supply.

In summary, inflationary pressures are not building, and there is no need to raise interest rates.

INFLATION AND THE DOLLAR
Price rises in the United States are connected to the falling dollar. Import prices are soaring as international demand for primary commodities pulls at suppliers.



The rise in commodity prices is directly related to the fall in the value of the dollar.



Notice the plunge in the dollar in 2006, and the simultaneous rise in PPI.

TACTICS
Prudent A/L managers will continue to lengthen liability maturities, shorten asset maturities, and work for higher spreads in lending.

Money market arbitrage is more profitable than ever, and those clients pursuing this activity have found their yields soaring dramatically.

The key to this business is a careful analysis of credit quality. High quality credits have been pushed off the curve hundreds of basis points, providing opportunities for lenders with excess cash.

STRATEGY
Now is the time to report to senior management and the Board on the A/L condition of the portfolio.

The institution is liquid, carrying good credits, good spreads, and profitable liabilities. In short, we are ready to lend to our existing customers, and prepared to take business from our weaker competitors.

The Asset/Liability department can take a bow.

End of a 25 Year Bull Market in Bonds

The bull market in bonds is over. Never again will investors see a run like this.

Since Paul Volcker crushed inflation back in 1980 bond yields have made new lows with every cycle.



10 year US Treasury notes peaked at 15% in 1981, and have fallen consistently till the lows of 3.5% in 2003.

During this period real estate values boomed as capitalization rates fell and the cost of borrowing tumbled.

Refinances further fueled the mortgage banking business, bringing profits to finance companies.

Companies like GE, which based their growth on this trend will now see that portion of their earnings disappear, never to return again.

STRATEGY
For diversified companies, reduce expectations of future growth from financial activities. Explain to senior management and the board that lower interest rates will not happen again - ever.

For finance companies, explain to senior management and the board that the competition in the finance arena is about to get as tough as it gets, with more competitors chasing every deal, and lowering profits in order to compete.

TACTICS
Asset and Liability Management will dominate the discussion on adding assets and liabilities.

As the Fed moves to more market-based allocation of Fed Funds, expect to see more volatility at the short end of the curve.

Lengthen liability maturities and focus on solid spreads.

Stock markets making new highs

In the month since the end of the correction, all major stock market indexes have surged to new highs.

The bull market is intact and will move higher in the months and years to come.

Get long and get rich.

STOCK PRICE INDEXES
First, the New York Stock Exchange Composite



Second, the S&P 500


Finally, the Nasdaq 100


GOLD
Gold prices are a puzzle. I would expect them to be surging with bonds falling.




BONDS
Bonds are at major support. The gold charts suggest this is the time to buy bonds.

Correction is Over

As the chart of the NYSE Composite shows, the correction is over.



Prices make a double bottom
Trade up through resistance
Fed warns against inflation
Fed won't lower short rates any time soon
Stock prices retreat for one day
Prices make new highs for the move.

This correction is over.

Time to get back in the market and put that new money to work.

Storm Strengthens

VOLUME yesterday was not enough to say this decline is over.

BEWARE the continuing fall in stock prices.

DO NOT add new money to the stock market.

STAND BY for continuing updates.