Overstimulated: Government Spending and Its Impact on Bonds

by Brandon Chapman, CMT

As the Obama administration settles in, many opaque revelations have emerged regarding possible policy action to handle banks and stimulate the economy. But among the uncertainty is a clear message that this administration and the Fed Chairman intend to spend our way out of the current economic slump. The efficacy of their actions and its eventual economical impact will likely create market indecision. Investors will do well to recognize where trading opportunities generated by these circumstances may arise.

Bonds Reaction
Amidst early rhetoric from the Obama administration, Treasury bonds with long-term maturities have failed to provide investors with much of a safe haven from January’s recurring stock sell-offs. In fact, Treasury bonds with 10- and 30-year maturities were met with selling pressure as prices fell and yields moved higher. This reaction is in contrast to the buying that occurred as equities fell at the beginning of January.

Interpretation
There are two factors investors can take away from long-term Treasury rates’ significant move higher.

First, the proposed spending amount will likely cause higher inflation down the road, making investors nervous because of the length of time required for these bonds to mature as well as their extraordinarily low yields. Along with future inflation concerns is the strong chance the U.S. will issue trillions more in debt during the upcoming years. This will likely prompt many foreign governments to diversify away from U.S. debt.

MARKET SNAPSHOT: S&P 500 Actively Slashing Dividends To Another Record Quarter

By Kate Gibson

The stock market's fall Friday had the S&P 500 Index near its bear-market low as companies listed on the broad-market index engaged in another record- breaking quarter of slashed dividends.

After lapsing more than 200 points, the Dow Jones Industrial Average (DJI) recovered some to end at 7,365.67, down 1.3% for the day and 6.2% from last Friday's close, its worst week since Oct. 10. Earlier, the blue-chip index fell to an intraday low of 7,249.47, its lowest level since October 2002. The S&P 500 (SPX) also pared losses, falling 8.89 points, or 1.1%, to end at 770.05, down 6.9% from a week ago. The Nasdaq Composite (RIXF) declined 1.59 point, or 0.1%, to 1,441.23, leaving it down 6.1% on the week.

After leading losses earlier on, financials fronted sector gains in afternoon trade, which also had gold futures closing above $1,000 an ounce.

"Given the uncertainty with corporate earnings, gold is one area investors should be looking at to hedge themselves against the perception that the dollar decline is somewhere on the horizon," said Dan Greenhaus, an analyst at Miller Tabak.

Gold is often purchased as a hedge against inflation, which is not an immediate concern, with consumer prices flat for the past 24 months.

While inflation could be on the more distant horizon, it is an unlikely cause for concern for near-term investors, analysts said.

"The rational investor is hiding, not investing in gold, money markets and Treasurys -- those harbors of safety represent pent-up demand for stocks," said Art Hogan, chief market strategist at Jefferies & Co.

MARKET SNAPSHOT: Stocks At The Mercy Of Bank Nationalization Debate

By Nick Godt

U.S. stocks are likely to face choppy waters next week, as the debate about whether or not to nationalize banks intensifies along with growing investor demand to rid the financial system of its toxic assets.

"Financial markets appear to be fixated on 'toxic' assets, and until they are removed from bank balance sheets, pressure will remain on the sector," said Benjamin Reitzes, an analyst at BMO Capital Markets.

Such concerns have helped drive the Dow Jones Industrial Average (DJI) to fresh six-year lows. For the week, the blue-chip average fell more than 6%, marking its worst week since October of last year.

The broad S&P 500 index (SPX) fell nearly 7% for the week, while the Nasdaq Composite (RIXF) lost 6%.

A big chunk of the pain came from the financial sector, where Bank of America (BAC) sank to new lows and Citigroup (C) fell to an 18-year low on Friday amid concern the government may take over the banks, wiping out their shareholders.

Senate Banking Committee Chairman Christopher Dodd on Friday said banks may have to be nationalized for a short time, according to Bloomberg News. But Robert Gibbs, the White House press secretary, said the Obama administration supports a privately held banking system.

While the comments seemed to help financial shares come off their lows Fridays, stocks on Wall Street have again taken a turn for the worse since last week after Treasury Secretary's Tim Geithner unveiled a plan to help ailing banks.