Market Outlook: 03-12-08

Robert Hsu, March 12, 2008

It has been quite a week on Wall Street–investors have experienced whiplash from watching U.S. stocks sink to recent lows before bouncing dramatically yesterday after the Fed announced a recovery plan. Let's kick things off this week by talking about the current economic picture in the United States. Then we'll talk about what's happening in Asian markets, why it's time to close out one of our positions, and a brand new buying opportunity for our portfolio.

From the final days of February up until the close of Monday's trading session, the major U.S. indexes were suffering heavy losses. In fact, on Thursday the S&P 500 broke through the bottom of my forecasted trading range of 1320–1440, closing the day at 1304. The index kept falling from there, heading back down to its old support level near 1270.

Two main factors caused the recent declines. First of all, last Tuesday Fed Chairman Ben Bernanke called for banks to accept principal reductions on delinquent mortgages rather than pursue foreclosure proceedings. This was a bad move on Bernanke's part. Banks simply won't make mortgage loans if customers who refuse to pay get off the hook with a principal reduction at the bank's expense. Naturally, this makes banks reluctant to lend money for mortgages. If banks are hesitant to lend, the credit market would dry up even further. The stock market responded to Bernanke's blunder with a four-day sell-off.

Then, on Friday, the government reported the biggest drop in jobs in five years. Payrolls fell by 63,000 in February, following a decline of 22,000 in January. In the past, such back-to-back monthly employment drops have only occurred during recessions.

The Fed's Plan Injects Liquidity

The Federal Reserve was able to turn things around yesterday by taking steps to re-liquify the credit market. Yesterday morning, the Fed announced that it will loan up to $200 billion in cash and Treasury securities to banks and brokers. In exchange, the Fed will take on the banks' debts, including mortgage-backed securities, for up to 28 days. The Fed coordinated its effort with central banks in Europe and Canada, which plan to inject up to $45 billion into their own banking systems.

This plan allows banks to temporarily swap illiquid debt that no one wants to buy for liquid U.S. Treasury securities. This was a smart move because it gives lenders time to rebuild liquidity in the credit markets. It also allows the Fed to help shoulder some of the mortgage default risk, which helps restore confidence in the credit market.

The stock market responded enthusiastically to the Fed's plan, with the Dow skyrocketing more than 400 points yesterday–its biggest one-day gain in more than five years. In the next month or so, I believe that American markets probably won't experience a new low due to the Fed's recent actions and the increasing likelihood of a 75 basis-point rate cut next Tuesday.

But with mounting evidence of a U.S. recession on the horizon, I think that the upside for most sectors is limited. There is one sector, however, that I'm bullish on right now, and that's where our new buy comes from this week. Do you want to know what my top buy is, one that will make us profits even as the U.S. economy is weakening? Subscribe to Asia Edge today to find out!

A Peek at Asia's Markets

Asian stocks have also been struggling recently. Last week, Asian securities experienced their biggest weekly drop since August. The MSCI Asia Pacific Index lost 5%, its biggest dip since the week ending August 17. So far this year, the benchmark has declined 11%. However, I think Asian stocks in stronger economies will gradually decouple with the U.S. market in the months ahead.

Regional indexes also suffered losses over the past week. In Japan, the Nikkei 225 Stock Average retreated 6%. At the same time, South Korea's KOSPI fell 2.8%, and China's Shanghai A-Share Index dipped 1.1%. The biggest declines happened in India and Hong Kong. India's Bombay index was down 9.1%, and Hong Kong's Hang Seng Index fell 7.5%.

The only major Asian market that experienced gains was Taiwan. The Taiwanese market was up 1.4% in the past week. Taiwan's socks have gotten a boost lately due to the upcoming presidential election there. It's widely expected that the pro-China candidate, Ma Yin-jo, will win the election on March 22. If he wins, increased economic cooperation with Mainland China will be bullish for Taiwanese companies and the economy.

Also this week, shares of financial companies listed in MSCI's Asia Index plunged 7.8%. Financial shares have slumped 18% this year, the biggest drop amongst the benchmark's 10 major industry groups. Not surprisingly, the share prices of financial stocks have decreased as global losses and write-downs on U.S. subprime mortgages swelled to more than $180 billion.

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