Weekly Wrap

The Thanksgiving holiday made for a short week of trading, yet the major indices still made huge moves that no doubt left investors something added to be thankful for when the closing bell rang Friday.

Government action was a key catalyst for this week's rally, as a rescue of Citigroup (C), the unveiling of President-elect Obama's economic team, and an $800 billion plan of attack for getting credit flowing smoothly again for consumers drove a continuation of buying efforts that perked up in the prior week after the S&P 500 hit a new low for this bear market and touched levels seen in 1997.

The gains were extreme in many cases.  The market itself soared 12%; however, it ended the week at a level that was 21% higher than the low seen only five sessions ago.

The financial sector played a huge part in the big gains. 

Buyers returned to the beaten-down area after the government said it would provide a guarantee for the bulk of $306 billion of troubled assets identified at Citigroup.  In turn, the government also said it would take an additional $20 billion of TARP funds and inject it into Citigroup by purchasing the bank's preferred stock.

While there were other provisions for the relief the government provided to Citigroup, the main thrust for the market was (a) that Citigroup wasn't going to be allowed to fail (b) that Citigroup wouldn't have to sell core assets at distressed prices to raise capital (c) that common shareholders were spared in the rescue plan and (d) that it was reasonable to expect other financial companies would get similar guarantees if need be.

On the heels of the Citigroup rescue, the Federal Reserve, in conjunction with the Treasury Department, announced Tuesday that it is creating a new $200 billion facility focused on getting liquidity flowing in key asset-backed securities markets that help facilitate auto loans, student loans, credit card loans and small business loans.

In addition, another $600 billion will be allocated for the purchase of direct obligations of government-sponsored enterprises and mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae in an effort to help drive down mortgage rates and improve conditions in the housing market, which lies at the heart of the financial crisis.

Word of the latter initiative did help drive down mortgage rates and improved the general tone of the market, as there was a measure of relief in the thought that the government is finally concentrating its attack in the right place.

Even so, there remained an underlying sense of skepticism with respect to the stock market rally given that more bad economic news was heard and knowing that past rally attempts following government rescue plans have all failed.

Furthermore, there was reason to question the sustainability of the rally considering the 10-year note yield reached its lowest level on record (2.91%) in the midst of it and that Libor rates went up across a number of time horizons, including the widely-watched overnight and 3-month rates.

If there were strong conviction behind the idea that the latest initiatives were going to be successful in getting banks to lend willingly again, it seems that Libor rates should have come down. 

The wrinkle here in assessing the situation is that banks typically aim to bolster their cash holdings to meet increased year-end funding needs, so it is too presumptuous at this juncture to think the bump in Libor rates meant there wasn't confidence in the government's efforts to inject liquidity into the financial system.  That could be the case, yet there won't be a better understanding of the matter until after the new year.

For this week anyway, participants largely set aside such concerns and took advantage of deeply marked-down equity prices.  To wit, Citigroup surged 111% this week while General Motors (GM) jumped 71%.  Pulte Homes (PHM) and Goldman Sachs (GS), up 50% and 48%, respectively, were examples of other big gainers.

From an economic standpoint, there wasn't much good news.  Q3 GDP was revised down to -0.5% from -0.3%, durable orders slumped 6.2%, existing home sales fell 3.1%, new home sales dropped 5.3%, personal spending declined 1.0%, and weekly initial claims, while improved from the prior week, continued to register a reading above 500,000.

The consumer confidence report, remarkably, showed an increase from the prior month as falling gas prices helped sentiment, yet the confidence reading remained at historically depressed levels.

That the market managed to look past any worrisome news, including a well-orchestrated terrorist attack in Mumbai, India, suggested it had gotten to a point where prior selling efforts had been exhausted.

The selling this month has been significant, too.  Despite the big gains in this final week of trading, the market still declined 7.5% in November.

The coming week is sure to bring more Christmas music... and a test of the newfound bullish bias. 

--Patrick J. O'Hare, Briefing.com