This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, December 14, 2009

End of Year Conditions Blur Trendlines

With 2009 drawing to a close, the market is now heading into end-of-year trading, typically characterized by lower trading volume and, as a result, increased volatility.

Towards the end of every year there are variables aside from market conditions that come into play which can have drastic effects across any and all asset classes.

At the end of each quarter, and even more pronounced at year’s end, many traders and investors undergo strategies of window-dressing and/or profit-taking. Window-dressing is a strategy where professionals, especially financial advisors, begin purchasing assets that have been performing well, with the intention of making end-of-year statements of client portfolio holdings appear more attractive.

Conversely, profit-taking is just what it sounds like; traders, investors, et al sell assets that have been performing well in order to lock in gains and decrease exposure to market risks. There are many reasons for profit-taking, but the underlying theme is that investors see market risks as outweigh any potential gains.

Historically speaking, window-dressing tends to bolster market returns as an influx of cash pours into already-high prices. Contrarily, profit-taking acts as a negative effect on prices, since many market participants are rushing to unwind positions before a perceived deadline.

Each year the battle rages on between these two counteracting forces, and while this year has seen remarkable returns among a wide range of investments, we feel there is a much stronger argument that profit-taking will dominate window-dressing.

One such argument is in regards to tax policy. With the likely repeal of Bush capital gains tax cuts during 2010, investors who choose to take profits before the New Year will be taxed at current rates, while those who wait run the risk of those tax rates increasing over the next reporting period.

On the other hand is the argument that we are in the beginning of a significant economic recovery, and for that reason window-dressing could be much more likely that profit-taking, and the market will likely advance.

Those who make this argument point to falling housing inventory numbers. They conveniently forget that many November home sales occurred because it was not immediately announced that the government would renew the first-time homebuyer tax credit. This had many Americans moving up their closing dates to ensure they received their tax credit.

Even more importantly, housing inventory, as it is reported, does not include the more half-million homes in foreclosure, which lenders may or may not choose to dump on an already-saturated market.

Market bulls also point the recently reported improvement in employment numbers. However, few realize that this so-called “improvement” is almost entirely due to seasonal adjustments made by Federal Reserve and Bureau of Labor Statistics. They also do not include Americans who have given up their search for work.

Fortunately, some Americans have undoubtedly found part-time seasonal work, and employment numbers may very well recover in the future, given the right government policies. In fact, a new article on CNNMoney discusses President Obama’s recent hints at changes in tax policy may provide incentive for small business hiring (Obama Touts Tax Breaks to Boost Small Business Hiring, Clifford).

According to his speech given Tuesday at the Brookings Institute, the Obama administration has recently begun considering a program for instituting tax breaks for small business who hire new employees.

Additionally, there have reportedly been talks to cut capital gains taxes for small business, also as an effort to spur employment. While the link between capital gains from company investments and employment is so far unclear, any tax incentive would certainly be an improvement.

For a brief market update, the last week has seen the US dollar strengthening and the prices of commodities simultaneously weakening. While it is unclear whether these two events are directly connected, and even more importantly, whether the dollar is beginning a significant rally.

There can be no doubt that recently the dollar had reached oversold levels, but it remains to be seen whether the currency has reversed its recent trend. However, it has certainly been showing signs of life.

Helping to fuel the dollar’s recent decline, a huge carry trade has lately built up as investors have borrowed dollars and purchased foreign assets, only to pay back borrowings later with weaker dollars.

If the dollar really has turned a corner and this trend reverses, a large rally in the dollar would eliminate this carry trade and leveraged traders would be forced to unwind their positions, making the reversal quick and violent.

This rapid change in market direction would create rampant demand for dollars as investors scramble to shed other assets to pay back borrowed dollars before they are wiped out by leverage.

So far the dollar’s strength is little more than a flash in the pan. Only time will tell whether the tides are changing or the dollar will continue its already-substantial decline.

Dock David Treece is a stockbroker licensed with FINRA. He works for Treece Financial Services Corp., www.TreeceInvestments.com. The above information is the express opinion of Dock David Treece and should not be used without outside verification.

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