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.

Thursday, January 21, 2010

Elections, Economy, and Ever-Expanding Leverage

This week we've seen an excellent example of a common saying in financial market: "Buy the rumor, sell the news." I'm referring, of course, to the senate election of Republican Scott Brown in Massachusetts on Tuesday.

Popular opinion, prior to the election results coming in, was that the financial markets would experience a rally if Brown was victorious, because of his conservative stance on health care and fiscal spending. Instead, quite the opposite occurred.

Instead, the market staged a rally on Election Day as investors speculated that Brown would come out on top. Once the results were in, however, the market took a dive on Wednesday, led by commodities and raw goods.

Despite this recent pullback, things are beginning to look up. On Wednesday housing numbers were released for December, while hinted that the recovery in real estate would continue. While housing starts declined for December, the number of permits increased, which suggests a coming change of circumstance.

Home builders do still face obstacles, particularly with regard to pricing. Many are having difficulty selling recently-completed homes because they can't compete with the prices of existing housing already on the market, including foreclosures.

This fact, though unfortunate for builders, reveals an important fact that investors need to note. It tells us that currently many homes on the market are selling below their replacement cost, a condition which, while beneficial for buyers, is not sustainable for any extended period of time.

This circumstance can be corrected one of two ways: either housing prices begin to rise, or replacement costs fall. While the former is certainly more likely than the later, one development in the markets may contribute to falling replacement costs.

As noted previously, and in previous blogs, the prices of commodities have lately been falling across the board. While certainly not the only cause for this development, the Chinese government has undoubtedly played a role the recent decline in prices.

The Chinese government, in recent weeks, has been ‘encouraging' Chinese banks scale back lending, for fear that they are creating asset bubbles, particularly in commodities. Reports lately have attributed this rise in prices to prospects of future economic growth, but recent government actions seem to suggest otherwise, and that speculation may have played a role.

Unlike the Chinese, who appear to be students of history, intent on not repeating past mistakes, US bankers seem to be back to many of their old tricks. Recently released information indicates that many banks have, in recent months, been ramping up many of the lending practices that contributed to the financial crisis.

While credit is finally beginning to loosen for many well-capitalized companies and individuals, it has been flowing for months to financial firms including hedge funds and traders. This has allowed traders and hedge funds to trade on margin and establish massively leveraged positions. Should the market take a second dive, the ensuing deleveraging could easily take stocks back to lows set in March of 2009.

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