June 2009 Market Update – Hope Springs Eternal

We’ve been reading for several months about the green shoots springing up in the economy indicating that the recession is over. Unfortunately, the green shoots refer to factors like unemployment and loan foreclosures not increasing at the same horrific rate they had been for the prior months. “BAD IS THE NEW GOOD” as some analysts are saying.

The latest big shoe to start dropping is the commercial real estate market. The extent of the damage to the financial system as a result of these loans defaulting will make the subprime debacle pale by comparison.

Another big shoe on the horizon is China’s ability to sustain itself without the massive injections of export dollars. So far both the Chinese and American economies have been running on huge government stimulus packages. Everything will depend on whether China can stand on their own once these programs end. Remember, it is their investment of those export dollars into our stock and bond markets that has sustained the bull market through the 80’s and 90’s.

Disconnect Between the Economy and the Stock Market

The markets continue to gyrate. Controlled not by economic activity as much as by the machinations of derivative trading conducted by the big banks; explaining their profits while the rest of the economy contracts.

Perhaps the biggest story to come out of the financial crisis is the size and unpredictability of the derivative markets. Although no one can be certain because derivatives are not traded on regulated exchanges, it has been revealed that the size of the derivative market is approximately 680 trillion; 16 times the capitalization of the regulated markets and 10 times the GDP of the entire world.

The potential for extreme volatility in the markets unrelated to real economic fundamentals caused by this “shadow market” is alarming.

Given the still fragile state of economics and financial markets worldwide, and until some of these systemic problems are addressed; I believe the best place for nest egg money is in short term treasurys. Short term bonds are not as subject to price declines that intermediate and long term bonds are if interest rates rise. The most important concern for the individual investor is still safety of principal and treasurys are the best protection of value.