The Bailout of Fannie Mae and Freddie Mac

By: Paul_J_Nolte

The official take-over of Fannie Mae and Freddie Mac has begun. Whether this is the beginning of the end or merely the end of the beginning is yet to be determined, however it is certainly the hope that this move will begin to calm the housing market and allow mortgage money to once again flow. The effect of money back into housing should put a floor in the housing markets, but those effects will only likely begin to show up in the data a few months from now.

On top of the swirling around housing and the lack of punch in the most recent hurricanes, the job market has provided it's own swirl, as the jobless rate climbed to over 6% and non-farm payrolls lost over 125,000 jobs (with revisions included). We anticipate that before the job market turns around, we will be averaging over 100,000 job losses per month and based upon the current trajectory, that would likely occur mid-'09 at the earliest. With the news breaking over the weekend on Freddie and Fannie, much of the economic news coming up this week will likely be buried by the government actions. We do have an inflation report, trade and consumer related reports on retails sales and credit. Outside of the Washington focus this week, there should be additional data pointing to overall economic weakness. Monday morning should be fun!

We talked last week about “confirmation” of the recent move higher or resumption of the June/July decline. Given the huge reversal early in the week (and a very small one at the end), our guess is that the markets will be heading lower over the coming weeks. The BIG question is how low can they go? Based upon strictly fundamental valuations of the markets, our guess is the worst could take the markets down another 15-20% before finally bottoming around 1000 on the SP500.

The markets finally enter relatively inexpensive territory just 4% below current levels. So the risks remain relatively high that at least one more large decline looms in the future. There are also the beginnings of a bottom in some of our indicators that could point to this decline being the last - ultimately set up the markets for a rally as we enter 2009. This does fit with the notion that the stock markets bottom in advance of the economy bottoming – which we are figuring sometime mid-'09. Keep an eye on the financial sector, as a rally in these stocks could lend credence to the “bottom is in” theory.

The bond model continues to benefit from the decline in the CRB index. Interest rates are projected to decline over the next few weeks – even as the bailout of Fannie and Freddie are likely to add to the amount of bond issuance in the months ahead. An interesting thought on oil prices: on their way to $140+ it was thought that the prices would rob consumers of spending money. Now that prices are falling, the discussion is about how the lower prices are a reflection of a weak global economy. The roughly 10% decline in pump prices is not quite the 25%+ decline in a barrel of oil, but neither will be making much of an impact upon the still strapped consumer. We'll get a check on spending habits with the release of retail sales and consumer credit this week – may be enlightening.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2008 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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