Paulson's Bold Bailout Plan Supportive of a Stock Market Bottom

By: Paul_J_Nolte

Trust me, I'm from the government and I'm here to help. In essence, those words are exactly what Treasury Secretary Paulson is saying in laying out the bailout of the banking system. He would have rein over hiring of managers to purchase the debt and be able to do so as needed without oversight from any other part of government. While desperate times require desperate measures, this might be a bit too desperate. The limit on national debt will be raised by nearly $1 trillion and gives the Treasury the authority to buy up to $700 billion in mortgage related assets. While there are few worries if the plan works, the proposal severely hamstrings the government to act on any other issue that may come up and is likely to increase government borrowing over the coming two years from sources that are already up to their eyeballs in our paper.

It is a bold plan with concentration of power and authority in the Treasury that could be fraught with more problems than we have today. Of course, even if passed, the program will not have an immediate impact upon the markets, it will be drawn out over the next 6-12 months. However, if the markets believe this is the solution, we could see some freeing up of the mortgage market sooner, which will help begin turning the economy around and allow some spending by consumers.

Much ado about nothing? From Friday to Friday, the markets moved very little, however they did so in spectacular fashion. For but a brief moment, the markets actually got near buyable ranges only to rocket higher and finish unchanged for the week. Many have commented upon the casino like feel of the markets over the past week, making actual investing a tough proposition. Based upon the late week momentum and very high volume, we can see the markets continuing their skyward trajectory for a few more weeks and tacking on another 3-5%.

However the 1300 level for the SP500 could provide some resistance, as it marks the most recent highs. There are some signs that the bottom is in, however our best guess is that we will once again visit the lows of the past week before yearend, from which the markets could set up for a more meaningful rally as the Paulson plan begins to take hold in the economy and financial institutions. Like stopping by the woods on a snowy evening, the crisis has miles to go before (I) it sleeps.

For a brief moment, the short-term bond market was so awash in buyers that the yields actually fell below zero – meaning you were paying to own short-term treasury paper. With some money market instruments “breaking the buck” and actually trading below the magical $1.00 per share the race was on to load up on the safest of all securities. While not paying anything in yield, it was more important to actually get a return of your money than get a return on your money!

The bond model, even after last week's rollicking trading, still points to lower rates ahead. The Fed took a pass last week and held interest rates stable, even in light of the market turmoil. However, we do believe that before all is said and done, the Fed will have to cut rates sometime before the economy finally turns higher.

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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