US INTEREST RATES

10-year T-note prices surged to an all-time high and have rallied by more than 11 full points in the last  1-1/2 months. The 10-year T-Note yield plummeted to a record low of 2.98% and is down by 112 bp from  last month’s 4-month high yield of 4.10%. Bullish factors for T-Note prices include (1) the Fed’s planned  purchase of as much as $600 billion in mortgage securities, prompting investors to purchase Treasuries to  offset the shortened duration in their portfolios that would otherwise occur from the sale of longer-term  mortgage bonds from their portfolios, (2) the prediction from Goldman Sachs that the US recession will be  deeper than previously expected as the US unemployment rate surges to 9.0% by Q4 2009 and that the  US economy is weak enough to send 10-year T-Note yields down to 2.75% by the end of Q1 2009, and (3)  the larger-than-expected decline in the Nov Chicago purchasing managers index to a 26-year low (-4.0 to  33.8 versus expectations of –0.9 to 37.0). Bearish factors include (1) for US government’s actions in  backstopping $306 billion worth of Citigroup’s toxic assets, and (2) the Fed’s plan to set up a $200 billion  program to promote consumer and small business lending, potentially unfreezing lending markets and  reducing demand for the safety of Treasuries.

FOMC expectations—The market is fully expecting a 50 bp rate cut to 0.50% at the next FOMC meeting on Dec 15-16 and is discounting about a one-third chance of a 75 bp rate cut to 0.25%. The market expects the funds rate to stay at or below 1.00% throughout 2009 and not to rise above 1.00% until early 2010. 

US STOCK INDEXES

 The S&P 500 index showed a fairly large recovery rally from the recent 11-1/2 year low. The S&P index has fallen by an overall 51% from its Oct 11, 2007 record high and retraced nearly all (99%) of the 2002-07 bull market rally. Bullish factors for stocks include (1) overall market approval of President-elect Obama’s economic team with appointments of Timothy Geithner as Treasury Secretary and former Fed chief Paul Volcker as the head the administration’s new economic recovery advisory board, (2) the Fed’s pledge of up to $800 billion to unfreeze credit markets for homebuyers, consumers and small businesses, and (3) the prediction from Richmond Fed President Lacker that the US economy will regain momentum in 2009 as “monetary policy in now quite simulative.” Bearish factors include (1) Oppenheimer analyst Meredith Whitney’s prediction that US banks will post $44 billion in writedowns this quarter, (2) the FDIC’s comment that US banks categorized as “problem” institutions increased by 46% in Q3 to the highest level in 13 years, and (3) continued weak economic data that points to a deepening recession.

Earnings expectations for the S&P 500 are as follows, according to Thomson Financial: Q3-2008 (-18.5%), Q4-2008 (+16.6%), Q1-2009 (+0.8%), Q2-2009 (+6.3%). S&P 500 annual earnings are expected at -8.9% in 2008 and +11.7% in 2009 (2007 -3.7%, 2006 +16.1%, 2005 +13.7%, 2004 +20.2%, 2003 +18.4%, vs 25-year average of +8.6%). The S&P 500 forward P/E (based on forwardlooking earnings) is at 11.5, well below the 3-year average of 15.0 and far below the 10-year average of 19.1.

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