Trading Patterns Emerging For 2009

January 7, 2009

To all the traders looking for market direction, saddle up, we're unofficially in a trading range. Following September and October's monumental collapse in global and domestic indices, stocks have been trading in the 8,000 range for most of the last two months, and the trend seems likely to continue.

Forecasting market direction has been anything but a sure thing of late, yet a trading pattern is emerging based on fundamentals and the expectation for continued weakness in the labor market. On Wednesday, the ADP report suggests the private sector will lose just under 700,000 jobs for the month of December. Friday brings the official Labor Department report; analysts are expecting an estimated 500k decline, causing the unemployment rate to drop to between 6.8% and 7.1%.

Massive softening in the labor market coupled with projections for huge infrastructure and government stimulus spending translates into a probable tug-of-war between bulls and bears. A near-1,000 point trading channel might have been considered too large a range just a few years ago, but 2008's extraordinary volatility has changed most preconceived notions of what is normal behavior on Wall Street.

Will the safe-haven trade continue in 2009? The short answer is yes. Making money in Treasurys has been almost too easy as rising prices depress yields to record lows. At some point, the trend must reverse as equity yields improve and risk aversion subsides. Yet fear is still driving investors into the arms of the U.S. Treasury and the Federal Reserve.

Will the commodity trade rebound following nearly half a year of deleveraging? The answeris less clear than the flight-to-safety question. The global recession, responsible for lowering demand and crushing commodity prices off their summer of 2008 highs, has shown no signs of abating. Friday's jobs report will affirm a foregone conclusion: The economy is not approaching a recovery in the first half of 2009. If economic activity does not pick up, commodity prices find little demand-side support. Yet there are signs of supply-side support, especially in the energy trade. This past week, crude rebounded from $40 to $50 on the back of the Israeli-Palestinian conflict and the potential for supply disruptions.

Will attractive valuations and historically low stock prices lure investors back to the table? Taking Citigroup for example, in 2007 the banking supergiant was at one point the largest company in the world as measured by market capitalization. Following the fallout of systemic risk and a historic crisis of confidence in financial institutions, common shares of Citi traded below $4 per share by December, down from the mid-$50's reached in 2007, despite having billions of dollars in marketable assets. If hedge fund redemptions slow and markets stabilize, valuation buyers could provide a soft floor for stock prices.

If we are set to be range-bound over the near term, infrastructure could be the upside play of 2009. President-elect Obama has announced expansive plans for a crusade of fiscal stimulus, focusing on infrastructure spending and investment in alternative energy research and production. Regardless of Wednesday's Congressional Budget Office report predicting the U.S. deficit for 2009 will exceed $1 trillion, ex-stimulus plans, Wall Street is banking on record fiscal spending this year. Given the U.S. government's historically gaudy and contemptible spend-without-a cause mentality, a little more debt expenditure (To the tune of trillions of dollars) seems likely.

So get ready for a roller coaster ride of a different sort compared to last year, as stocks ride over similar ground for the next few months. Luckily, there is money to be made up and down the track.