Kass: Two to Tango
While I continue to expect some short-term market weakness, two important developments occurred over the past few days that will have a positive intermediate-term impact on the markets and on risk assets:
- Mitt Romney has materially regained his lead in the Florida primary and the likelihood of him winning the Republican nod for presidential candidacy has measurably increased as well (based on this week's Intrade probabilities). A political regime change and Republican presidential win in November must be viewed, in the fullness of time, as market-friendly.
- The Fed announced its intention to keep interest rates low into 2014. This will have a generally positive impact on equities but will have a mixed impact on financial stocks.
Let's first start with the Romney/Gingrich contest, remembering that a regime change in the November 2012 elections would be considered market-riendly and is an important precondition that I hold for the possibility that the S&P 500 regains new heights in 2012.
This morning's Wall Street Journal features a headline-grabbing poll conducted in tandem with NBC (below) that gives the impression that Gingrich is a clear leader over Romney. But when we read the fine print, we see that the poll was conducted days ago (Jan. 22-24) and only 441 Republican primary voters (a small sampling) responded. I totally dismiss the poll and question why The Wall Street Journal even published this old poll.
By contrast, below are the current Intrade probabilities (Jan. 27), which are more important to me and clearly show that Romney has resurfaced as a frontrunner for the Republican Party's nomination.
- Intrade has Romney's chances of winning the Florida primary at 91% vs. Gingrich's chances of winning the Florida primary at 8%.
- Intrade has Romney's chances of winning the Nevada caucus at 94.5% vs. Gingrich's chances of winning the Nevada caucus at 5%.
- Intrade has Romney's chances of winning the Republican nomination for presidential candidacy at 87.5%.
- Intrade has Obama's chances of being reelected at 54%.
I view the reestablishment of a large Romney lead as an important intermediate-term market positive.
Fed Policy Buoys Risk Assets, Hurts Some Financials
The second development -- that is, the Fed's announcement on Tuesday that interest rates will remain low into 2014 (and perhaps longer) -- while also a general market positive, will adversely impact certain sectors of the financial industry. If interest rates remain subdued, equities are now more valuable (in any discounted cash flow/earnings model).
That said, some areas of the financial sector (in particular) will be negatively impacted by Fed monetary policy, as net interest margins and low reinvestment rates will reduce many bank and insurance companies' earnings power and likely yield lower valuations and risk/reward ratios by threatening upside price targets.
Since I have been carrying a relatively large exposure to the general financial sector I have taken action and modestly reduced my exposure in discount brokers, banks -- I have decreased the size of my Financial Select Sector SPDR
It is important to note that I don't think there is much downside risk to financial stocks but I do think upside targets have been reduced and (obviously) industry risk/reward has turned less favorable.
That said, some areas of the financial sector will benefit from lower interest rates in the form of improved capital market activity, continued low mortgage rates and a rotation out of bonds into stocks. These include private mortgage insurers such as MGIC Investment
Banks, in particular, including Citigroup
Life insurance companies such as Prudential
Discount brokers such as Schwab
Bottom line: I believe that this week's two new developments -- namely, the improved prospects for a Romney presidential election win in November and lower interest rates -- will serve to limit the degree of market consolidation that I previously had expected in my opening missive on Monday and raise the probability that new highs in the S&P 500 will be achieved later in the year. At the same time, the prospects for lower interest rates will negatively impact certain financial companies. Net-net, I still expect a correction (though more shallow than previously thought) and a period of backing and filling ahead -- before a new bull market leg commences.