Comments from BCA Research

The recession is deepening, in terms of key consumer indicators such as employment and spending. Some surveys are showing that sentiment has bounced a bit, albeit insignificantly relative to the plunge in the second half of 2008. Importantly, leading economic indicators are still pointing down, as are leading gauges for inflation.

Against this backdrop, policymakers are going all out to support the financial system and provide some fiscal stimulus. So far the results are unimpressive in terms of easing lending standards or lowering private sector borrowings rates. Our expectation is that the authorities will continue to provide stimulus until the economy stabilizes, but this could still take some time and any recovery will be slow to develop.

The fed funds rate will hover at zero until the economy has decisively gained momentum and the credit creation process has been restarted, i.e. at least through to the end of 2009. The recent rebound in Treasury yields has been driven by fiscal angst and inflation fears, both of which should diminish in the coming months because higher yields reduces the odds of economic recovery. The Fed may soon purchase Treasurys if yields keep rising. In terms of fixed income sectors, we still prefer those credit areas where the government is providing direct support, as well as higher-quality corporate bonds.

For stocks, the slide in earnings and lack of positive guidance remain powerful headwinds. Good value and policy stimulus suggest that the late-2008 low should hold, but a sustained rally awaits some glimmers of economic hope. Most likely, a volatile bottoming phase will occur, similar (but longer lasting?) to the environment after the crash of 1987. Only a gradual nibbling in favored equity sectors is recommended.