While we believe the markets and economy remain on the path for our base case detailed in our 2009 Outlook publication and modest gains in the stock and bond markets, we are watching key drivers closely for indications that would shift developments toward the bull or bear cases we also detailed there. Last week, we presented important credit market barometers and this week, we are focusing on important policy actions. The effectiveness of the Obama administration’s bank rescue plan discussed in last week’s commentary and the fiscal stimulus package moving through Congress are important drivers of the economy and markets in 2009. However, significant trade policy changes may also have a pronounced impact – the Obama administration’s economic stimulus package passed last week by the House contains provisions that other nations may view as protectionist. Historically, a shift toward protectionism has been a potent negative for the markets, and such a shift this year could tip the balance toward our bear case and further sharp market declines in 2009.
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Since his inauguration President Obama has been moving swiftly to address the recession and financial collapse, but in some areas the recovery effort has been stalled by the transition and other issues. Also, a raft of post-September economic and financial market statistics have been coming out that document a serious recession around the globe. All this bad news has slowed the “healing” in credit markets and led to further weakness in equity markets. The S&P 500 is down about 10% so far this year, but still well above the low hit last November. Hardest hit have been Financials, down nearly 30% year-to-date due to economic conditions and the dithering over how to use the Troubled Asset Relief Program (TARP). Industrials and Consumer Discretionary are the second and third worst performers, while Healthcare and Utilities are down less than 2%. Given the economic backdrop, this relative performance picture indicates that investors may be through with the undifferentiated panic selling we saw in the fourth quarter, and are returning to discretionary investing based on policy and economic indicators.