Washington to Dictate Market's Direction

The rally leading up to the Thanksgiving holiday cemented the market's current dependence on government intervention. The rescue of Citigroup (C), a flood of federal funding to jumpstart consumer lending and Barack Obama's key economic appointments, including some familiar names, trumped bad data on spending, unemployment and home sales. Our panel of experts concedes that policy responses from Washington will continue to shape market behavior for some time.

Distasteful as that may be to Ed Yardeni, the head of Yardeni Research gave the president-elect his due for assertively addressing the crisis as he prepares to take office in just a few weeks.

"[Obama] obviously gets it: He realizes that the economy fell off a cliff in mid-September, and his administration must act quickly, boldly and decisively to revive economic growth," Yardeni wrote in a Nov. 24 commentary. However, Yardeni said that "fairly conventional and lame Keynesian stimulus ideas" won't do the trick. Eliminating capital-gains taxes on investments made in small and start-up businesses would help more, he said.

Recent rally aside, the market's months-long downward spiral could continue through year's end, LPL Financial strategist Jeffrey Kleintop warned Nov. 24. He added that investors will probably take their cues from the government's moves.

"The potential near-term catalysts that may establish support for the markets include: another temporary ban on short selling for financials that may be implemented, members of the Obama transition team interceding at the Treasury to take action with the TARP funds, the Federal Reserve renewing purchases of mortgage-backed securities and undertaking guarantees of more financials," he wrote.

The last suggestion found form in the recent bailout of Citigroup, which CreditSights banking analyst David Hendler applauded in a Tuesday report.

"With the terms of the Citi package, we also note that the government authorities may not necessarily demand onerous terms that severely dilute common equity shareholders for this systemic support," Hendler wrote.

That could be the approach that finally gets things going, Yardeni wrote in a separate commentary on Tuesday: "As long as the recession persists, there will be more bad assets that need to be corralled by the cowboys in D.C. The government has simply been too focused on stabilization and not on stimulation. Still, if the government guarantees can deliver a good Santa Claus rally for the financials and the overall market over the rest of the year, that's OK by me."

Citigroup chief strategist Tobias Levkovich was the rare pundit who avoided politics in his Nov. 24 commentary, dryly noting "equity markets have not worked out as expected in 2008 on so many fronts." He cut his year-end outlook for the benchmark S&P 500 stock index to 850, not far from where it stands now. More sobering, he lowered his projection for the end of 2009 to 1,000 from 1,200. When 2007 came to a close, the S&P 500 was near 1,500.