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MARKET COMMENTARY - December 2008
It is now official; the U.S. economy is mired in recession and it is destined to become the longest downturn since the Great Depression. According to the National Bureau of Economic Research, the recession began in December, 2007 and it is certain to surpass the previous record of sixteen months. Investors have fled to U.S. Treasury securities in droves pushing U.S. Treasury yields down below 3% -- the lowest level since the mid 1950’s. When credit markets “locked up” last September, the pain was quickly felt by businesses of all size. Access to capital was essentially suspended leading to massive employee layoffs and sharp reductions in spending which, in turn, put further pressure on an already imperiled economy. By October, fear intensified as investors began to realize the powerfully negative impact brought about by deleveraging (reducing debt) by banks, insurance companies, investment banks, hedge funds and mortgage lenders. The elements of this decline are markedly different than any experienced in the last eighty years. Previous downturns were triggered by a single company – Continental Illinois or Long Term Capital, or a single event – the oil embargo in the early 1970’s and were far less pervasive. This time, the virus spread quickly from housing to the financial sectors, then to all economic sectors and, in a short time, spread globally. Financial institutions, in an attempt to “clean-up” their balance sheets, found no market for “suspect” securities and, with capital imperiled, were compelled to sell massive amounts of other securities in hopes of remaining solvent. This chain of events is certainly not all inclusive but, was very much a part of the initial trigger. Presently, sources of credit have yet to “thaw” despite aggressive moves by both the Federal Reserve and Congress to inject capital in critical areas. Housing prices have yet to bottom, automobile sales are down sharply (to say nothing about the entire industry facing bankruptcy), retail sales have plummeted and job losses and unemployment are up sharply. It is hard to characterize the current environment as anything but dismal. There is, literally, no point of reference in formulating a strategy of dealing with this crisis. The U.S. Treasury Department has already amended their initial game-plan when the intended results failed to materialize. The Federal Reserve has moved massive amounts of capital into the system with more likely to come and Congress has authorized unprecedented amounts of money for the banking and insurance industries and is likely to provide substantial funds to the automobile industry soon. Amidst all the turmoil, it is apparent that public opinion, as well as Congressional opinion, is becoming weary of the use of public funds to bail out private companies. So much for the brief commentary on the past and present. It is far more important, at this juncture, to look at what lies ahead. There is no escaping the fact that this will be an extended recession with broad impact across all sectors of the economy. We see little likelihood of the economy turning positive before the third quarter of next year. Unemployment, which tends to be a lagging indicator, is unlikely to show much improvement before early in 2010. With a soft job market for all of the coming year, consumer activity will be limited. We fully expect to see continued volatility in stock prices during the next few months as valued-induced market rallies run into hedge-funds and mutual funds selling to meet redemptions. We are, however, encouraged that current stock valuation levels are equal to or below levels where previous bear markets ended their declines. Several respected analysts have already gone on record declaring the low point has been reached. However, it is more important to identify which sectors and companies will benefit the most from the recovery. Market recoveries have always preceded economic recoveries by six to nine months. Using historical timing of market turns and assuming reasonable accuracy of current economic recovery forecasts, a sustainable stock market recovery may get underway in the first quarter of next year. With massive amounts of liquidity being pumped into the system by the Federal Reserve and Congress, it is highly probable that interest rates will remain low well into next year. The Fed has completely changed direction and in Chairman Bernanke’s words, “For now, the goal of policy must be to support financial markets and the economy” – in other words, whatever it takes! Our fixed income strategy remains unchanged. We are maintaining a low-risk profile in fixed income portfolios – all U.S. Treasury securities with shorter duration and maturity parameters then the benchmark. Industry Performance At A Glance...
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