Looking Back: Surviving Landmines |
By Mike Frazier
That’s what it’s felt like so far in 2008: surviving economic
landmines. This was the worst quarter for stocks since 2002. The “R-Word” was the recurring theme. The possibility/probability of recession struck fear in investors
as the housing market deteriorated and bad debt accumulated. The American Consumer has been plagued by escalating food and energy costs for quite some time, but with the weakening of the housing market and increased foreclosures, American discretionary spending has shrunk at the expense of the U.S. Economy.
The crisis in confidence, both in the economy and capital markets, has sent stocks lower the world over. The S&P 500 has fallen 10% so far in 2008. This pales in comparison
to the international markets, where France, Germany and Japan each fell more than 16% this year, and China’s Shanghai index plummeted 34%. Pain and fear have been felt across the globe as toxic loans jumped the Atlantic
and Pacific. U.S. demand for foreign goods could shrink. |
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To address the credit crunch, the Federal Reserve has been vigilant in cutting interest rates to stave off recession and bring stability back to the markets. Casting fears of inflation aside, the Central Bank began performingsurgery |
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on the U.S. economy. In addition, the White House pulled a lever to re-ignite the economy by introducing a stimulus package, in the form of rebate checks that will hit Main Street by Summer.
Amidst all these pressures, commodity prices continued to surge. Both crude oil and gold hit record levels climbing 15%+ in the process. Fundamentals have supported the strength in these commodities, as global demand remains strong. Since both trade in U.S. dollars, however, speculators have actively driven them higher as the U.S. dollar weakened. Commodity prices are off their highs, but remain elevated and a thorn in the side of the consumer.
Stocks were sold across the board, as appetite for risk evaporated. A flight to safety has taken the ten-year Treasury
yield down to levels not seen since 2002 when the dot-com bubble burst. Blue chips aren’t given credit for their quality and track record. Growth has been ignored in the face of fear of the unknown. Rallies were sold, and cash positions are at record levels. Pessimism is the highest
it’s been since 1998. Investors are more negative now than they were in 2002. Psychological lows have historically
coincided with Market lows.
Does this imply that the worst is over for the stock market for this period in history? We think so. The Federal Reserve
is focused on restoring confidence in the market and keeping the U.S. economy on life support while we get through the challenges. It’s always easier to pick a market bottom than predict a top. Why? Bottoms follow predictable
patterns of behavior, whereas market tops behave maniacally and often work outside-the-box.
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When hedge-fund Long Term Capital Management failed in 1998, the Asian market collapsed. Recent news of Bear Stearns’ pending demise this month was strikingly similar in nature, and will undoubtedly be the face of this financial credit crunch for years to come. Was this the cathartic event the Market was looking
for to finally move forward? History suggests it is. It’s not uncommon for a major financial institution to go under near market bottoms. In addition to LTCM in 1998, there was the Orange County Savings |
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| & Loan scandal in the 1990’s, Continental Illinois Bank in 1984 and Penn Central
in 1970. The commonality of these important events was that significant market bottoms occurred within three months of the crisis. The basis for our optimism is outlined
in our Looking Forward column which follows. |
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Looking Forward: Passing the Torch |
By Jude Bedell
The Olympic Torch left Athens enroute to Beijing for the Summer Olympic Games. It will cross oceans, deserts and mountains.
While this momentous journey is taking place from now until 08.08.2008, another is happening on Wall Street. Stock markets have traveled through euphoric buying, dissolute selling, false bottoms
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and sucker rallies to pass from one bull market to another, with a bear run in between. This process cannot be prevented. It needs to be respected. It’s a difficult passage that requires tough decisions.
We are ready for the task.
This challenging course will be overcome by investors who “get it” on both a gut level and an intellectual one. We are talking about globalization which embraces the reality of science and technology advances. Innovative technology transforms old-world markets into futuristic dynamic economic units. The natural outcome should result in dissolving country borders, which will promote wealth all over the world. We envision a new marketplace for US goods and services: a bull market for the esteemed “made in America” label on American goods and services
which will be hyped during the upcoming Summer Games. |
4 billion people will see familiar American icons emblazon their TV screens with logos of Coca-Cola, Apple Computer and General Electric. Yes, really: 4,000,000,000 will watch the games worldwide, a 25% increase over the 3 billion who watched the Athens 2004 event. Opportunistically, now is the time for investing in such stalwart stocks because they also wear an invisible label: recession-proof. For decades during economic slow-downs like we are now |
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experiencing, smart investors hid comfortably in solid growth stocks like Coke, Apple and GE while less predictable stocks are more vulnerable to market and currency vagaries. Common sense investing is alive and well where growth trumps value.
In the meantime, we are faced with a bear market which declines 35% on average. We are already in a bear market,
currently down about 17% from the highs of last October.
But when will it end? Soon! Very soon. And where will stocks go from here? Higher, much higher. Think a 20% increase from current levels but first comes the relief rally, which began in mid-March. Next comes the real rally which is building momentum right now. That said, we do not expect anything to crystallize without wild gyrations from the upside trend line. |
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The credit crunch of 2007-08 has created one of the worst hangovers in American financial history. The burgeoning global economy has created new wealth at a staggering rate, and the volume of money that needed deployment was off the charts. |
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Remember the old adage: The best returns are found where capital is scarce. It didn’t apply but was more important than ever. Since 2003, money was chasing everything, driving assets higher, it was the most liquid environment in memory if not ever. Hedge funds emerged by the thousands, using leverage as their greatest tool. Sovereign wealth funds, based in emerging markets became a new financial powerhouse. American mortgages changed hands multiple
times, with the trace to the original loan underwriter opaque. Literally, billions of dollars raced across the globe with the click of a mouse.
If the word “billions” doesn’t impress you, think of this: a billion seconds ago it was 1976; a billion hours ago, our ancestors were living in the Stone Age; a billion days ago, no one walked the Earth on two feet. |
Billions of dollars were loaned expeditiously, particularly into the U.S. housing sector. Borrowers
were handed capital without documentation or evidence of ability to repay. The joke was that anyone with a pulse could get a mortgage, which wasn’t far from the truth. Aggressive mortgage companies abandoned strict policies to make a sale. The loans were basically asset-based loans, and the |
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bet was that house values would continue to climb. For all intents and purposes, the borrower’s credit quality was inconsequential.
The result? Debt positions soared while the value of the assets sank. Last Summer, when it was clear that some financial institutions
were over-extended as the housing market fell, the liquidity
spigot was shut off and the money well went dry. Financial company balance sheets deteriorated when forced to write-down bad loans.
The Fed has made major strides to address this financial mess by lowering interest rates so that banks could lower their borrowing costs and make sure that money would once again flow to those in need. Call it a cleansing if you will. Bernanke and Company went a step further by actually taking on some of the toxic paper on its balance sheet in a trade for ironclad treasury securities. More time will be needed to evaluate this intervention but so far it seems to be working. Much needs to be done to ensure that this crunch will never re-occur.
Dramatic reforms to our American financial system were announced
on March 31st by the Bush administration. It could be the most far-ranging overhaul of the financial regulatory system since the stock market crash of 1929 and the ensuing Great Depression.
The plan would change how the government regulates thousands of businesses from the nation’s biggest banks and investment houses down to the local insurance agent and mortgage broker.
States rights over banking and insurance regulation will be hotly contested as the plan proposes more Federal control such as:
- Giving the Federal Reserve more power to protect the stability of the entire financial system while merging day-to-day bank supervision into one agency, down from five at present.
- Creating one super agency in charge of business conduct and consumer protection, performing many of the functions of the current Securities and Exchange Commission.
- Eliminating the Office of Thrift Supervision and the Commodity Futures Trading Commission, merging their functions into other agencies
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| Some of the plan is well overdue for modernizing our financial system but some of it will be difficult to agree on when it’s time to make the sweep of this plan into enforceable laws. We can only hope these reforms happen quickly. |
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