A Sobering Start to Spring

March 3, 2009 Edition
Volume VIII


Inside this edition of Signature Update

- A Sobering Start to Spring
- Still, there are positive notes that we ought not to ignore.


A Sobering Start to Spring

Last week’s declines in the major US market indices were troubling to say the least. The market ‘flirted’ with a bottom that had been set in November 2008, but by mid-week it became apparent that the critical support level would not hold. Monday’s decline stretched the equity market’s slide into the third consecutive month of the New Year and raised investor fears that there may be more to come. By the close, the market had experienced a virtual free-fall and the DOW closed at less than 6,765 – its lowest level in more than 12 years.

Analysis reflects that the market is severely discounting for even lower-than-expected 2009 corporate earnings. Investors are making a clear statement that they do not expect the government’s recovery efforts to provide any measurable benefit to the economy, and while this would be tragic, it would also be reflective of the growing frustration over the ineffective, even damaging, partisan rhetoric of many of our elected representatives and media fear mongers.

The truth is that the credit markets and the banking system continue to be under tremendous pressure and though literally trillions of dollars have been funneled into the system, little appears to be coming out in the form of loans through the extension of credit. The result is lower GDP, employment rates, real estate prices and equity market valuations. Even though the M1 and M2 money supply figures (indicators of the amount of money circulating within our economy) have exploded in recent months, the velocity of money (the rate at which money changes hands) continues to be at a near standstill. The financial services sector (banks, brokerage firms, etc.), a major contributor to US GDP and a significant US services export, has been decimated and share value declines of 80-90% are no longer the exception. Other stock values have suffered, but most other declines pale by comparison to the reductions seen by the more influential players in the financial services group.

Federal Reserve Chairman Bernanke, while recently testifying before Congress, accurately stated that the banking and credit markets must be stabilized before the economy can improve. He went on to discount the likelihood of any ‘nationalizing’ of US financial institutions, and repeated his position in similar testimony Tuesday morning by stating that he didn’t believe ‘nationalization’ was either warranted or necessary. Treasury Secretary Geithner has offered similar comments in various
public statements. Bernanke also commented on the government’s 76% and 36% equity stakes in AIG and Citigroup, suggested that if further capitalization is necessary for these institutions to resume normal credit operations, it will be provided, and affirmed that greater federal oversight will be provided both AIG and Citigroup in an effort to assure the operation (credit and investment decisions) of these institutions meets the government’s goals. Any way one looks at it, this represents ‘nationalization’ – like it or not – and, as can be observed by Citigroup and AIG’s stock values, free market forces clearly do not like it.

The unemployment rate currently rests at 7.6% and will almost certainly trend higher towards 9% - the Federal Reserve estimates unemployment at 8.8% by year end, declining through 2010 and 2011. GDP declines were revised to .3% and 6.2% for the 3rd and 4th Quarters of 2008, and are expected to continue with 1st and 2nd Quarter 2009 declines of 5.0% and 1.7% respectively before making 2nd half increases of 1.0% and 2.1%.

These markets offer the very definition of ‘financial pain’, but from pain comes growth. The question is when? The S&P closed at just over 700 points Monday, clearly a buying opportunity to many, but if the S&P falls below 600, then an S&P and DOW at 50% of today’s levels would not be unthinkable – horrifying, but possibly within reason.

Still, there are positive notes that we ought not to ignore.

The US dollar continues to strengthen and has gained 9% against the Euro, 7% versus the Japanese yen, and has edged higher against the British pound. Though this will maintain pressure on US exports it also signals that global investors continue to bet on the dollar; it remains the currency of choice around the globe. The domestic equities market fell dramatically in 2008, but still closed the year as one of the best performing of the global markets; and foreign economies anticipate that the US market, which led the way into the recession, will also lead the way out.

As recently as December 2008, over 50% of money managers across the country were pessimistic over the prospects of economic recovery by year-end 2009; today barely 6% expect the global economy to be worse off one year from now (source: Merrill Lynch).

Inflation, which surfaced as a major concern in mid-2008 has become a non-issue as the year closed with the lowest inflation rate since 1955. More concerning is a possible deflationary trend that most economists suggest as far more damaging than inflation. Those proponents of the ‘absolute value of money theory’ recognize that an increased money supply, coupled with higher currency ‘velocity’ creates inflation. Given the current state of the credit system, it will be some appreciable time period before currency ‘velocity’ is high enough to support any inflationary environment; even with the recent growth in M1 and M2.

It is difficult not to fear the types of markets we’ve experienced for the last 15 months. Though unemployment rates and GDP declines offer no comparison with the 1930’s, we’ve traced roughly 60% of the market decline seen in the depression. Is it possible for us to lapse from recession to depression? Certainly. Is it likely? No. I love the adage, ‘that which does not kill you only serves to make you stronger’, and these are times in which strength will ultimately be rewarded. Even Warren Buffet, whose Berkshire Hathaway shares have fallen from $151,000 to $75,700, and whose net worth has plummeted, proclaims this as a time in which the courageous may become wealthy. Thank goodness for that.

Signature Update is offered by RIchard Haskell, Sr.,

Managing Director, Signature Wealth Management