Quarterly Market Updates
MARKET UPDATE AND OUTLOOK : JANUARY 2009
Looking Back: Q4 2008 and Full Year, 2008
Where to begin? Frequent readers know that I usually enumerate the performance of various asset classes, styles and sectors over the preceding periods in an attempt to provide perspective on the markets. The volume of analysis on what went wrong in the financial markets in 2008, and especially during October and November, is already enormous, and promises to expand dramatically in the coming year. Readers are acutely aware that virtually every asset class, style or sector declined significantly last year, with stocks, commodities, real estate and corporate bonds doing so in dramatic fashion, including volatility not seen in nearly 70 years. How dramatic? As of December 15, the number of trading days with movement of 4% or more over the prior 100 calendar days (back to September 6) was 26, or about 36% of the trading days. Prior to September 6, 2008, to find 26 days of 4% or greater volatility required over 20 years of trading days! If you were wondering why opening up the financial pages of your morning paper was such a gut-wrenching experience last fall, there was the reason.
How bad was it? The return on the S&P 500 Index was -21.94% for Q4 and -37.0% for all of 2008, the worst year since 1931, making it the second worst year in the past century. The MSCI EAFE Index of Foreign Developed Markets stocks was down even more (in dollar terms) at -43.38%. Emerging Markets went down still more, with many down over 50%. Commodities dropped drastically, with many down over 60%, led by Oil down nearly 70% from its early summer peak at one point. As the panic reached its crescendo in late November, U. S. stocks were down 52% from their previous peak (October 9, 2007 to November 20, 2008), making this the worst bear market since the 1937-42 drop of over 60%. Corporate bonds were hammered, with many losing 25%-35% in value during the period on fears that massive defaults were only days away.
The actions of the U.S. government, as well as foreign governments, did much to quell the rising tide of unease and fear, primarily through massive injections of liquidity into the financial system and cutting of interest rates to rock-bottom levels, all in the attempt to keep credit flowing. These measures have been successful enough to this point, but much more will be required to avert a prolonged economic contraction. The U.S. has been in a recession since December, 2007, and likely just experienced our weakest quarter since 1982. The markets anticipated this beginning in early 2008, though not the severity of the contraction until September/October. Looking back is always a lot clearer than looking forward, so now it seems almost obvious that trouble was brewing. A year ago, while there were problems that we observed and commented on (see Q1 2008 Market Update on our website), it wasn’t obvious that we were heading for a once-in-a-lifetime market and economic contraction. A recent Business Week article quoted the 10 worst predictions of 2008 including comments from investment newsletter editors, Wall Street analysts, Congressman Barney Frank, President Bush, and even Federal Reserve Bank Chair Ben Bernanke. Suffice to say, with rare exceptions the entire country and financial advisory profession was surprised by the events of late summer/early fall 2008. The fact that they were unexpected made their impact so dramatic: anticipated events arrive with a whimper, not a bang.
Looking Forward: Q1 2009 and Beyond
The two questions on eveyone’s mind are simple: How bad will it get and when will it end? Of course, no one knows the answers to these and related questions about the economy and the markets. The new year has already started off on shaky footing with more bad economic news (record layoffs, bankruptcies, corporate losses, especially banks) and falling markets (S&P 500 down 5.8% and MSCI EAFE down 8.9% through January 16). There’s little doubt that the economy is in for more hard times before things start looking up. The optimists believe we could see a return to positive economic growth as soon as the second or third quarter of this year. The pessimists say we’ll be in contraction until mid-2010. After reading a large number of articles and analyses over the past four months, my view is that the economy will remain in recession through at least the first nine months of 2009, with Q4 2009 being the earliest possible positive quarter, though more likely Q1 2010 will be it. This recession will be longer and deeper than any since 1973-74, and may eclipse even that one. The wringing out of excessive leverage (borrowing) in the society, particularly at the consumer level, that has built up over the past 17 years, will take at least 2 years (12/07 - 12/09), in my opinion.
As for financial markets, we may have seen the bottom (752 on the S&P 500 Index last November 20), or not. We believe there’s about a 30% chance the market could go lower, probably during the first half of 2009. By the end of 2009, we expect the markets will be “looking across the valley” to the recovery in 2010 - 2011, and will be entering a cyclical “bull” phase. Even then, we don’t expect a return to previous highs (1,565 for the S&P 500 Index) for several years. But after the past 10 years, during which the total return on the S&P 500 Index was in the bottom 1% of all 10 year periods since 1926 (-1.38% per year), merely returning to the previous high 5 years from now would be an annual average compound return of 11.6%, plus dividends (currently about 3.5%), for a total return of 15.1%, which would be outstanding. Of course, there’s no guarantee of this, or of any specific return in the future. We don’t need to forecast a specific outcome, merely to align our strategies with the prevailing probabilities, which we believe are now more favorable for long term investors than they have been for many years.
A reminder that we will be holding a client education event on Wednesday, February 4, from 5:00 -7:00 p.m. at Round Hill Country Club in Alamo. Our guest speaker will be Douglas Pratt of Fidelity Investments who will speak on the 2009 Economic Outlook, Guests are welcome. Please rsvp by January 30.
James P. King, CFP®
January 20, 2009