Market Commentary: August 2008
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Capital Markets  

The analogized three-headed beast of the capital markets remains relentless, represented by the financial markets, housing environment, and inflationary pressure.  In July, it was the financial markets that dominated the beast, with the IndyMac Bank closure and questioned stability of Fannie Mae and Freddie Mac.  The federal government attempted to ease concerns with the FDIC assurance for insured assets of depositors as well as reiterating its support of the troubled government sponsored enterprises.    

Meanwhile, the other heads seemed to have lost strength, at least temporarily.  Consumers received a slight reprieve from inflationary pressures as gas prices retreated during the month.  Some measures of home sales and inventories have also recently slowed their rate of deterioration, after an extended period of downturn. 


Source: PMFA  

Equity markets were mixed for the month.  Small caps showed resilience in July, particularly small cap value which rallied over 5%.  The other equity sub-asset classes, including international equity, continued their pullback.  The Dollar strengthened nominally during July, further exacerbating local market losses in the EAFE.

VIX - CBOE S&P Market Volatility Index – History

Source: Yahoo Finance

Volatility spiked again in July following the insolvency of IndyMac Bank and the heightened concerns surrounding the stability of Fannie Mae and Freddie Mac.  While the economic horizon remains clouded, we continue to expect heightened market volatility over the near term. 


Source: PMFA  

Emerging market currencies, as measured by the JP Morgan ELMI+ index, continued to be a positive performer.  The relative strength of emerging market currencies and attractive yields remain positive fundamental contributors to their outlook.  Municipal bonds experienced a reversal from June’s negative performance and are now outperforming their taxable counterparts on a year-to-date basis. 


Source: PMFA

Soaring gas prices began to curb consumer driving behavior, allowing inventories to build a bit and contributing to a decline in prices.  The broad commodities complex also pulled back nearly 12% for the month, led by the downturn in energy.  With that sharp reversal, nearly half of the gains realized by commodities year-to-date were wiped out.  REITs bounced back with a positive monthly return after a double-digit decline in June, yet they remain in negative territory year-to-date.  Hedge funds continue to tread water this year, as the CSFB Tremont Hedge Fund Index remains up only fractionally in 2008.

Economy

GDP  

Aided by the economic stimulus package, the economy grew by 1.9% in the second quarter, based on the advance estimate.  This result was met lukewarmly by the market, which had raised expectations to a 2.3% rate in the early weeks of July.  Annual revisions were also released which adjusted GDP growth for the past several quarters.  The most notable revision was to Q4 2007, which was revised downward to a negative 0.2% annualized pace.  Expectations are for economic growth to remain sluggish and likely decelerate again through the balance of 2008 given ongoing credit woes, expected further deterioration in housing, and the exhaustion of the temporary liquidity provided by the tax stimulus checks.        

Real GDP & Personal Consumption – Quarterly % Change


Source: PMFA, Bureau of Economic Analysis (BEA)  

Interest Rates 

Hawkish rhetoric is increasing from the Fed, but in the short-term, it appears that maintaining accommodative monetary policy holds center stage.  The need to continue to provide liquidity to the banking system in an effort to avoid any further freezing up of activity and the broad expectation of a softer economy over the next few quarters appears likely to keep the inflation hawks at bay for now.  

Expectations are for the Fed to hold steady at their August meeting.  Inflationary pressures are being felt globally, and many Central Banks have been considering or implementing rate increases to combat it.  Fed Funds futures currently suggest that an increase in the rate is somewhat probable by year end.

Current Probabilities for future FOMC Meetings

Source: PMFA, Bloomberg  

The yield curve steepened nominally during July.  Shorter term yields fell 22 basis points, as measured by the 3-month Treasury.  The 10-year Treasury remained virtually unchanged, while longer-term yields increased marginally during the month.

Treasury Yield Curve – History


Source: PMFA, U.S. Treasury

Inflation  

Energy prices remain among the primary catalysts driving the reflationary cycle.  The trailing one-year consumer price index (CPI) increased to 5.0%, a 17-year high.  Producer costs have increased to a materially greater degree, reaching a 12-month change of 9.1% for the PPI, the highest pace since 1981.  

Inflation Indices – 12-Month % Change


Source: PMFA, BEA, Bureau of Labor Statistics (BLS)

The recent decline in commodity prices, if sustained, will carry through in time to drive headline inflation down.  The Fed anticipates this easing to continue throughout the year, but acknowledges some uncertainty exists.  Excluding food and energy, core inflation indexes remain just above the upper end of the Fed’s implied comfort zone of 1.0–2.0%. 

      
Source: PMFA, BEA, BLS   

Employment

The unemployment rate reached a 4-year high in July at 5.7%.  The labor market continues to weaken, as initial jobless claims spiked to 448,000 during the last week of the month.  Although opinions remain mixed regarding whether the US has entered a recession, job losses have been more gradual than in prior recessionary periods, but consistent.  Nonfarm payrolls reported their seventh consecutive decline in July.  

Initial Jobless Claims & Unemployment Rate – Monthly


Source: PMFA, BLS  

Housing  

The housing market has been on a downward trend for much of the last three years.  In recognition of this significant deterioration, legislation was recently passed to provide some increased credit and tax incentives for new home buyers.  Gauges of the housing market have recently demonstrated a slowdown in the pace of deterioration, although housing inventories remain near historical highs.

Home Inventories & Existing Home Sales – History


Source: PMFA, Bloomberg  

The most recently reported results indicated that the S&P/Case-Shiller 20-City Index dropped nearly 16% year-over-year in May.  Foreclosures surged again in the most recent quarter.  This spiral of falling values and increasing mortgage delinquencies and defaults is likely to continue even after sales volume bottoms out.  



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Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.