Market Commentary: February 2008
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Capital Markets
January proved to be a difficult month for the equity markets as investor fears mounted in response to mounting evidence of an economic slowdown or recession. In the domestic equity market, mega-cap stocks fared nominally better as relative returns were tied to market cap, although the spread between large cap and small cap was relatively narrow, as is typical in a broad market selloff. International equities experienced a notable correction, with losses mitigated to a degree by continued weakness in the U.S. Dollar.
Source: PMFA
Volatility spiked again in January and is expected to remain elevated given the pervasively high uncertainty in the market. During trading on the day following the Fed’s intra-meeting rate cut, the S&P 500 Index fluctuated in a wide range of over 5%. Any further news signaling potential weakness in the economy is almost certain to be met with a strong negative reaction from the market in the near term.
VIX - CBOE S&P Market Volatility Index – 1-Year Change
Source: Yahoo Finance
The flight to quality continued in January in response to increased market volatility and economic worries. Concerns about inflation and the broad rally in Treasuries drove the Lehman US TIPS index higher by nearly 4% for the month. Low grade securities continued to suffer as investor concerns about credit, delinquencies, and the prospect of rising defaults sent yield spreads relative to Treasuries higher.
Source: PMFA
Returns for Alternative Investments have been mixed in the midst of the market turmoil. Commodities advanced, helped in part by surging precious metal prices. As a perceived safe haven against both inflation and a falling dollar, gold continued to rally. REITs continued to lose ground, although concerns persist about valuations of commercial real estate despite a correction of about 30% in the Wilshire REIT Index since peaking in February 2007.
Source: PMFA
Economy
GDP The advance estimate for Q4 GDP growth was a slower than anticipated 0.6% annualized rate, much lower than the 4.9% pace in the prior quarter. Calendar year growth for 2007 has been estimated at 2.2%, continuing a trend of slow decline in the pace of growth since 2004. The primary factors contributing to the slowdown were the steepening decline in residential housing and a deceleration in consumer spending and exports.
Source: PMFA, Bureau of Economic Analysis (BEA)
Estimates for Q1 growth remain mixed; the primary source of discussion in economic circles remains whether or not the U.S. is on the verge of, or has even already entered, a recession. Congress recently passed a fiscal stimulus package that is expected to pump approximately $170 billion into the economy in the form of tax rebates for middle- and low-income taxpayers and tax incentives for businesses. President Bush has indicated that he will sign the bill shortly, and rebate checks are expected to begin arriving in taxpayers’ mailboxes in May.
Interest Rates
January was a historically significant month for the FOMC, with two cuts in the Fed Funds rate totaling 1.25%. Over the course of the last four months, the Fed Funds rate has been reduced from 5.25% to 3.0%, with additional easing expected by the markets in the months ahead.
Current Probabilities for FOMC Meeting 03/18/08
Source: PMFA, Bloomberg
The yield curve trended downward in January, particularly at the short end as precipitated by the Fed’s aggressive easing. The ten-year treasury yield ended January at 3.67%, declining by 37 basis points during the month.
Short-term rates continued their descent with the one-month treasury yield falling to a three-year low of 1.64% at January 31.
Treasury Yield Curve History
Source: PMFA, U.S. Treasury
ISM Index
The Institute for Supply Management (ISM) Services Index which represents the broad economy ex manufacturing, slipped significantly to 44.6 for January. The business activity component dipped even more significantly to 41.9, reaching levels not seen since October 2001. A result below 50 is generally viewed as indicating contraction in the service sector of the economy.
ISM Index – Manufacturing & Non-Manufacturing
Source: PMFA, Bloomberg
Employment
Employment figures were mixed during January as the unemployment rate slipped fractionally lower to 4.9%. During that same period, the rate of job creation turned negative for the first time in over four years, as non-farm payrolls declined by 17,000. This statistic is often subject to significant revision, however; we expect the February results (including the January revision) should help to clarify the current employment picture.
Nonfarm Payrolls & Unemployment Rate - Monthly
Source: PMFA, BLS
Inflation
The major inflation indices were mixed in December. Generally, the 12-month trailing percent change declined marginally for the inflation indices; however, excluding food and energy, the indices rose.
Source: PMFA, BEA, BLS
While we expect that inflation could ease in the short-term as a result of the economic slowdown, the absorption of fiscal and monetary stimulus into the economy should be expected to precipitate further inflationary pressures.
Inflation Indices - 12 Month % Change
Anticipated future inflation can also be measured by the spread between Treasury Inflation Protected Securities and nominal bonds. The current spread of 2.37% remains below the ten-year average CPI rate of 2.53%.
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Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other source believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.
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.
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