Special Market Commentary: October 15, 2008
After the most challenging week in U.S. equity markets in several generations, we are beginning to see some particularly encouraging developments that we have been anticipating for some time. While the Federal Reserve has been working aggressively and via increasingly unconventional means since early this year, the policy response to the current global financial crisis outside of the U.S. had been generally weak. On Wednesday, October 8, the coordinated effort to cut interest rates involving a number of key global central banks was a positive sign that the warnings sounded by U.S. officials were reverberating more loudly around the globe. Over this past weekend, additional coordinated measures were announced to bring stabilization to the financial system.
In Europe, policy initiatives estimated to reach a cost of $1.8 trillion permit European governments to invest directly in banks, guarantee loans, and provide additional liquidity to the system. In the UK, that country's Treasury recently took controlling stakes in Royal Bank of Scotland and HBOS, two of the country's largest financial institutions. In doing so, they have announced plans to directly intervene to assist homeowners struggling to meet their mortgage obligations. This was followed by plans announced in the past few days for the U.S. Treasury to invest $125 billion into nine major U.S. banks with an additional $125 billion targeted to smaller banks as well. We believe that this represents a significant step toward bank recapitalization and thawing credit markets.
As noted above, we welcome these developments and believe that they represent a turning point in terms of global acceptance of the situation and commitment to finding solutions. Clearly, the strong positive reaction in global equity markets earlier this week indicates that we are not alone in this view. However, we remain cautious about market conditions overall. We interpret this positive market response as a repricing of risk based on the expectation that the depth and breadth of the economic contraction likely improved, not that it would be avoided altogether. Moreover, we do not expect that this coordinated policy response - despite its anticipated effectiveness in addressing many credit market concerns - will be sufficient to immediately navigate the U.S. (or global) economy back into a positive economic trajectory.
Current economic conditions remain challenging. As we have previously noted, U.S. consumers remain under pressure. Inflation already appears to be receding with commodities prices falling and labor costs well in check, affording producers greater flexibility to avoid raising prices. Retail sales, manufacturing activity, and construction all continue to soften. Employment markets also remain weak as the U.S. economy continues to shed jobs. Personal income is still faltering, while average household debt levels remain high. Home values nationally continue to decline, erasing paper equity for homeowners and pulling more properties "under water" relative to the associated mortgage debt.
Collectively, these issues point to economic weakness and a struggling consumer. The issue for stock markets in the future will revolve mainly around whether or not the extent to which the economy will slow is already "priced in." The stock market will move forward if the current economic conditions are reflected in prices, and further deterioration of the economy does not come to pass. As we have stated in the past, significant negative expectations have already been priced into this market.
Looking forward, we expect that market conditions will remain very volatile, and additional downside in risk assets continues to be a distinct possibility if future developments are worse than expected. Once the market absorbs the full extent of the policy initiatives that are already underway, we expect that it will turn its attention to other concerns. Capital markets are forward looking, making them particularly susceptible to material surprises - both positive and negative. We anticipate that the first official look at third quarter GDP growth will indicate that it was very soft and perhaps negative, while corporate earnings will weaken as a result. Further, broad expectations for the fourth quarter suggest continued weakness. The key for the capital markets will be how closely those results align with current expectations; results that are materially worse than anticipated will almost certainly put additional downward pressure on stocks and other risk assets.
We will continue to monitor the flow of events closely to evaluate how best to position portfolios. In times of uncertainty, we continue to believe that casting a wide net across the range of investment opportunities, while maintaining awareness of both undue risk and sufficient liquidity, remains prudent. We believe that this market environment is creating significant opportunities for long-term investors, and we remain vigilant in our efforts to identify those which we believe to present attractive long-term risk/return profiles.
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
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.
