More companies and municipalities were able to issue bonds, and more businesses were able to re-establish lines of credit with their banks. Another major bank (National City) went off the air without depositors or bondholders losing a penny as it was merged into a more healthy rival (PNC Bank).
The leading economic indicators for September were +0.3%, which gives some credence to my thoughts that the economy was about to turn the corner and move on to recovery just prior to Lehman Brothers going bankrupt and the financial scare sending the stock market down another 1,500 points.
Existing home sales also surprised on the upside, suggesting that perhaps the economy is starting to work toward balancing higher demand due to lower prices with escalating supplies due to the foreclosure problem. I don’t think the housing market has turned the corner, but sometimes just a small improvement at the margin (we not getting worse anymore!) can make a significant difference.
I still applaud the Federal Reserve, and to a lesser degree the Treasury, for their aggressive response to the crisis. We will definitely look back at this time period and have some criticisms. Did the taxpayers really just give Goldman Sachs $10 billion so that they could pay out obscene bonuses to the "Masters of the Universe" who engineered the recent collapse, or will Warren Buffett put a stop to such nonsense because he, too, needed to pony up to the bar to keep Treasury Secretary Paulsen's alma mater afloat?
Peter Fisher, a BlackRock Managing Director, noted that we may look back and conclude that Bernanke and Paulsen erred in March by issuing a public warning that all banks need to go out and raise more capital. "The only thing worse than yelling fire in a theatre," Fisher said at a recent Conference on De-leveraging, "is having the Fire Marshall do it for you." By the time that Lehman failed and the financial crisis began in earnest, the financial markets were primed with an unprecedented amount of fear. It's not clear that this climate could have been avoided. On the other hand, had the Lehman failure been contained (as was the Bear Stearns bailout), who knows what pain might have been avoided.
The market has re-tested its October 10 low, and thus far it has held up. It is a fragile victory at this point, but an important one. It seems to me that the U.S. market wants to bottom, but the global market sell-off, which now exceeds the U.S. market plunge, may not let it. If the foreign markets can't catch a bid, the current bottom may not hold.
In the meantime, we're probably going to get another round of interest rate cuts across the globe. Next week, the Treasury will start buying commercial paper (very short-term bonds) of real businesses - to enable companies that actually make and sell things to keep people working. Thus far, the banks are mostly sitting on the money they've (just) received from the Federal Reserve. They're using it to "de-leverage" their balance sheet, rather than using it to make new loans. They're using it to take over other failed institutions. They're using it to pay down debt. We need it to find it's way back into the economy. Perhaps General Electric, which has said that it will take advantage of the new Treasury program, will use it to pay down some accounts payable so that Joe the Plumber has some money next weekend to go out to eat.
The money from the Treasury is starting to flow into the system. However, in econ-o-speak, what has also happened is that the "velocity" of money has dropped considerably. People have a bit less of the green stuff, but even more importantly they're afraid to spend it because of the lingering uncertainty. Economic activity can come to a standstill if no one is willing to spend what they've got. At the bottom of the 1933 Depression, at his inaugural address, Franklin Delanore Roosevelt said, "the only thing we have to fear is fear itself." This problem, fortunately, is not structural - but rather psychological. After 9/11, the nation was similarly paralyzed. I would expect a similar economic reaction for the balance of 2008 and into 2009. There will be a sharp slowdown, but it need not result in economic disaster if the global selling can be contained and people gradually return to more free-spending ways.
In the future, the most leveraged companies and individuals will have to adjust. The de-leveraging of America has begun and will likely last for several years. Some of the adjustments will be painful, but a doom and gloom forecast suggests that the economy will come to a standstill and remain there for a long period of time.
I have more faith in the Fed than that. The Federal Reserve is bound and determined to get money back into the system to offset some of the wealth destruction that has occurred. Though Greenspan should have taken away the punch bowl a few years back, before the real estate market began to froth, now the punch bowl is back, full, and the government is handing out chasers to anyone near the front door.
So, does that mean we're about to put our remaining reserves back into this market? I'm now on my third week of waiting and watching, mostly. We went into individual portfolios to rebalance the current positions which, given the severity of the sell-off, left some positions under-represented while other, more defensive holdings (which hadn't sold off as quickly) were over-weighted. We evened out the weightings, but still have cash in reserve which we're hoping to reinvest while there is still upside to the market.
I've been digging deep into my research files to confirm that stocks go both ways, both down and up. It's getting hard to remember that, some days. As the money returns to the economy and nerves settle, I expect that we'll soon be reminded of the good side of stock volatility.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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