December Update
Stocks were again volatile last week. The S&P 500 closed at 879 versus its close of 876 last Friday. The Dow closed at 8629, essentially unchanged from the prior week. There were plenty of gyrations throughout the week though.
For 2008, the S&P 500 and Dow are now down 40% and 35%, respectively. The S&P is up nearly 20% from its low of 741 which was reached in November. This intraday low actually eclipses levels dating all the way back to 2002.
The week started off with a large rally when President-elect Obama unveiled his plan for a large stimulus which focuses on infrastructure and energy build outs.
Later in the week, selling pressure began to mount. All eyes turned to the fate of the US automakers and potential economic fallout if they were to collapse.
Tension and selling pressure accelerated Thursday. Bank of America announced its plans to cut 35,000 jobs over three years (largely merger related). Also, JP Morgan CEO Jamie Dimon discussed that the U.S. bank is having a “terrible” November and December, blaming the “normal culprits:” mortgages, credit, high yield bonds and loans.
Friday morning, news that the Senate killed the auto bailout plan sent stocks sharply lower. Stocks regained their footing after the White House said it would be willing to extend the auto industry funds from the TARP (Troubled Asset Relief Program). The S&P climbed 6.7 points erasing a 3% loss. The Dow climbed 65, while the NASDAQ climbed over 2%.
More broadly, while equity market volatility and bad economic news remains the norm, we are encouraged by the performance of equities over the last few weeks. There is now resilience, which is noticeably different than the swift and relentless declines witnessed in early to mid fall.
That period was punctuated by panic selling as investors started to come to grips with the depth and magnitude of the problems facing the world economy. Of perhaps greater magnitude, large financial institutions were in the midst of a painful process known as ‘deleveraging.’ Deleveraging is process whereby institutions (particularly hedge funds and large financial institutions) are forced to sell assets to pay down the lines of credit that are being called by their lending facility. Forced liquidations like this (unlike fundamental ones) create a viscous cycle. The more the market declines, the more participants have to sell, and the more participants have to sell the more the market declines. While painful, it is a curative process that takes excesses out of the system, which eventually can allow asset prices to rise going forward.
In contrast, market action from the November lows has been much more constructive. Yes, the market is higher, but even on “down” days the selling appears more “orderly” and not full of panic. Earlier in the fall, sellers met no resistance what so ever and totally overwhelmed any buying activity. The market wound up in what seemed like constant free fall. Not so of late.
Perhaps more importantly, we also are seeing several cases where worse than expected economic or earnings news comes out, yet stocks actually go up.
For example, on December 5 it was reported the economy lost over 530,000 jobs for the month which was far worse than expected. Yet, stocks rose sharply. This may indicate that the forced sellers are out of the market. Hedge funds are reporting high cash balances, which may signal at least a temporary respite from the deleveraging phenomenon.
Or, it may indicate stock prices were already so depressed they reflected horrible economic news – and then some. There is no rule that says stocks have to immediately settle to fair value – dislocations above and below true value can be large and persistent. Perhaps investors now can quantify the depth and magnitude of the recession (which officially began last year) and its impact on earnings (which most expect to be quite severe). This way, instead of worrying about which financial institution will fail next, we can all look out to the other side of the canyon, and start assessing long term value, which is quite possibly higher than where we are today.
No one knows if we’ve hit bottom, and plenty of challenges remain. News flow will likely be negative for a while. But recent action has been more encouraging, however. If in twelve to eighteen months we are rewarded with substantially higher equity market values, we may look to this period, when stocks stopped going down on increasingly bad economic news that marked the turn.
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