October 31, 2008
October Economic Update
October has been a month of unprecedented volatility in the stock market which resulted in the worst month for stocks in over 20 years. The month of October alone had losses that nearly equaled the year-to-date losses through September 30. From the high in October 2007 to the low in October 2008, the DJIA had lost about 45% (excluding dividends). That one-year loss was more than the three-year loss accumulated during the bear market of 2000 to 2003. That loss was about 37% (excluding dividends).
Government bond yields are slightly higher than a month ago at 3.97%. Bond investors continue to favor certainty over risk by pouring money into Treasuries while shunning lower grade corporate issues. Even high quality investment grade corporate bond prices have suffered and are now yielding much higher spreads than normal over Treasuries. Short-term interest rates have been cut to 1% and may go lower as the Fed tries to inject liquidity into capital markets.
Inflation threats have subsided and some analysts are watching for deflation. Oil prices have declined from a high of $147/bbl to the current level of about $65. Companies that had fuel surcharges may see those costs reduced which could result in lower prices in other products such as food.
The credit crunch is being felt everywhere. Banks are reluctant to lend to other banks as well as individuals and companies. Credit is becoming more expensive and has stricter requirements than in years past. Significant government action in the US and around the world has been taken to combat the problem. In the past, other countries such as Sweden, Norway and Japan have faced weakened financial systems brought on by their housing markets, but have persevered. The quicker appropriate government action occurred, the less of a downturn they experienced. Injecting capital into markets, temporarily nationalizing their banking systems, and lowering interest rates were successful strategies which are now being implemented by the United States.
The market was expecting Third Quarter GDP growth of -0.5%. The initial estimate surprised as it was only -0.3%, but personal consumption fell at a 3.1% negative rate which is the largest since 1980. Personal consumption is expected to continue to be a drag on GDP going forward as recession worries result in less consumer spending. Slowing growth is having an impact on unemployment which is on the rise. Since employment is a lagging indicator we expect to see the unemployment rate continue to climb over the next few months. The recession is expected to occur not just in the US, but worldwide, and will probably peak this quarter.
Some of the media is forecasting a second Great Depression. However, even though unemployment is rising (currently 6%), the Great Depression saw unemployment at 25%. Taxes were high, interest rates were high, there was no FDIC insurance, the Fed didn’t act, and protectionism measures were taken. Now, we have lower taxes, low interest rates, $250,000 FDIC insurance and the Fed is acting aggressively.
The stock market has priced in a very significant economic slowdown. We will likely see more volatility in the short-term and retestings of the lows before a rally is sustained. Some analysts are calculating that the stock market is 30-40% undervalued at current levels even when slower growth is factored in. The stock market typically anticipates a recovery and begins to rebound before improvement is actually seen or felt in the economy. In the past, stocks have returned an average of 15% in the three months following the bottom of a bear market. Investors who waited until the outlook was good had missed out on much of the initial rebound in stock prices.
Investors in taxable accounts have opportunities before year-end to “harvest” their tax losses. To harvest a tax loss, a stock is sold at a loss which can be used to offset gains that are realized in the current year or future years and up to $3,000 against ordinary income each year. If proceeds are reinvested in securities that match or exceed returns on the securities sold, your after-tax returns will be higher by employing this strategy.
If you have questions about the strategy for your account, please do not hesitate to call me at 402-697-1166 or 800-395-5601.
Justin S. Anderson
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