Beware the Fear-Mongers
With Dick Clark counting down as the ball dropped in Times Square, 2007 has now ended. It was another good year for our clients, although it might not have “felt” too wonderful in the last half of the year.
With gains of 6.4% for the Dow, 3.5% for the S&P 500, and a healthy 9.8% for the NASDAQ, 2007 was a decent year. The strongest-performing sector was Energy. That’s why gasoline prices are so high. All of these results are excluding dividends, which, if included, raise the returns. These returns were lower than 2006 and most of the profits occurred in the first five months of 2007.
Even with recent market weakness, all three index indicators are currently above their 200-day moving averages, a common measurement of long term market strength. The fear mongers would have you believe that the markets are in terrible shape heading into 2008. Beware those fear mongers! For all the doomsday headlines, we are just a smidgeon off the lifetime highs of all indices except the NASDAQ. The financial press often makes it sound like we are 20% off the market highs. Yes, when weak economic numbers are released (like Friday, January 4th’s Employment Report), the markets have responded with a “temper tantrum” of price drubbing. On the heels of those declines comes the cry for the Federal Reserve (Fed) to pacify us with rate cuts. Folks, what you’re seeing is a good old fashioned “market cleansing” of weak participants and poorly-managed banks having to write off bad loans, thus cleaning their balance sheets in front of the new year. I believe most of the “bodies have already floated to the surface,” if you’ll excuse the graphic description. We expect this “charge off/write down” process to reach a “crescendo” (there’s my music background sneaking through) in mid-2008.
Yes, the tentacles of the sub-prime mortgage financial crisis have gripped not only the real estate and “junk” credit markets, but some of the largest and well-known banks in America as well. Citigroup accepted a large 4.9% equity position from a large Mid-Eastern investment firm. Yet, corporate balance sheets remain strong. I believe that many sectors are already “priced for disaster.” If the Fed co-operates by lowering the Funds rate to at least 3% from its current 4.25%, and the American consumer continues to spend, it is entirely likely the U.S. will experience a so-called “soft landing” from the present economic woes.
We’ve all heard the “pundit calls” for a recession in America. Logic would suggest that the greater the build-up in anticipation of a recession, the more likely that the markets will have already absorbed the prospect of one. We are ascertaining how far the market has already gone toward pricing in a recession risk. We think there is little risk left to the downside as of this writing.
The market’s valuations – based on price earnings ratios – are still quite reasonable. We do believe that the housing slowdown will impede domestic growth in 2008, and that Gross Domestic Product (GDP) might also be lethargic. However, I expect the market to turn in at least as good a performance in 2008, as it did in 2007. Last year, exports made a huge improvement over 2006’s deficits. I do not expect this trend will continue unless the U.S. Dollar makes a substantial recovery versus the Euro, Pound, Swiss and Franc. I am not concerned about rapidly rising inflation. I am watching for stagflation which is defined as a slight inflation coupled with no growth – and how this will affect our market performance.
If you still aren’t convinced about the “reasonableness” of the current market valuation let me show you this: the current “write downs” on bank losses from the sub-prime loan defaults is estimated to affect about 2.5% of the U.S. and Eurozone GDP. While that’s significant, it is far less than the 3.6% of GDP that was written down during the Savings & Loan Crisis of the late 1980s and early 1990s. The banking crisis of the early 1990s affected a whopping 13% of the GDP. Remember the Asian currency crisis of 1998-1999? That crisis affected 14.6% of that region’s GDP. Taken in that context, we really are in decent shape here in America with our subprime “crisis de jour.”
I assure you Chris, I, and our team are watching your accounts daily, as we evaluate how to best serve each of our client’s investment objectives. Please feel free to send an email with questions and/or concerns to cbrown@weg1.com.
