One step forward and two steps back.
More than $31 trillion has been erased from the value of global equity markets as write downs and credit losses have topped $965 billion $U.S. This is the worst financial crisis since the Great Depression. The Standard & Poor’s 500 Index has slumped by 42% this year - the biggest decline since 1931. The MSCI World Index in local currency has dropped by more than 48% over the same period.
Global shares look to fall again this morning, hampered by the growing prospect of a deep global recession and one of the biggest job cut plans in history at Citigroup (15% of their workforce or 52,000 jobs). Despite the fact that credit markets are relatively stable, banks were struggling to contain climbing losses which is contributing to these stock market losses.
“The U.S. economy fell into a recession last spring and will contract sharply this quarter as more than 200,000 workers per month are added to the rolls of the unemployed”, says the Philadelphia Federal Reserve’s latest Survey of Professional Forecasters. The Philadelphia Fed’s survey predicted gross domestic product (GDP) would shrink by 2.9% in the fourth quarter of this year, a sharp downgrade from the previous prediction of 0.7% growth. It said “the U.S. economy entered a recession in April and that it will last 14 months.” According to Reuters that would make it one of the longest recessions since the 1930s, only the 16 month recessions in the mid-1970s and early 1980s were longer.
Contributing to the “negative” sentiment in equity markets is the fact that Treasury Secretary Henry Paulson is unlikely to use what remains of the $700 billion Wall Street rescue fund to launch “substantial new programs”, preferring to keep the money in reserve for unforeseen emergencies and to preserve flexibility for the Obama administration. According to the Wall Street Journal, the fund has $410 billion remaining.
U.S. Treasury Secretary Henry Paulson and two of President- elect Barack Obama’s top economic advisers agreed that more steps are needed to shore up the economy. “There’s still a good bit to be done because the economy has turned down,” Paulson said at a conference late yesterday.
Bloomberg data shows that profit for the 445 companies in the S&P 500 that posted results shrank by 17%, falling short of analyst estimates by 4.4%, marking the 5th consecutive quarter of declining year over year earnings. This matches the length of the 2001 earnings recession.
Actual results continue to trail analyst estimates by a relatively wide margin, keeping stock prices under pressure. This week’s slew of analyst estimate cuts should make some headway in bringing earnings estimates down, a prerequisite to get stocks moving higher again.
“Inflation is now yesterday’s story,” oil prices have fallen by about 2/3rds after climbing above $147 a barrel for the first time in July. Corn and wheat prices are also down by more than 50% from records reached earlier this year. Central bank Governor Mervyn King (Bank of England) said last week that the economy is probably in a “recession,” and policy makers will cut interest rates as low as needed and didn’t rule out putting interest rates at zero.
Analysts are no longer wondering if we are in a recession. The question now is how long and how painful will this economic contraction be. The risk aversion trade is back as investors sell anything that is risky during this period of change and uncertainty regarding the U.S. government transition plan, the next steps for the TARP plan (and change is not good in the short-term) and any auto industry bailout plan.
In the interim, stay diversified since the levels of ‘fear’ are still elevated and justifiable, but take comfort in the fact that things are not likely going to get worse in this very chaotic time. We are seeing stocks give up some of their recent gains but the volatility is declining even in the ‘wake’ of further ‘bad news.’ This will not be a short-term fix but if oil prices ever hit their live-time high, that will be a gain of 200%, but they may drop another 10% first.
Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV
SVP & Partner
