We are experiencing a total collapse of trust and confidence in everything fundamental and rational. We are taking ourselves off the ledge. There are no buyers or investors in sight (or at least it doesn’t feel that what way). We are making history and this will be a year that will go down in history.
Stocks plunged to their lowest in 5 ½ years yesterday (and they have been barely above water in the last 10 years) as investors braced for a lengthy economic downturn. Automotive executives in Washington have predicted a far reaching “calamity” without government assistance. Stocks dropped more than 5% and closed below their October closing lows but are still marginally higher than their intra day lows from October. We are likely to test those levels again today.
A lack of confidence can be attributed to Treasury Secretary Henry Paulson and him abandoning or changing the plan to use the Troubled Asset Relief Program (TARP) to buy mortgage assets from banks. In turn, it doesn’t look good for the Big 3 Detroit auto-makers who are looking for some TARP money to help them bridge their troubles. Stocks likely reacted negatively to the news or the realization that one or all the big auto-makers are going to go into chapter 11 bankruptcy. Chapter 11 means that they will continue to operate as a business but are not required to repay debtors on a temporary basis in order to restructure. Chapter 7 bankruptcy is when the company liquidates assets in order to pay debtors but this is significantly less common.
International economic conditions are worsening. Data is showing that the number of workers filing new claims for jobless benefits surged to a 16 year high last week. In short, unemployment rates are growing quickly and will hit approximately 8% within 2009. Oil fell toward $50 a barrel on Thursday, deepening losses over the previous four sessions as battered financial markets reflected ever lower confidence in the world economy and evidence mounted of falling fuel demand. Fears about falling revenues have prompted some members of OPEC to urge further cuts as soon as possible and ministers are to gather for informal talks on November 29 in Cairo.
Sustained deflation (lower prices) is a concern as consumers “hold off purchases now hoping to get lower prices later.” The mindset that you could buy a car for $1,000 less if you wait a month does not help things in the short-term because it will impact corporate profits. Longer-term, it will help stocks rebound. Prices on ‘stuff’ are coming down very quickly, 1% in October alone which is a record drop as consumers close their wallets.
U.S. home builders in October “broke ground” on the fewest amount of new U.S. homes (current environment) and obtained the fewest amount of building permits for future construction (future environment) at the lowest levels on record. This is a signal that the housing slump may extend into a 4th year. Construction starts on new housing fell 4.5% in October, at an annual rate of 791,000, that was the lowest level since records began in 1959, the U.S. Commerce Department said. This over the long-term is good news as supply is reduced which helps prices find a floor and stabilize but for today investors will sell.
The throne speech in Canada didn’t really tell us anything new but I do give credit to Canada for being able to avert the worst of this current crisis.
There is a ‘silver’ lining in all this. The S&P 500 for example will likely fall from peak to trough (from top to today) by 50% which has really only happened once since World War II. Conversely, for stocks to regain what they lost they will have to appreciate in value by 100%. With stocks trading at around 10 times earnings or an earnings yield of 10% then for the next 10 years all that companies have to do is not have their earnings drop further in order to regain what they lost. This should enable them to generate a return for investors of more than 10% per year (contact the office for a copy of the relevant slides). In short, stock markets and risk aversion have really assumed a worst case scenario which in retrospect is likely not going to materialize although, it will be painful and it will take time to fix.
There is some room for optimism as Saudi billionaire Prince Alwaleed bin Talal plans to increase his stake in Citigroup to 5% after the U.S. bank lost almost a quarter of its value yesterday.
Wilfred Vos Bcs, CFP, FMA, FCSI, CIM, CFA, MBA, DMS, CBV
SVP & Partner
