Fundmastery Blog

Kurt Brouwer January 21st, 2008

The weakness seen in the stock market at year-end has continued so far this year with concerns over financial issues, the subprime lending mess and a potential recession contributing to the negative environment. At this point, we are in what has historically been considered a stock market correction, which is a drop of 10-20%. From the most recent high point (October 9, 2007), the S&P 500 had fallen approximately 15% through January 18. So, now it is official. We are in a stock market correction, which is usually defined as a decline of 15-20% for stocks.

This is the first such correction in five years. Downturns are never much fun, but in my opinion, they are a necessary and normal aspect of stock market activity much as the occasional recession is a normal part of economic activity. They usually occur more often so this one is a bit daunting to people who have had a steady five-year run of positive markets. Here is an interesting story about a bullish analyst at Citigroup of all places [emphasis added]:

Burned But Bullish At Citigroup (New York Times, January 20, 2008, Nelson D. Schwartz)

IF any Wall Street seer should be bearish right now, it’s Tobias Levkovich, the chief United States equity strategist at Citigroup.

After all, last week his employer announced a whopping $10 billion loss, not to mention a 41 percent dividend cut and 4,000 additional job cuts. Shares of Citigroup and other financial giants are down sharply in recent months, a fact hardly lost on Mr. Levkovich, who has worked for the bank and its predecessor companies for 20 years.

“The hit my portfolio has taken has become a significant loss by anyone’s measure,” he says. “I feel crummy.”

Nevertheless, from his perch at the beleaguered global financial giant, Mr. Levkovich has the distinction of being among the most prominent bulls on Wall Street. His forecast calls for the Standard & Poor’s 500-stock index to reach 1,675 by the end of 2008, 350 points and 26 percent higher than where it closed Friday…

When it comes to predicting a 26% gain for stocks, Mr. Levkovich is probably in a party of one right now. Nonetheless, at some point the gloom will lift. What he is pointing out is that the sharp drop in stocks is indicative of a very steep decline in economic activity and corporate earnings. If the economy does not sink into a recession and corporate earnings do not crater, then stocks are oversold. He is in a minority right now, but it does appear as if the gloom and doom has been overdone, particularly in the financial stocks.

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Kurt Brouwer January 17th, 2008

I tuned in to CNBC this morning, which had live coverage of Federal Reserve Chairman Ben Bernanke in testimony before the House of Representatives. From his testimony, it became pretty obvious that the Fed intends to drop its Fed Funds rate at the next meeting which will be on January 29-30. While watching, I noticed lots of selling on the ticker which runs at the bottom of the screen. Share prices in the two big bond insurors — MBIA and Ambac — absolutely plummeted. Turns out that Moody’s announced a review of Ambac’s rating and that was the cause of a slump in the shares of both insurors. Also, the the Fed announced a decline in manufacturing activity and suddenly a race was on for the exits. This story spells out what happened [emphasis added]:

Dow Ends Down 307, Economic Angst Mounts (Associated Press / Yahoo, January 17, 2008, Tim Paradis)

Wall Street extended its 2008 plunge Thursday, tumbling after a regional Federal Reserve report showed a sharp decline in manufacturing activity and as investors feared that downgrades of key bond insurers could trigger further trouble with souring debt.

The Dow Jones industrial average lost more than 300 points, or nearly 2.5 percent, and skidded to its lowest close since March 16. The Standard & Poor’s 500, the index closely watched by market professionals, fell nearly 3 percent.

Stocks opened higher but quickly gave up their gains after the Philadelphia Federal Reserve said its survey of regional manufacturing activity registered a negative 20.9 from a revised reading of negative 1.6 in December. The reading came in well short of what Wall Street had been expecting and underscored the seriousness of the economic concerns that have gripped both Wall Street and Washington in recent weeks.

Credit concerns also dogged Wall Street after rating agency Moody’s Investors Service placed bond insurer Ambac Assurance Corp. on review for a possible downgrade. That possibility alarmed Wall Street because it would place all bonds insured by Ambac on review as well. Ratings agencies are concerned that bond insurers would be unable to absorb a spike in claims…

…The Philadelphia manufacturing reading caught Wall Street by surprise — igniting fears that the economy is slowing precipitously and that policymakers might be too late in aiding it.

Economists had expected the Philadelphia index would come in at a negative 1.5, according to Dow Jones Newswires. Instead, the negative 20.9 figure was the weakest since October 2001 when the economy was reeling from the shock of the Sept. 11 terror attacks…’

At this point, there is bad news as far as the eye can see. Credit crisis, impending recession, higher inflation and so on. Either the world is coming to an end — which I seriously doubt — or we are in a pretty typical stock market correction. From the October 9th high point, the S&P 500 was down approximately 14% as of the market close today so we are clearly in a correction (defined as a stock market decline of anywhere from 10-20%). However, many financial stocks are priced as those the end of the world is in sight, if not immediately at hand. Though they are undervalued, the timing on picking a bottom in an out-of-favor industry is tricky (see Bank of America Snaps Up Countrywide).

For those concerned about a pending recession, click on this post to learn more on how stocks reacted in past recessions (see History Lessons On Recessions). But it is not just stocks that have been hit. Last year, muni bonds had their worst year since 1999 so muni bonds funds look good to me (see Bad Year For Muni Bonds).

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Kurt Brouwer January 16th, 2008

Though the central bank in China is tightening the monetary system, here at home the Federal Reserve is getting criticized for being too tight and for its inaction in the face of the credit crunch [emphasis added]:

Anna Schwartz blames Fed for sub-prime crisis (Telegraph.co.uk, January 14, 2008, Ambrose Evans-Pritchard)

‘As rebukes go in the close-knit world of central banking, few hurt as much as the scathing indictment of US Federal Reserve policy by Professor Anna Schwartz.

The high priestess of US monetarism - a revered figure at the Fed - says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. “The new group at the Fed is not equal to the problem that faces it,” she says, daring to utter a thought that fellow critics mostly utter sotto voce.

“They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence,” she told The Sunday Telegraph. “There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for,” she says.

Mr. Greenspan no doubt would disagree with her, but it appears self-evident that the Fed allowed the excesses of subprime lending to go on far too long. Ms. Schwartz’ comments were a bit unusual in the cloistered world of central bankers, but she certainly has the background and experience to do so. Also, this is not the first time she has criticized the Fed.

Source: Telegraph.co.uk

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Kurt Brouwer January 16th, 2008

In case you missed it, our stock market is not the only one that has been falling lately. Chinese stocks are taking a hit these days as you can see from this MarketWatch story [emphasis added]:

Chinese Shares Plunge As Big Funds Head For The Exit (MarketWatch, January 16, 2008, Chris Oliver)

‘…China shares listed in Hong Hong plunged Wednesday, sending the market lower for a fifth straight session, as large institutional funds scaled back exposure to the mainland growth story.
The 43-issue Hang Seng China Enterprises Index, or H-share index, fell 6.6%, or 938 points, to 14,016.12. The index, which tracks mainland-incorporated firms and is heavily weighted towards state-owned companies, has fallen 32% since touching an intraday high of 20,609.10 on Nov. 11...

Analysts said many Hong Kong-listed China stocks were looking overpriced compared to other equities in the U.S. and Europe following declines in recent weeks.

“They (H shares) have held up the most relative to other stocks so they are playing catch up now,” said Andy Mantel managing director of Pacific Sun Investment Management.

After the close of trading Wednesday, the central bank lifted the ratio of reserves banks must set aside as deposits by 50 basis points to 15%. The move, which will take effect from Jan. 25, was the first such tightening this year and comes on the heels of 10 such moves in 2007.

“The timing of this move underlines China’s determination to curb liquidity and deter excessive investment,” said Jing Ulrich, J.P. Morgan’s head of China equity strategy, adding the central bank’s move would dampen lending growth and act as a drag on the economic expansion…’

Chinese stocks had a huge runup last year so it is not surprising to see a correctionary retracement. However, the move by China’s central bank may point to additional softness in the market due to the impact of a tighter money supply. In general, moves by a central back to tighten the money supply and reduce banking activity are one of the clearest signs of future problems in the stock market.

When the central bankers of a given country think the party [no pun intended] has gone on too long, they should do what all good party hosts do — take away the punchbowl , brew up some coffee and send the partygoers home in a cab. This is the 11th such move in the past 12 months or so and it would seem the Chinese banking authorities are serious that they party is over — at least temporarily.

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Kurt Brouwer January 14th, 2008

The R word is being bandied about quite a bit these days as many in the media and on Wall Street publicly worry about an impending recession. Thus, it makes sense to take a look at what it might mean for investors in stocks if a recession is on the way. This article from the Wall Street Journal does just that [emphasis added]:

History Lessons: Past Recessions Yield A Few Clues (Wall Street Journal, January 14, 2008, Mark Gongloff & Scott Patterson)

‘If the economy is heading into recession, as many on Wall Street fear, history may offer some clues about what that might mean for stocks.

No two downturns are alike, but a look at market performance during previous recessions gives some clues about whether the market will have a relatively smooth rebound, meaning investors should be setting themselves up for the recovery, or a long, tough slog.

In many ways, today’s situation is reminiscent of the recession of 1990-91, which featured a housing bust and piles of bad loans, which hurt banks. The Federal Reserve started cutting interest rates even before the recession began. The economic downturn was no day at the park, but it was fairly easy on stocks, which rose during the recession and managed to avoid a bear market.

Source: Wall Street Journal/Standard & Poor’s

…In the 1970s and in 2001, recessions were marked by nasty bear markets. In both cases, investors ignored the risks that were building in the market, believing that high valuations were justified, be they on houses or stocks, because prices would continue rising. The earlier recession also featured soaring energy prices…’

As you can see from the WSJ’s chart, recessions come in many different flavors, not all of which are bad for stocks. The worst periods for stocks seem to occur when the economy slides into recession at that same time that stock valuations and investors’ expectations are high. Stock valuations (particularly for technology stocks) were high at the start of the most recent recession, which began in early 2001. Thus, began the most severe stock market downturn since World War II. The severity of the 2001 recession was also significantly increased by the terrorist attacks on Sepetember 11, 2001.

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