Smart401k Blog

In the headlines

A look at some of the market movers over the past week:

• Bank of America (NYSE: BAC) missed analysts’ earnings estimates and predicted very slow GDP growth for the US
• Oilfield services provider Halliburton (NYSE: HAL) beat estimates and projected a strong market ahead for them
• Texas Instruments (NYSE: TXN) disappointed with a weak outlook
• Underscoring the agriculture boom, Intrepid Potash (NYSE: IPI) had a stellar IPO
• Missed estimates and a poor outlook hurt Unitedhealth (NYSE: UNH)
• National City Corp (NYSE: NCC) raised $7 billion through Corsair Capital
• No surprise here: oil prices continued to surge
• eBay (Nasdaq: EBAY) and Craigslist got in a bit of a row
• Existing home sales continue to struggle, and new home sales were even worse
• Wall Street is expecting another small interest rate cut from the Federal Reserve next week
• Starbucks (Nasdaq: SBUX) fell hard when the company reduced its second quarter guidance
• Stocks soared in China on the announcement that the government is cutting taxes on share purchases
• The Delta (NYSE: DAL) and Northwest (NYSE: NWA) merger looks to be on track, but future mergers may not be as smooth
• Unemployment claims fell sharply

Commentary

As predicted, this past week was all about earnings. Investors were glued to the wire for earnings releases to try and figure out whether companies are feeling the pinch yet from a slowing US economy.

The results were mixed. Many of the financials that were still reporting came out with poor numbers that were anticipated. There were plenty that fell short of the pessimistic projections, but there were also some that didn’t do as badly as expected, and the market definitely took notice. Technology was the other industry reporting, and it had a much better showing thanks in part to the broader geographic diversification.

The S&P 500 was up roughly a half percent overall for week, but more notable was the fall in volatility. There wasn’t a single day during the week where the S&P closed up or down more than 1%, though this belies the intraday volatility to some extent. As I’ve pointed out in the past, a fall in volatility would be a positive sign, as it would suggest that investors and traders see the recent high amount of uncertainty dissipating. Of course we need to see this continue, since a single week is hardly telling

With the notable exception of unemployment, most of the economic and housing reports out during the week were negative. It’s questionable whether these were drowned out by earnings or if the market feels that the deterioration has already been priced in.

Looking ahead

Next week will be a good test of whether the market can keep a lid on volatility. Earnings will continue to roll out, and, specifically, we will start to see some consumer-based businesses, which many expect will show some wounds from the slowdown. Topping that off, the Federal Reserve comes back into the picture next week and will be deciding whether to cut rates further or keep them where they are.

But of course for our purposes the week ahead isn’t a primary concern. Fortunately, the view further out looks even better. As of now, the housing downturn and credit crunch doesn’t appear to be having any crippling effects on the underlying economy. Though banks are writing off billions in bad loans, they’re also going out to investors and raising new capital. Meanwhile, the economy itself is dipping, but there is a low likelihood that it is anything other than a normal cyclical downturn.

As always, while the rest of the market frets about what’s going to happen over the next six months, long term investors have the advantage of being able to sleep well. In fact, the easiest way for a long term investor to deal with this market is to simply tune out the daily noise and fluctuations and stick to a diversified portfolio and a set investment schedule.

In the headlines

A look at some of the market movers over the past week:

• Wachovia (NYSE: WB) announced a first quarter loss and other banks, including JPMorgan (NYSE: JPM) and Merrill Lynch (NYSE: MER) followed with similarly lackluster results
• Blockbuster (NYSE: BBI) made a surprise offer for Circuit City (NYSE: CC)
• Delta (NYSE: DAL) announced that it is buying Northwest (NYSE: NWA) for $3.1 billion
• Brazil’s Petrobras (NYSE: PBR) may be sitting on a massive oil field
• Standard & Poor’s warned that a government rescue of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) would likely have consequences on the government’s credit rating
• The London interbank offered rate came under scrutiny
• Intel (Nasdaq: INTC) gave the tech sector some pep and IBM (NYSE: IBM) followed with more of the same
• There is still no stopping the rising price of oil
• Energy and food boosted wholesale prices, though core CPI was within expectations
• The Fed’s beige book showed slowing economic output through most of the country
• Sallie Mae (NYSE: SLM) said that times are tougher than ever
• Google (Nasdaq: GOOG) crushed earnings expectations

Commentary

It’s earnings season once again. For the next few weeks, that will be the beginning and end of the story. With serious questions about the strength of the economy still swirling, investors are going to be looking at each and every major earnings announcement as another data point on where the market will be headed.

So far, the market has been receptive to most of the earnings announcements, and the market finished the week up more than 4%. It seems that most of the weakness from the financials had been anticipated, if not overestimated, and the positive notes from Intel, IBM, and Google provided an extra push.

On the flip side, reports coming from the government have yet to start showing any light at the end of the tunnel. Economic activity continues to slow and appears to be fairly geographically broad. Housing continues to scrape lows that haven’t been seen for a long time and lack of demand combined with hesitant financing seems to promise that it won’t change quickly. Meanwhile, measures of inflation continue to track higher, thanks in large part with soaring energy prices.

Looking ahead

Though the economic indicators are hardly encouraging, it should be noted that the market has already assumed at least some amount of broad economic weakness in the coming months. That means that as new reports come out, the market — rather than reacting to whether the news is objectively “good” or “bad” — will react to whether the news is above or below the generally held expectations.

As earnings season presses on, though, earnings reports will likely overshadow economic indicators. Though the showing so far appears to have exceeded the market’s expectations, the real test will be the reports from retail and consumer-based businesses. There is a lot of concern that the current economic issues are going to depress consumer spending, so there will be a lot of focus on retail earnings for signs of that slowdown and how pervasive it is.

Looking at the bigger picture, however, there are still no signs that the current problems are intractable or will permanently damage the US or global economy. There have been major excesses to be sure, and in some areas there have been excesses greater than we’ve ever seen. However, it appears at this point that these problems will work through the system in a reasonable amount of time. For long term and retirement savers, this means that the green light is still on to continue steadily saving and investing in a diversified portfolio. Leveraging the advantage of time, long term investors are likely to benefit from the current uncertainty and depressed prices.

We know a blog is normally meant to spawn discussion with its readers, and to illustrate that we are keeping up with trends in the world. We have heard you all asking for our take on this volatile market, and want you to know we are listening. Check out these articles on the Insights page of our website – Risk and Investing and 10 Do’s and Don’ts of Your Retirement Plan, and please continue to let us know what you want to read.

In the headlines

A look at some of the market movers over the past week:

• Alcoa‘s (NYSE: AA) did not start earnings season on a good note
• Home prices in the UK showed notable declines
• AMD (NYSE: AMD) announced that sales will be light and it’s cutting 10% of its workforce; the company’s CTO also resigned
• Washington Mutual (NYSE: WM) raised $7 billion from private investors
• Minutes from the last Federal Reserve meeting and comments from the International Monetary Fund raised recession concerns further
• Pending home sales continued to sag
• UPS (NYSE: UPS) disappointed by lowering earnings expectations for the first quarter
• Crude prices continued to amaze
• AMR (NYSE: AMR), parent of American Airlines, cancelled an amazing number of flights
• Frontier Airlines (Nasdaq: FRNT) filed for bankruptcy
• Linens ‘n Things is said to be nearing bankruptcy as well
• The battle for Yahoo! (Nasdaq: YHOO) rages on and just keeps getting weirder
• Consumer sentiment continues to be on the downswing, while inflation has been making more headlines
• GE‘s (NYSE: GE) miss brought the whole market down with it on Friday

Commentary

Through Thursday it was a relatively calmer week than what the markets have seen in recent times. The earnings shortfall from GE, however, broke that on Friday and the S&P 500 fell 2%. The GE miss was notable because GE is an economic bellwether, and it was particularly surprising to the market because GE CEO Jeffrey Immelt had previously been reassuring Wall Street that results would be within expectations.

The broader economic view continues to stay dim. Though the “r” word has been thrown around a good deal, it is yet unclear whether the US economy will see a true recession or just very slow or flat growth for a few quarters. As mentioned on this blog before, whether or not the US crosses into true recession territory — which is defined as two consecutive quarters of negative growth — is of little consequence, what matters is that economic output will fall and that will hurt a variety of businesses.

Inflation has also played a central role in media coverage lately. Soaring oil prices have played their part in pushing up overall price levels, but core inflation — which excludes food and energy — has been rising as well. This has put the US Federal Reserve in a tough position of balancing fighting inflation with easing monetary policy to help the economy cope with the housing downturn and credit crunch.

Looking ahead

There are two camps currently leading competing charges in the markets. One believes that the recent strength on the markets has been an anticipation of an economic recovery in the second half of the year. This group thinks the Federal Reserve’s decisive action in dealing with the credit crisis will pay off and debt and equity markets will regain their footing.

On the other side is the camp that calls the recent upturn in the indices a “fool’s rally,” and does not believe that we are out of the woods yet. These participants see the credit crisis as a deeply entrenched problem that will be with us for at least a few more years.

Both sides of the issue have persuasive arguments and have proponents with impressive records and pedigrees. So who is right? Luckily, those who are investing for the long term don’t have to concern themselves with this question. In fact, they are better off not concerning themselves with it.

There is no doubt that it would be beneficial to have a functioning crystal ball that could show us the outcome and timing of the current problems. The investor that had such insight could stay out of the market until the very bottom and then put all of his chips on the table and reap a windfall during the ensuing rise. This Paul Bunyan of the stock market would then know exactly when to pull his money back out of the market before the next downturn. Rinse and repeat a few times and this giant would be immensely wealthy.

Like Paul Bunyan and his pal Babe, though, the idea that investors can consistently practice this kind of market timing is folklore. You might even say it’s the modern day alchemy. However, what has been a proven strategy for some time is the practice of investing on a regular schedule through a variety of market conditions. This practice allows investors to take advantage of the big-picture, long-term returns of the equity and fixed income markets without having to accurately predict the short term movements of the markets.

In the headlines
A look at some of the market movers over the past week:

• Treasury secretary Henry Paulson announced a plan to radically change how the financial sector is regulated
• Two blockbuster cholesterol drugs from Merck (NYSE: MRK) and Schering-Plough (NYSE: SGP) were said to be potentially ineffective
• Massive losses at UBS (NYSE: UBS) have put the Swiss bank under pressure to split up
• Lehman Brothers (NYSE: LEH) got a $4 billion shot in the arm
• Microsoft (Nasdaq: MSFT) is doggedly sticking to its bid for Yahoo! (Nasdaq: YHOO)
• Citigroup (NYSE: C) announced a major restructuring
• The International Monetary Fund lowered its outlook for global growth in 2008
• The Federal Reserve defended its actions in the collapse of Bear Stearns (NYSE: BSC)
• Federal Reserve chief Ben Bernanke said that the US economy could contract in the first half of the year
• Congress is putting the finishing touches on a bill to help the ailing housing market
• The Federal Reserve set up shop in some of the major brokerage houses to monitor activities and financial health
• Blackberry maker Research in Motion (Nasdaq: RIMM) showed that there are still pockets of strength in the market
• Four US airlines face inspections from the Federal Aviation Administration for missed inspections and compliance issues
• Jobless claims and unemployment both rose, creating more recession worries
• Airlines ATA and Aloha Airlines both shut down during the week

Commentary
The action in the markets this week emphasized the fact that stock market participants are primarily concerned with the outlook for the future, as opposed to current fundamentals.

On the economic side, withering reports seeped out throughout the week. Unemployment and jobless claims continued to rise, while Federal Reserve Chief Ben Bernanke suggested that the US economy could contract in the first half of the year and potentially slip into true recession. There have yet to be solid signs that economic activity, or even consumer confidence, are preparing for any imminent turnaround.

The stock market, however, has been preparing for this reality since mid-year last year, so even with new write-offs from banks like UBS and Deutsche Bank (NYSE: DB), the equity markets posted a very strong week. With such a complex financial dilemma facing the US and the rest of the world, many investors took swift and drastic action from the outset,  cutting exposure to affected areas and equities in general. Much of this happened in anticipation of write-offs and other turmoil, so now as the problems come to light investors are using the new data to reevaluate market prices.

Caution should certainly be exercised, though, when considering the recent market gains and the reactions to the write-offs at the major banks. We’ve now been through a few rounds of banking write-offs and there has been some sense of “that must’ve been everything” with each iteration. Unfortunately, the complexity of the situation means that it’s almost impossible for accurate predictions to be made on how far this all unravels until it has actually stopped.

Looking ahead
Contrary to recent experience, a movement on the S&P 500 of more than 2% in either direction is not terribly common. For instance, there wasn’t a single instance of it happening from the beginning of 2004 to the middle of 2006. Since the beginning of March, however, nearly one out of every three days has had such a movement, and since the start of 2008 it’s been 20% of all trading days.

The significance is that markets get this volatile during times of distress. A look back at history shows similar shakiness during the peak and aftermath of the Dotcom bubble, the 1998 trouble with Long Term Capital Management, and the stock market plunge of 1987. The volatile swings are both indicative of the uncertainty and fear in the market, and a mechanism that shakes many investors out of the market at the wrong time.

While economic projections run the gamut — from saying the downturn is nearly over to claiming it’ll be as bad as the Great Depression — the most likely outcome seems to be that the global economy will continue digesting these problems over the next year or so and in the meantime will be buoyed by other areas of growth. The market, meanwhile, will likely see improvement before that, as investors will anticipate a recovery before the recovery actually comes to bear.

Meanwhile, the volatility will persist, which makes it more important than ever for long term investors to resist the urge to check investment balances on a daily, or even a weekly basis. As long as the money being invested won’t be needed for the next few years, the best way to handle the current market is to stick to a measured and diversified investment plan that consistently adds new money over time. (more…)