A Week in the Rearview - week ending 4/4/08
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.
