A Week in the Rearview – week ending 12/19/08
In the headlines
A look at some of the market movers over the past week:
- After a week of deliberation, the White House decided to provide the US automakers with $17.4 billion to help get them through the next three months
- The Federal Reserve took unprecedented actions to help spur the economy
- Fallout continued from the Bernard Madoff fraud
- Consumer prices continued to fall
- Oil prices continued to slide despite a big production cut announced by OPEC
- Barack Obama picked Mary Schapiro as the new head of the SEC
- Investment bank Goldman Sachs reported its first loss since becoming a public company
- The massive stimulus plan proposed by President-elect Obama continues to grab headlines
- Economic leading indicators in the US took a big hit in November
- Initial jobless claims fell from the prior week
Commentary
It was a rocky week with a big exclamation point on Tuesday that helped the S&P 500 index finish with a slight gain. Though three of the five days this week were down, the market finished with a gain just short of 1%.
The biggest news of the week was the announcement that the Federal Reserve would be targeting a rate of 0% to 0.25% for the Federal Funds Rate. The Fed’s press release cited deteriorating economic conditions as well as moderating inflationary pressures as the reason for the drastic move. Also sparking optimism for investors was the potential for the Fed to take even more unorthodox actions like buying agency and mortgage-backed debt. The S&P index rallied on the news and finished the day with a 5% gain.
Also playing a big part in the week’s news was the bailout for US automakers GM and Chrysler. Though hopes were high that the White House would step in early in the week, deliberations continued throughout the week and it wasn’t until Friday that the final approval came. Investors cheered the potential for a White House bailout at the end of last week, but didn’t have much of the cheer left by the time the loans were made official.
Meanwhile, economic news continued to be bearish. Housing starts and building permits were both below forecasts, while leading indicators fell in line with expectations. Initial unemployment claims were down from the prior week, but continued to be at an elevated level. While the fall in consumer prices will help alleviate some of the gains that prices made earlier in the year, there is a focus on the extent of the declines as fast falling prices can be a threat to the economy.
Looking ahead
Due to the Christmas holiday, next week promises to be a rather quiet one. There will be some important economic releases with final GDP and consumer sentiment numbers coming out on Tuesday. Initial jobless claims will be released on Wednesday and will still be a focus. Earnings, meanwhile, will be extremely light, with Walgreen’s report on Monday being the highlight of the week.
As we head into the holidays — regardless of what holiday you celebrate — it seems a good time to take a step back and look at the big picture. The big picture, of course, is primarily made up of everything outside of your portfolio, and this is a great time to enjoy all of that.
You are here, however, to read about the stock market and the economy and put the pieces together as to how all of that impacts your portfolio. Now, as we finish a particularly trying year and get ready to head into a new one, is likewise a good time to think about the big picture for your portfolio. While there are plenty of news sources that highlight performance of the stock market over hours, or days, or even years, it’s not all that often that you see 30- or 40-year returns highlighted. Given the fact that most people saving for retirement will (hopefully!) be saving over a period of much more than ten years, focusing on returns over this period doesn’t give the full picture.
As it has been noted elsewhere, it has been a truly sour dose of medicine for those that have been invested in equities over the past decade. The S&P 500 index is down roughly 28% over this period — a performance that makes stuffing cash in your mattress look like a very attractive option. Few should find this performance quite as disturbing as those preparing to retire this year or next. Those now preparing to retire, though, have likely been saving for more than just the last ten years in preparation of retirement, and even with the past decade’s slump, the S&P index is up 219% (or 6% per year) over the past 20 years and 825% (or 7.7% per year) over the past 30 years. It would seem that those that have consistently invested in stocks have benefitted from their equity exposure.
The picture may look even better for those that aren’t currently knocking on retirement’s door. While the ten-year slump is a disappointment for equities already owned, it could turn out to be a great buying opportunity for the future. A recent issue of The Economist came out in favor of stocking up on equities now, arguing that savers may be turned off by the extended underperformance of equities and be turning too conservative at the wrong time. In one article on the subject, the author put it:
The problem is that investors do not regard financial assets as they do other goods; lower prices do not encourage them to buy more, but simply reduce their confidence. Past returns are the main determinant of flows into the stockmarket; investors buy when prices have gone up, not down.
In another article from the same issue, the author concludes:
Caution is understandable, after the trauma of this year. Equity and corporate bond markets could yet fall further, especially as the news on the economy seems to get worse every week. But it is still perverse that investors were happy to buy shares nine years ago, when the ratio of share prices to profits was three times what it is today, and are now determined to keep their money in cash and bonds. … Implausible as it may sound, right now equities and corporate bonds are a better long-term bet than cash.
In short, if now isn’t the time to put extra money into equities, it certainly isn’t the time to pull out of stocks or cut back on regular savings. So enjoy the holidays and what may be an unusually quiet week on Wall Street, and be sure to take some time to see 2008’s turmoil for what it may well turn out to be — an opportunity for higher future returns.
December 26th, 2008 at 8:01 am
As the saying goes “there are lies, more lies and statistics”. The use of the % gained in the S&P index or for that matter, any mutual fund over various timelines is very misleading. I noticed that you use this verbage in your radio shows very frequently. In a practical sense it is reasonable but the fact of the matter it hides what people really want to know, i.e. how much money did the fund make. A 20% rate over 3 or 5 years may sound impressive but it goes not give you an accurate
idea of how much profit was realized during that period. In fact, I know you are aware that even with an average gain of 20% over x amount of years, you could still ending up losing money since the real value is based on the principal at the moment. For example, if one invests 100 dollars in a fund and it loses 99% the first year then it gains 100% over the next 7 years (601% total gain for 8 years without dividends) you will still have lost 36 dollars or 36% of your original investment. Negative gains or losses in principal make the returns over extended periods of times suspect. As you also know, a 40% loss means you need to make a gain of approximately 67% to just break even because of the reduction in principal. I notice that many brokers or financial consultants tend to ignore telling people that fact. They always give the “based on a x% gain” but they should also include “and no negative returns”. The individuals who panicked in this environment and sold equities when they were 20% down or less may indeed be the real winners after all. If they invest now, they have more upside than those of us which includes me who followed your and the vast majority of financial advisors advice. Sometimes it pays to panic or be extermely cautious.
Frank
PS. I hope you reply and tell me my comments are basically wrong. I certainly would feel better about it.
December 29th, 2008 at 5:48 pm
Hi Frank,
Thanks for posting your thoughts. I did find one error in the example – if you lose 99% the 1st year and have 100% gains in the 7 years that follow, you would actually have a positive return (6 years of 100% gains after a 99% loss would give you a negative return). You are correct, however, in your proof that it takes greater returns to recover any previous losses. For this reason, and to avoid any undue volatility, we prefer to choose funds that have consistent performance each year rather than ones that may have greater average performance with less consistent annual returns.
For example, if Fund A outperforms others in its category 4 out of 5 years and has an average 5-year return of 15% vs. Fund B that only outperformed its category 2 out of 5 years, but had a 5-year return of 17% (due to 2 great years but 3 poor years), we would have a strong preference for Fund A.
Even though we can’t predict short-term market movements, and therefore won’t make major attempts to time the market, we do focus on creating investment plans that match each client’s objectives and tolerance for risk with the best possible mix of funds available. Each client’s situation will dictate how much risk is suitable, it is up to us to work within those constraints and requirements to build an appropriate recommendation each quarter.
Kevin Jaegers, Senior Investment Advisor