Smart401k Blog

In the headlines

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

• The US government agreed to rescue Citigroup
• President elect Barack Obama is expected to look for a high number when implementing a stimulus plan
• Homebuilders joined the legion of industries looking for government money
• The US Treasury announced a new program that will focus on freeing up consumer lending
• Mining giant BHP Billiton dropped its $66 billion offer for Rio Tinto
• The OECD is expecting a recession through mid-2009 followed by a slow recovery in the US
• Existing home sales declined in October
• The market is awaiting next week’s initial GAO report on the TARP
• In an effort to boost its economy, China’s central bank cut rates by more than 1%
• Third quarter GDP was revised down to an annualized decline of 0.5%
• The conference board’s reading on consumer confidence improved in October
• All eyes are on the results of Black Friday shopping

Commentary

The holiday-shortened week was a great one for investors as the S&P 500 index bolted up 12%. The gains were sparked by a big 6.5% jump on Monday as investors cheered the government’s efforts to save Citigroup.

Though business activity slowed considerably during the week because of the Thanksgiving holiday, investors heard all they needed to bolster all the indices. Aside from the rescue of Citigroup, the government stepped in during the week to offer further assistance through additional funding designed to free up consumer lending such as credit cards, student loans, and auto loans. Meanwhile, economic data released during the week continued to paint a bleak picture of the US economy over the next few quarters.

Looking ahead

Heading into next week, the big question is whether the good cheer that investors carried through the past week will hold up.

With the close of the month of November, there is plenty on the economic calendar next week. The most important reports on the schedule will be the Fed’s “beige book” report on Wednesday and the dual employment reports coming Wednesday and Friday. Off the schedule, we will also have reports on Black Friday shopping and TARP usage to look forward to.

Earnings season will be continuing to wind down this week, so the company-specific news dominating the headlines will likely be focused on financial companies dealing with the turbulent times. Homebuilders, however, are scheduled to report third quarter earnings during the week, and investors will key on their results looking for signs that the housing market is starting to recover.

The big gains from last week gave investors plenty to be thankful for on Thanksgiving and it was a good reminder that the direction of the market can be very difficult to predict. This will hold true moving forward as well, and that means that while we enjoyed the gains last week, the market could turn right back around next week. As I’ve heard it cleverly put, picking tops and bottoms is best left for bathing suit shopping.

So while we find ourselves lacking a working crystal ball to predict the near term movements of the market, we continue to be believe in the longer term prospects of the global economy and global equities. For that reason, we continue to recommend the simple strategy of consistently investing new money on a regular basis to build your retirement nest egg.

In the headlines

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

• Leaders from the so-called Group of 20 met to discuss the state of global finance
• Company insiders are busy snapping up shares in the open market
• Multiple Goldman Sachs executives opted out of 2008 bonuses
• A survey by the National Association of Business Economists shows a pretty dim outlook for the US in the near term
• Japan’s economy entered recession
• Embattled Yahoo! leader Jerry Yang opted to step down from his CEO position
• Citigroup announced 52,000 job cuts, but couldn’t seem to stem the slide in its stock
• Dallas Mavericks owner Mark Cuban ended up on the wrong side of securities laws
• Bank of America doubled its stake in China Construction Bank
• Industrial output was up more than expected, but may not portend a recovery
• It’s been a rough year for most hedge funds
• The Producer Price Index (PPI) dropped a record amount in October
• Consumer prices posted a likewise steep drop
• Minutes from the most recent Federal Reserve meeting show that more rate cuts could be on the table
• Economic leading indicators fell in October
• Congress held off on pushing through a bailout package for US automakers
• Rumors on Friday suggest that Barack Obama will name New York Federal Reserve president Timothy Geithner the new Treasury Secretary

Commentary

Selling pressure continued on the markets this week with major downswings on Wednesday and Thursday pushing the S&P 500 index down nearly 14% by Thursday’s close — the lowest level on that index since 1997. Excitement over the potential naming of Tim Geithner as the new Treasury Secretary sent markets on a roaring upswing to help Friday finish with a 6.3% gain, but even with that the S&P closed the week having shed over 8%.

Economic news continued provide a drag on the equity markets this week. The only upside highlight of the week was industrial production notching a better performance than expected for October. However, this was largely explained away as just a recovery from a lackluster September because of Hurricane Ike. The Producer Price Index and Consumer Price Index both logged significant declines showing that the drop in energy prices is helping to moderate price levels. While this would have been heralded as good news earlier this year when inflation was beginning to look like a problem, today it’s being taken as a sign that recession is deepening and The Fed will have its work cut out trying to prevent a deflationary spiral.

Meanwhile, company specific events played a big role in the markets this week. Front and center were Citigroup and the “big three” US auto makers. Citigroup’s stock continues to struggle as investors weigh the possibility that loan losses will overwhelm the company and induce a forced sale or government rescue — either of which would make the equity close to worthless. Massive layoffs at Citigroup and a follow-on investment from Saudi prince Walid bin Talal failed to comfort investors. The company, which was at one time the world’s largest bank, now carries an equity value of just over $20 billion and a stock price of under $4 per share.

The US automakers didn’t have much luck either this week. Hopes were high that some agreement would be reached so that Ford, General Motors, and Chrysler would receive some kind of funding or bridge loan to help them survive quickly-dwindling cash reserves. Supporters of such an action say that a failure of any or all of these companies would severely impact the US economy and ripple out into other areas, while opponents claim that the automakers do not have sustainable business models that would allow them to operate profitably without continued bailout funding. Talks reached a standstill when Congress demanded a recovery plan from the automakers before moving forward.

Since the one bit of news that seemed to cheer investors during the week was the announcement of Tim Geithner as a potential successor to Hank Paulson as Treasury Secretary, readers may wonder who Mr. Geithner is and why his appointment is so important. He has a pretty impressive resume, which includes serving as Undersecretary for the Treasury for International Affairs under Treasury Secretaries Robert Rubin and Lawrence Summers as well as serving as a director at the International Monetary Fund. His most recent position as the president of the Federal Reserve Bank of New York is also very notable as he is also the Vice Chairman of the Federal Open Market Committee under Fed Chairman Ben Bernanke.

However qualified Mr. Geithner may be, though, the reaction at the end of the trading day on Friday was much more straight forward. Investors tend to hate uncertainty of any kind. The length and depth of the current recession is a very large current source of uncertainty and investors have certainly reacted very unfavorable to that. Another current source of uncertainty, though, is the Presidential transition from George Bush to Barack Obama. Positions such as Treasury Secretary have taken on extreme importance in today’s crisis, so the unveiling of who will be taking over these financial positions should bring some comfort of certainty to investors.

Looking ahead

With a wake of so much bad news from last week, what can we look forward to next week? Unfortunately, extreme volatility is probably still all that I can promise will be on the menu for sure. It’s unlikely that economic reports will cheer the markets much next week, as it seems unlikely that existing home sales, consumer confidence, personal income, or personal spending will surprise to the upside. A preliminary reading of third quarter GDP also has a good chance of bringing on pessimism as the market expects it to decline to an annual rate of contraction of 0.6% from 0.3% last quarter.

On the brighter side, though, as I’ve discussed in the past, the market tends not to move based on what is happening currently, but rather what is expected in the future. So though current economic readings continue to decline, the market is already looking ahead to the next quarter and next year to see what they will hold. Any indication of light at the end of the tunnel — even two quarters out — could cause markets to begin to recover. At the same time, there have been some indications that President Elect Obama may be naming the rest of his economic posts next week and that could likewise spark markets to the upside.

To a large extent corporate earnings will be lighter next week due to the Thanksgiving holiday. There will however be some notables like Hewlett Packard and Deere that will report prior to Turkey Day. More likely, though, the major company specific news that we’ll see will be continued focus on the travails of Citigroup and the automakers.

In retrospect, this has now been one of the worst stock market collapses that we’ve ever experienced. Not only has any excess excitement been shaken out of the market, but there seems to be an overdose of pessimism which has brought the S&P index’s current earnings multiple markedly below its long term average. While this doesn’t mean that there isn’t room for the market to fall further — after all, investors don’t always act rationally — we don’t recommend making any drastic changes to your long term investment strategy. 

In the headlines

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

• China unveiled a $586 billion stimulus plan
• As losses increased at AIG, its bailout got bigger
• American Express converted to a bank holding company in hopes of accessing TARP funds
• Citigroup launched an aggressive mortgage modification program
• Talks continued on the possibility of bailing out the big three US automakers
• Hedge funds recorded another lousy month in October
• Economists have turned very bearish on the US economy
• Treasury Secretary Hank Paulson materially changed the way the TARP program will try to achieve its goal
• GE got some help from the FDIC
• Wal-Mart reported a strong quarter, but was cautious about the future
• The OECD cut its growth forecasts for 2009 again, now showing a contraction next year
• The Euro area officially fell into recession
• It’s unclear what can really be expected from the G-20 summit over the weekend
• It may be too late for GM by the time Barack Obama takes office
• Retail sales caused a fresh round of bearishness

Commentary

Investors weary from dizzying volatility were still without respite this week. Though a 1.3% drop on Monday could be considered calm in light of recent times, the gap between low and high was still nearly 5%. Monday was followed by four days all with 2%-plus moves, including a truly rattling day on Thursday where a loss of 4% from the open was followed by a massive rally that took the S&P up 11.5% from the nadir.

The 6% loss that the S&P index finished the week with was driven primarily by increased pessimism over the state of the US and global economy. Though it was a light week for economic reports, nearly all of the numbers reported were worse than expected, from initial unemployment claims to the big drop in retail sales. If there was any economic highlight it was the fact that preliminary consumer confidence readings for November came in above where the market had expected. Meanwhile, as earnings season grinds on the market has been met by one company after another projecting future earnings to be weak.

And the wildcard in the whole mess is the government. Now caught in a bit of a no-man’s-land between the lame duck Bush term and the upcoming Obama Presidency, there is clearly somewhat of a holding pattern feeling in a lot of the government’s actions. Top of mind in this category is the “to bailout or not to bailout” question that faces the government when it comes to the major US automakers. Less the fault of the Presidential overlap, the market also responded poorly to the Treasury’s decision this week to abandon its initial plan to use TARP money to buy troubled assets directly from banks.

Looking ahead

It continues to be tough to say what we have to look forward to next week aside from continued volatility. Monday will likely be dominated by reviews of what the G-20 conference over the weekend accomplished or failed to accomplish.

On the economic front PPI and CPI will be released during the week and both are going to show that price growth on both the producer and consumer side has slowed drastically, though this is less likely to be much encouragement at this point. Midweek we’ll see the minutes from the most recent Federal Reserve meeting, and there will likely be a focus on the implications of what was said at that point.

The earnings calendar remains heavy through next week, with Lowe’s and Target reporting Monday, Home Depot and Saks on Tuesday, BJ’s Wholesale and Ross Stores on Wednesday, Dell and Gap on Thursday, and HJ Heinz and JM Smucker rounding out the week on Friday. There’s no reason to think that the general tenor of the reports will be any different from what we’ve heard over the past few weeks. Current numbers are likely to be moderate to weak, and outlooks will be very much on the conservative side.

As I noted above (and have been mentioning for weeks now), the one assurance that we have in this market is volatility. The reason is simple — financial markets are made up of a combination of actual finance and a healthy dose of psychology. In the quiet times — those years when the economy is relatively stable and the markets don’t move a whole lot in one direction or the other — finance takes a much bigger role. In times of great excitement or great despair, psychology tends to take over. And this is what we’ve seen recently.

The big five and even ten percent swings in the market are simply not dictated by financial or economic fundamentals. Sure, the moves are happening because of changes in some fundamental factors, but they not moving based on those factors. That may seem like a small difference, but it’s important. The economic reports that we’re getting from day-to-day to not equate to fundamental changes of these magnitudes. Instead, what investors are doing is taking these current period changes and reacting based on the direction of these changes and the expectation that these changes will persist and get significantly worse.

The problem with this is that there’s really no way to know whether investors’ are right or wrong in these predictions. Six months ago investors obviously weren’t bearish enough. Are we still in that same situation today? Or have investors swung the other way and gotten too bearish now? A lot of it boils down to a guessing game.

Still, we can’t simply sit back and wait for an economic recovery to show itself before jumping back into the market. Just as investors are trying to anticipate the economic bottom, they will likewise try to anticipate the beginning of the recovery. By the time good economic numbers start coming out, the market will long since have started its recovery.

What’s an investor to do then? We believe the answer for most investors is to avoid playing this guessing game at all and not only keep your money invested, but continue to consistently invest new money. If you don’t need the money for at least the next five years you have the luxury to be able to wait for the recovery and in the meantime take advantage of beaten down stock prices. Unfortunately, we can’t predict the timing of a turnaround, but we can predict that a turn will come and we want you to be there for it.

In the headlines

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

• Morgan Stanley had to use $23 billion to help prop up its money market funds
• Talks between GM and Chrysler continue as the US auto makers struggle
• BP announced a better than expected third quarter
• Whirlpool announced 5,000 layoffs as the global economy continues to slow down
• GM’s GMAC is looking into becoming a bank holding company to be able to access Treasury bailout funds
• Consumer confidence plunged to an all-time low this month
• The Federal Reserve cut the Fed Funds Rate 50 basis points to 1%
• Japan announced an economic stimulus plan and cut interest rates
• Sprint decided to keep its Nextel unit after failing to find a buyer
• GDP fell in the third quarter, but not as much as expected
• Crude oil had its worst month in October since futures began trading 25 years ago

Commentary

October finished on a good note with stocks shooting up over 10% for the week. However, that’s about all the good we can say about this past month. While a 10% weekly gain might normally be a heady week, after the month we’ve had it’s only part way to climbing back out of a deep hole. In the end, the S&P 500 index shed 17% in October.

The data out this week focused on two economic releases — the Federal Reserve’s interest rate decision on Wednesday, and the third quarter GDP reading on Thursday. In typical market anticipation, all three indices had a major rally on Tuesday ahead of the Fed’s decision, with the S&P finishing up nearly 11% on the day. When the decision to cut rates by a half percent came out on Wednesday, the S&P backed off some of the gains of the previous day.

GDP, meanwhile, is an interesting story. Prior to the release, the briefing forecast was a positive 0.3% annualized rate of growth, while the market was expecting a negative 0.5%. And this was coming off a slower-than-normal but better-than-bad second quarter in which the government’s stimulus checks helped push annualized growth to 2.8%.

The negative 0.3% rate that was released seemed to comfort the market. This may seem strange because it shows contraction and means that we will end up entering a “true” recession if next quarter’s number is negative as well. However, with the markets down heavily from the highs of last October, there is already a good deal of pessimism priced in. What market participants are looking for now are signs that things aren’t going to end up in a worst case scenario — and the GDP release seemed to be that.

Most other economic indicators released throughout the weak also showed a slowing economy, including a much worse than expected reading of consumer confidence by The Conference Board. One of the few upside surprises was better than expected growth in personal income.

Meanwhile, earnings season continued to chug along, delivering some surprises, but largely falling within the bounds of expectations. Earnings at most companies don’t seem to be falling alarmingly quickly, but the forecasts delivered by most management teams warn of slowness continuing next quarter and potentially through much of next year.

Looking ahead

October is a strange month. For whatever reason, the worst declines in the history of the stock market have taken place during this month. The steep decline that kicked off the market’s plunge in to the Great Depression was in October. As was the dive of 1987. And surely October 2008 will go down in history with those two previous crashes. Maybe it’s haunted? After all, the month does conclude with Halloween.

Of course, saying that we can breathe a sigh of relief just because we’re now out of the month is about as plausible as saying that October is a haunted month. Yet that’s what many commentators seem to want to believe. If you haven’t heard this already, let me be the first to tell you: if we start to see a rebound in November, it’s not because the changeover from October from November is magical, it’s simply because pundits and traders have convinced themselves that November will bring some type of recovery.

There’s no magic in the markets, there’s psychology in the markets. Anytime something is talked about enough, investors, traders, and so forth can convince themselves that it is so. And it doesn’t take a Nobel laureate to figure out that when enough participants are convinced of something, it’ll end up being a self fulfilling prophecy.

But we steer clear of all of that, and that’s where our advantage is. By avoiding taking action based on who wins the Super Bowl (don’t laugh, some people actually do that), the shape of a graph, or the phase of the moon, and instead consistently investing in a diversified portfolio of funds and holding onto them over the long term, we’ll capture the long term appreciation of commerce around the world with far less hair lost in the process.

In the headlines

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

• South Korea announced that it is launching a bailout program of its own
• ING received a $13.4 billion lifeline from the Netherlands government
• President Bush announced a series of global economic summits to address the current economic slowdown
• The Federal Reserve launched a new plan to help stabilize money market funds
• Fed chief Ben Bernanke spoke out in favor of a fiscal stimulus package
• Asian countries considered a massive program to shore up the region’s economic situation
• Apple managed to report good numbers despite the difficult economic environment
• Yahoo! announced big layoffs along with their quarterly report
• Consumer sentiment continues to be underwhelming
• Credit Suisse announced a big third quarter loss
• Goldman Sachs announced that it will cut 10% of its staff
• Foreclosures are still dangerously high but may be showing signs of slowing
• OPEC countries agreed to cut production in an effort to support the fast-falling price of oil
• Former Fed Chairman Alan Greenspan testified before Congress on his part in the financial crisis

Commentary

The market stats for the week were all too familiar for investors. Three out of the five days were down days, four out of the five days had moves of 3% or greater, and the week finished down just shy of 7%.

News-wise, coverage focused on the worldwide economic uncertainty. Though financial markets appeared to loosen up to some extent sparking a big gain on Monday, economic reports throughout the week — including a decline in third quarter GDP in the UK — were sobering. Earnings reports throughout the week were mixed, though even positive reports were overlooked by investors as they continued to focus further into the future.

At this point it is unclear exactly where the market is taking its direction from. Down more than 40% from a year ago, it would seem that even a significant recession has already been priced in. Reports have been making rounds that significant liquidation selling from troubled hedge funds has put downward pressure on markets, while even healthy hedge funds and mutual funds may be selling in anticipation of investor redemptions. At the same time, individual investors, worn down from the market’s wild volatility, may finally be throwing in the towel and selling.

Looking ahead

Last week I began this section by saying:

The more volatile and emotion-driven the markets become, the more difficult it is to predict what factors will play significant factors in its movements. That said, the news events that will cause the most commotion on the markets next week will likely be those that are unscheduled such as new information on the bailout progress.

It’s hard to come up with something more applicable this week. Volatility has continued and we’re somewhat at the mercy of a spooked market right now. Investors will continue to process economic data to try and figure out just how bad the economic downturn will be.

That said, at a time like this it’s important to keep in mind that the stock market and the economy do not typically move coincidently. Economic readouts give us a picture of current and recently passed activity levels. The stock market, meanwhile, tries to anticipate economic activity in advance. This means that stock market declines will precede the bottoms of economic declines and stock market recoveries will likewise precede economic recoveries. So even if the economic picture gets worse from where it currently stands today, that does not necessarily mean that stock market will.

Going into next week we have a heavy calendar on both the earnings and economic fronts. There are a handful of economic reports that could significantly impact the markets. On Monday and Tuesday we’ll see September new home sales and October consumer confidence, respectively, and both are expected to show declines from the prior month. On Friday we’ll see personal income, personal spending, and another reading on consumer sentiment.

The two highlights of the economic calendar, however, will take place right smack in the middle of the week. On Tuesday, the Federal Reserve will make its October policy statement. Based on implied probabilities calculated by the Federal Reserve Bank of Cleveland, the expectation is that the Fed will cut rates by anywhere from a quarter point to three quarters of a point. The following day, an advanced reading on third quarter GDP will be released. After a jump of 2.8% (annualized) that was driven by government stimulus payments in the second quarter, the briefing forecast is for an annual rate of 0.3%, while the market is expecting a decline of 0.5%.

Week after week we will continue to bring you a weekly recap and a look ahead to the next week. However, it’s important that our weekly coverage of news and events is not translated as a short term focus from an investing perspective. We continue to be firmly focused on the long term when it comes to investing, and while the current period is certainly trying, we expect that investors holding their investments, and continuing to invest, over the next five to ten years will benefit handily from the eventual market recovery.