Smart401k Blog

With the election upon us many of you might be wondering how the stock market might react depending on who’s elected.  So without further ado, here are some interesting statistics on market conditions prior to and after a presidential election.  Currently (and unfortunately) we are going into this election with the DOW down approximately 30% YTD (as of 11/03/08).   

Historically, election years have usually been good for the stock market; the average gain in the last seven months of the year was 7.2%.  Overall, looking at market trends since 1945 the S&P 500 has posted an average gain of 10.7% during the 28 years a Democrat was president vs. 7.6% during the 35 years of GOP residency. While we cannot predict who will win the election or what will happen we can take a look at some historical trends in the market based on party leadership.

There have been 27 Presidential elections since the start of the Dow Jones Industrial Average in 1896.

• The Democrats have won 12 times and the Republicans 15 times with the white house switching parties 10 times
• During election years, the Dow has been down YTD on Election Day only seven times.  Three of the seven times, the incumbent party was defeated.

The two months prior to Election Day the Dow, on average, has increased +1.92%.

• This year the Dow closed 9/2/08 at 11, 516.92 and closed 10/30/2008 at 9,180.69, this is a decrease of -20.28%
• When the current office is held by Republicans, the average is +0.6%
• When the current office is held by Democrats, the average is +3.5%
• When a Republican is elected, the average goes to +2.2%
• When a Democrat is elected, the average goes to +1.5%

In first Year of Elected President’s Term the Dow, on average, has increased +4.85%.

• When the White House stays Republican, the average increase is +8.2%
• When the White House stays Democratic, the average increase is +0.5%
• When the White House changes from Republican to Democratic, the average increase is +13.7%
• When the White House changes from Democratic to Republican, the average goes to being down -4.6%

Whatever the outcome is in the election, it seems as if the historical numbers are in our favor. 

Jessica Slaters, Investment Advisor.

Source: www.stocktradersalmanac.com

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.

Over the weekend I went to my first Missouri (MU) football game.  Prior to the game I had the opportunity to tailgate with a lot of MU fans, the majority of them I didn’t know.  Being a diehard KU (Kansas) fan I expected a lot of razzing and friendly bickering.  Instead, once people found out what I did for a living, football was the last thing people wanted to discuss.  Instead everyone wanted to talk about the market and their retirement accounts.  It seemed everyone I spoke to was unsure if they were properly allocated and if they should be moving their money to cash accounts.  I would explain to them that it’s a tough time to be in the market, and watch our accounts go down, but believed we have to remain committed to our investment strategies (assuming they are based on solid asset allocation strategies).  Historically, the market has rebounded strongly after reaching a trough.  On average it rebounds by approximately 30% within 12 months after finding the market bottom. Within two years of the hitting the market bottom, the S&P 500 average increase is roughly 55%.  These figures really got their attention. 

It was very important for them and for you to understand that no one can predict what the future will hold so it’s imperative to have a properly allocated and diversified investment strategy based on your risk tolerance and time until retirement. This doesn’t mean picking all the funds available to you, but rather building a portfolio that includes all the major asset classes (Lg Cap, Sm Cap, etc).  For someone nearing retirement age, they should probably be more conservative, while someone with 20 or 30 years until retirement can stand to continue to invest more aggressively.  

I know it’s tough with how the market is, but now more than ever it is time to have a good game plan and stick to it.  People should approach investing like coaches approach football games.  Coaches set a game plan going into the game and stick to it.  They review hours upon hours of game film and monitor the strengths and weaknesses of their team and opponent and create a strategy that gives them the best chance of success.  During the game, coaches make minor adjustments, but don’t throw their game plan out the window at the first three-and-out or turnover.  It seems people create game plans but then throw them away at the first signs of market turmoil.  If you’re not sure how to come up with a game plan for your retirement or are worried that your game plan doesn’t fit your retirement goals, feel free to contact us to talk through your situation. 

Needless to say, the football analogy connected with a lot of the people I talked to and I had a lot of new friends. Unfortunately for me, they were all MU fans.      

As always, if you have any questions or would like to discuss your account, feel free to call us at, 1-877-627-8401.

Jeff Studebaker, Investment Advisor

In my previous post on the current financial crisis, I reviewed the players involved in the crisis.  I also covered how an overheated real estate market and lax lending standards were the tinder that helped fuel the financial crisis we’re now smack in the middle of.

In this post I’ll talk a little bit about what happened to all of those mortgages once a borrower closed on a house/apartment/condo and how they added to the fire.

Historically, banks originated loans and held them on their balance sheet as assets.  They made money by lending at a higher rate than they paid on customers’ deposits.  Since the banks were holding the loan on the balance sheet (i.e. they were hurt if the loan went into default or otherwise underperformed) they were generally very selective in the loans they made.  This began to change when many of these banks and other lending institutions began to sell the mortgage loans they originated to financial institutions who would package them into mortgage backed securities (MBS) a type of asset-backed security. 

These structured securities allowed the originating bank to book a profit on the loan quicker and also freed their balance sheet and enabled them to make more loans.  Since the originating bank was no longer at risk if the loan went bad many began to relax their lending standards.  In order for banks to sell their loans, the loans just had to meet the minimum standards of the Federal Housing Administration (FHA) — an entity whose stated goal was to boost the rate of homeownership in the United States.

Financial institutions then created the MBS and sold them to institutional investors who desired a “stable” asset that produced a regular level of income.  The idea behind mortgage backed securities was that if you pooled a large enough number of mortgages you were actually decreasing your overall risk by diversifying through large numbers of individual loans and over various geographic areas.  In other words, one bad loan wouldn’t ruin your day.

In addition, mortgage backed securities were divided into “tranches” based on risk level and interest rate, allowing buyers to make purchases based on level of risk they were willing to accept.  The process for rating these tranches was similar to other fixed income securities. Rating agencies like Standard & Poor’s and Moody’s would give the tranches with the least risk investment grade ratings (think GE and Berkshire Hathaway debt), while slapping lower ratings on riskier tranches.  So in many cases, a pile of high risk sub-prime loans were magically turned into supposedly high-quality, investment grade fixed income securities.

After securitizing and selling the loans, these financial institutions were able to buy more loans and repeat the process over and over again.  As the real estate market continued to boom, all parties involved got hungrier and hungrier for more and more loans.  Everyone involved was happy until the real estate bubble started to deflate.  As defaults began to rise, the buyers of the MBS’s started to see losses that they weren’t expecting to see from such a supposedly high grade security.  Buyers quickly stopped buying the MBS’s, sticking the financial institutions with a bunch of unsalable mortgages. That caused the financial institutions to stop buying new loans, which in turn meant that the originators had to hold them on their balance sheets and quickly curtail their new lending.  In the end, this meant that a new home buyer suddenly had a lot more trouble finding a loan, which helped slow the pace of home buying.  With new buyers kept at bay, home prices started to fall and those who had overextended themselves to buy a property found themselves without clear path to safety.  It’s not too hard to see how this situation can feed on itself and create a downward spiral.

So now we have between $1 and $1.5 trillion dollars in sub-prime mortgages that no one wants and a large number of buyers who can’t keep up with the payment on loans they shouldn’t have taken out. The result? A frozen market.  Individual and corporate balance sheets are now full of loans they don’t want, which restricts their ability to spend or lend additional money.  And the spiral continues…

As always, please feel free to add to the commentary and ask any questions you might have.

Scott H

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.