Sound and Fury
Markets continued their volatile ways last week. We began with a 400 point up day on Monday and ended with a 300 point down day on Friday. In between, we had a series of wild swings, exacerbated by large hedge fund liquidations, making the last hour of trading the equivalent of its own trading day entirely. Capitol Hill was also abuzz this week as our blameless legislators took Alan Greenspan to the woodshed for holding interest rates down too long, and the ratings agencies for approving securities of mass destruction. This witch hunt will take no prisoners.
With all of this excitement, we have not moved materially off the lows set on 10/10/08. Millions of trades and decisions have been made since 10/10, but nothing has really changed in the indices. What has changed is that concerns over the credit crisis are receding, while concerns over the global economic slowdown are advancing. This push-me pull-you scenario will likely continue until some piece of heavily weighted news breaks. This news could include a larger than expected rate cut, direct government participation in the housing market, the collapse of an emerging market currency or the collapse of a notable investment fund. It will take either a piece of significant news, or simply time, to jar us out of this range. The downward pressure of forced liquidations and upward pressure of value buyers have drawn the parameters of our current range. Those who want to buy are waiting for selling extremes, and those who want to sell are waiting for buying extremes. Those who want to hold should simply tune this drama out altogether.
What does history say?
The market activity during the Great Depression has always been treated as an outlier. For this reason, the analysis done on market activity during recessions and bear markets has always begun post WWII. The post WWII data reveals that we have had nine bear markets, averaging 32.6% to the downside and lasting 14 months on average. There have been 10 official recessions, lasting 10 months on average, with market returns of 1.4% on average, during these periods. The takeaway is that bear markets end long before recessions end. By these measures, we should have booked the vast majority of the losses the stock market will incur during this cycle, and we could see an increase in value over the course of the recession.
What if this is a depression? First of all, it’s not, as I have supported in past communications. For the sake of argument, let’s look at the data. The stock market, going into the depression, was wildly over-leveraged and widely overvalued. The market decline between 1929 and 1932 amounted to a wrenching 85%. However, there were some remarkable rallies along the way. Between June of 1932 and 1937, the market advanced 27% annually, with 1935 and 1937 being two of the best years in history. Daily rallies were plentiful as well, with 32 days between 1929 and 1933 advancing by more than 6% each. The market had nearly recovered the entire loss until it slipped 50% between 1937 and 1938. This setback left a full recovery unattainable until 1945. Even during that most miserable of periods, an investor who began the 1930s with $10,000 in the market and reinvested dividends ended the decade with $9,950. So while the ’30s are remembered as a lost decade, the true bottom was reached very early on, in 1932. From that point, the market compounded money by about 15% annually, in pursuit of its previous high. The Great Depression also doubled as the deal of the century for brave and patient investors.
The great currency unwind
No markets are immune. The disruption in the housing market, which led to disruption in the credit market, which led to disruption in the equities market, has now led to disruption in the currency markets. Movements in currencies have become just as volatile as movements in other markets, as speculators and liquidators quickly relocate their currency positions. Without getting too detailed, essentially speculators borrowed money in low-yielding currencies like the dollar and the yen to bet on higher- yielding currencies like the kiwi or the ruble. With de-leveraging now forcing these speculators to repay the credit lines, they must reverse the currency switches, leading to fast and dramatic swings in exchange rates.
In a nutshell, many of the US investors who bought international funds put downward pressure on the greenback, as dollars had to be sold to buy the foreign currencies used to buy foreign equities. As these investors redeem, the foreign equities are sold, the foreign currencies are sold, and dollars are repurchased. As commodities have fallen, the attractiveness of the commodity producing nations has fallen as well. Year to date, the dollar has advanced 26% against the Brazilian real, 26% against the Canadian dollar, and 29% against the New Zealand dollar. The flow of funds out of European investments has been dramatic as well, with the dollar climbing 14% against the euro this year. Which major currencies have we lost ground against? The government controlled Chinese yuan, which has gained 6% on the dollar, and the Japanese yen, the most highly abused currency for speculators on the planet, which has appreciated 13%. In times of crisis, the dollar gets the grade. We’ll see what happens when the sun comes out again.
This week will provide two major data points. First, the Federal Reserve will likely announce another interest rate cut on Wednesday. Second, we will receive preliminary data on 3rd quarter GDP, which will likely validate the recession fears. Both events are widely anticipated, and therefore already priced in. In sum, the news is bad but the valuations are good. Eventually those variables will reverse, at much higher levels. Long time bears like Jeremy Grantham and Bob Rodriguez have begun putting cash to work. For value investors with long-time horizons, the daily volatility is meaningless. The opportunity to purchase premier assets at fire sale prices is Shangri-la.
The last three miles of the marathon are always the hardest; don’t give up now!
David S. Waddell
Senior Investment Strategist
Please let us know if you have any questions or comments.
David S. Waddell quoted, Bloomberg.com, October 24, 2008, http://www.bloomberg.com/apps/news?pid=20601109&sid=aQ6Rx0dg112I&refer=home.
David S. Waddell interview, Fox News Neil Cavuto Show, October 9, 2008, https://www.waddellandassociates.com/WADDELL/WEB/me.get?WEB.websections.show&SCH0529_256.
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**This blog represents the opinion of W&A and is for informational purposes only. It is not intended to be construed as tax or legal advice by the recipient. Past returns of investment are no guarantee of future results.
***Any data reported in this blog has been compiled from the Wall Street Journal, Morningstar, Investors Business Daily, or various other informational internet sites.