Friday, 31st October 2008
Investor returns for the month of October have been frightening. The S&P 500 shed 15% this month and registered historic volatility. Of the 23 trading days in the month, only 7 closed positive. They were resoundingly positive, however. The average advance for those seven days came to approximately 5%. In fact, two of the highest daily returns in history fell within the month. The gains on October 13th and October 28th, around 11% each, register as the 5th and 6th best days ever. The average daily move for the month was nearly 7%, top to bottom. The volatility index, which had peaked historically around 54, reached 90. With hedge fund liquidations, mutual funds’ fiscal year end positioning, tax loss selling, de-leveraging, and retail investor panic, October contained all of the elements of a perfect storm for investors. However, October also has a history of being the “bear killer” and as we wrap up this furious month, perhaps we should divide it in two. October A occurred between September 30th and October 10th. October A returned –28% from the October 1st open to the intra-day low on October 10th. October B occurred between October 10th and today, returning 15%. Are we out of the woods? Let’s revisit our commentary on Friday the 10th and see if progress has been made:
Looking for the Exit (from October 10th commentary)
“If you feel like you are in a dark room looking for a doorknob to turn, don’t look to the stock market. The path to redemption for investors will come through the bond market. Think of bond market spreads (simply the comparison of two different bond yields) as a thermometer of confidence. When spreads are high, we have fever, when they are low, we are healthy. The most important thermometers right now are the overnight inter-bank thermometers and the overnight corporate borrowing thermometers. The decline in these spreads will be the spark we need.”
Credit spreads have narrowed dramatically! Overnight, LIBOR reached an all time low of .41% last night, and the three-month LIBOR has fallen for 15 straight days to 3.03%, down from 7% at its high. How important is LIBOR? It is the benchmark used to set rates on $360 trillion of financial contracts worldwide. Commercial paper spreads on 30-day paper dropped to their lowest rates in four years, and overnight paper has fallen to its lowest rate in 13 years. Apparently, the $3 trillion or so of worldwide government assistance has had an impact in the credit markets. The substantial reduction in borrowing costs, and its renewed availability, will translate directly into consumer and corporate profitability. Incremental improvements in profitability assumptions should transfer through to stock prices, and indeed they have. As we have noted, there are plenty of irrational and mechanical forces pushing the markets lower, but there are some very real fundamental forces pushing markets higher. The rally that began on October 10th can be justified, and that is what might make it even more potent as selling pressure abates.
- This week we received interest rate cuts from the US, Japan, China, Taiwan, Korea, Norway and Slovakia, to name a few. The Bank of England and the EU should fall in line on November 6th. Money is getting cheaper!
- Economists expected US GDP to fall .05% in the third quarter; actual numbers showed a .03% contraction. Expansion in government spending and net exports was not enough to overcome reductions in investment activity and consumer spending. Consumer spending, which accounts for 70% of US GDP, fell 3.1%, its first decline in 17 years and the most dramatic since 1980. Santa will likely be filling retailers’ stockings with coal (and coal prices have fallen as well).
- The government has begun more deliberate discussion around directly assisting homeowners. The Treasury and the FDIC are currently discussing a $50 billion package, assisting 3 million mortgage holders at risk of foreclosure. 7.5 million properties currently have negative equity, and home prices continue to fall.
- Everyone has submitted an application to the $700 billion TARP for financial salvation. The most recent beggars include the auto companies, insurance companies and large real estate developers. If you have lent money to a family member who has not repaid you, consider submitting your own application. Pray that we start hearing “no” from the Treasury so that these businesses can spend their time considering more legitimate strategies.
Barring any hanging chads, we will have a new president next week. The markets have likely discounted the theoretical costs of an Obama regime, although the swing in Congress may not be fully priced in. A McCain victory might offer a relief rally, but I would expect that to be brief. The policy decisions of the government will be judged in real time as they manifest. Either administration will need to work with Congress and respond to the overwhelming needs of various and sundry constituents, all vying for their piece of the bailout buffet. What’s most important is that we assert our democratic right by participating in the process, so go vote! Happy Halloween!
David S. Waddell
Senior Investment Strategist
For more information on www.waddellandassociates.com.
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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.