Monday, January 12, 2009
Happy New Year!
The best thing I have to say about 2008 is that it’s over. The stock market logged its worst performance since 1931 and the non-government related bond market had its worst year ever. The real economy shed 2.6 million jobs, the most since the 1981-1982 recession, while the unemployment rate climbed to 7.2%, its highest level since 1993. The full brunt of the financial crisis escalated into a confidence crisis in the 4th quarter, when much of the real damage occurred. The economy went into cardiac arrest, as the recent dismal retail, employment and corporate earnings numbers show. It wasn’t just the credit markets that froze; everything froze to a certain extent. Will 2009 raise the temperature? We believe so, albeit slowly. But markets can accelerate rapidly as hope intensifies. I will commit to the fearless forecast that 2009 will outperform 2008. Now let’s get on with it.
The Fed has the accelerator to the floor. The overnight rates have drifted toward zero and the money supply has ballooned. Credit is available and getting cheaper, as the Fed has committed to backstopping the asset backed credit markets, acting as a buyer of last resort for mortgage, consumer credit, auto and corporate paper. The $800 billion in programs announced last quarter will only begin implementation this quarter. Yet the mere announcement of them has reduced interest rate spreads considerably, and credit markets have improved as a result. Look at the returns for some popular credit-linked ETFs over the trailing month thru 1/8/09:
iShares High Yield Corporate Bond (HYG): +19.61%
iShares Investment Grade Corporate Bond (LQD): +9.64%
iShares Barclays 10-20 Year Treasury Bond (TLH) +2.25%
SPDR Lehman 1-3 month T-Bill (BIL) -.11%
Advantage: Risk! These returns become more meaningful when you compare them to the anemic .05% return for the S&P 500 over the same time period. The bond market should lead the recovery process since it has been the protagonist in this financial tragedy. The stock market may get all of the headline attention, but the bond market is driving the bus. Thanks to the Fed’s activity, not only has the patient stabilized, but the vitals are improving as well. We will not be released anytime soon though, as we have just begun our rehabilitation program. Rehabilitation, by definition, is a forward-looking process, hence the improvement in bond market sentiment.
With $14 trillion in GDP, a $1 trillion US Government funded stimulus package (7% of GDP) will move the needle. While the composition remains unclear, infrastructure spending should enhance the economy by 1-1.5x the expenditure, while tax cuts should enhance the economy by .5-3x the expenditure, depending on their structure. Obama intends to create three million new American jobs, more than we lost in all of 2008, with the most ambitious infrastructure plan since the Eisenhower administration. The Council of Governors proclaims that it has 11,391 projects “shovel ready.” While we still have the Congressional approval process to contend with, the polling results show that Americans are largely in favor of the plan. No surprise here, as unemployment vaults toward 10%. The devil will be in the details and implementation. Speed matters here.
Remember that the US represents a large but minority portion of the global economy. Announced fiscal spending plans outside the US total another trillion, with China announcing $586 billion on its own. With global GDP roughly equivalent to $60 trillion, a $1.7+ trillion global effort amounts to 2-3% of global GDP. These programs will ladder in over time, meaning we will have a flow of global government spending into the economy for years to come. At the minimum, economic deterioration will slow; at the maximum, economies will overheat, and the conversation will shift to inflation. The realities of these activities have already begun resonating in the marketplace. We need look no further than some early cyclical industries over the trailing month thru 1/8/09:
Market Vectors Steel (SLX): +26.8%
SPDR’s Metals and Mining (XME): +21.8%
Claymore Delta Global Shipping (SEA): +21.2%
First Trust Global Engineering and Construction +8.2%
Powershares Dynamic Building and Construction +4.6%
Relative to an unchanged S&P 500, these returns stand out, and to a certain extent legitimize Obama’s intentions. Additionally, the political path of least resistance on fiscal spending appears to be more, not less.
Peering into the Telescope
The promise of monetary and fiscal stimulus in 2008 will become reality in 2009 and 2010. Marketplace adjustments in energy and employment prices also provide organic stimulus. These combined factors will solve the Keynesian “magneto” problem for restarting world economies. It will require patience, however, as we are in effect turning an oil tanker with a johnboat. In between here and redemption lie at least two quarters of dismal corporate earnings and the legislative debate over a stimulus package that will in effect boost our already high $500 billion fiscal deficit to nearly $2 trillion in the near term. As commercial real estate follows the path of residential real estate, and retail activity suffers from high unemployment and consumers-turned-savers, we will likely see more bank failures and corporate defaults. The conflict between an optimistic future and a pessimistic today will keep markets range bound for at least the first half of 2009. I don’t know about you, but range bound in 2009, compared with bottomless in 2008, feels much better. In light of what we have all experienced, flat is the new up! The S&P 500 stabilizing around the 900 level, after hitting 750 in November, would be very constructive. Allowing the recovery measures to mature under this advance will enhance stability. Realistically, for the first half of 2009, we expect reduced, but continuing volatility within a range as the rehabilitation process progresses.
David S. Waddell
Senior Investment Strategist
Global Media Mentions:
David S. Waddell commentary, Forbes, January 6, 2009.
David S. Waddell commentary, Taiwan News , January 7, 2009.
Click here for more information on Waddell and Associates.
**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.