By Marvin O. Ellis, CLU–Branch Manager

We have just witnessed some of the most turbulent financial times that any of us will probably ever see again in our lifetimes

What is our Current Situation?
March 9, 2009 appears to have been the bottom of our most recent financial downturn.  The S&P 500 declined from its high of 1,565 on October 9, 2007 to 677 on March 9, 2009, a 57% decline.  By September 30, 2009 the index had climbed to 1,057, a 56% increase (1).  However, because negative numbers in absolute terms are bigger than positive numbers, it will take another 48% increase in the market to get us back to the market high of 1,565. 

The S&P 500 for the decade ending 9/30/2009 lost 0.15% compounded (2).  Most other markets were also flat due to the two recessions we had during this time.  The first recession was the protracted down turn caused by the technology bubble that burst in early 2000.   The last time we had two recessions in the same decade was during the depression decade of the 1930’s.  But combined the declines in the market caused by the two recessions have produced a flat performance decade.

How did we get here?
The 10/2007-3/2009 decline in the financial markets was largely caused by the bubble bursting in the housing market.  The bubble started in late 1999 when the House Financial Services Committee put pressure on Freddie Mac and Fannie Mae to make sub prime loans more accessible.  This helped to spurre the housing boom.  Too many people speculated that homes would rise faster than was reasonable.  The housing bubble began to burst as prices stabilized in 2006 and then began to fall.  Many who had financed these purchases with sub prime loans could not meet their obligations.  Others who in normal markets would not have qualified to purchase a home also defaulted on their sub prime loans (3).   

Many leading financial institutions such as AIG and Lehman Brothers helped to package these sub prime loans into investment vehicles.  They were collateralized with promises of insurance which made these packaged products appear safer than they were.  They were sold to pension plans, endowments, trusts, insurance companies and many other institutions all over the world.  Towards the last half of 2007 it started to become apparent that there might be a problem.  At first the problem was like a small leak in a dam, not very threatening.  But then as housing prices fell further and sub prime loans became harder to get and more and more sub prime loans went into default the leak escalated as a vicious round of lower home prices and defaulting sup prime loans fed each other. 

By the second quarter of 2008 mark-to-market accounting rules which had been designed to create transparency, required financial instructions to price their portfolios at prices other financial institutions would pay for them.  Confidence and prices eroded as everyone became suspect of the quality of any investments that contained sub prime loans.  As prices fell the capital of many of our most prestigious institutions shrank.  The leak now was a gushing river.

To raise capital, institutions began to sell their best investments.  This drove higher quality bonds and stocks down in price.  By October the credit markets had almost come to a standstill and we saw one of the fastest declines in the US and world financial markets. 

Does History provide any prospective?
Yes.  This recession, as of the 3^rd quarter of this year, has just passed all other recessions in the last 90 years as the worst recession since the Great Depression and has been referred to as the Great Recession.  But it has only gained that reputation by a small degree. 

Our Gross Domestic Product has only fallen by 3.8% while during the depression it fell over 26%.  We have had other recessions that were close to this recession in length and depth.  Our unemployment rate may hit 10% while the Depression rate was 24%.  Top tax rates most likely will go up in spite of what President Obama stated during his campaign but even if they do they will not go up from 25% to 63% as they did during the Depression.  And, although many banks have failed and more will fail, we have not had close to one third of our banks fail as they did during the depression.  We also have FDIC insurance, Social Security and unemployment compensation which didn’t exist then (4). 

Have there been any efforts to repair our economy?
Again the answer is yes.   The Bush administration encouraged Congress to pass the $700 Billion Troubled Asset Relief Program (TARP) in the middle of the confidence meltdown last fall.  Most other major nations passed similar legislation.  The Federal Reserve (Fed) lowered short term federal interest rates substantially to 0 to 0.25% last fall and foreign countries have followed suit.   The Obama administration got Congress to pass the $787 Billion American Recovery and Reinvestment Act which is estimated to put $280 Billion into our economy this year.  “Cash for Clunkers,” First Time Home Buyer Credits, both at the national and state levels, and extension of unemployment benefits have also provided stimulus to keep our economy from stalling.   And the Fed has increased the money supply which has provided further stimulus rather than decreasing it as was done during the Depression.    

What is likely to happen?
Of the last eleven recessions, each one was completely different.  However, if you study each recession you will find they each had two things in common:  First, they all ended and second, they were all followed by a large growth in the economy and the markets.  This Great Recession will follow the same pattern.  Many economists have already stated that the recession has ended but it will take 9 to 12 months before that declaration is officially made just as it took 11 months to declare the Great Recession had started. 

Already we are seeing corporate inventories which hit historic lows being rebuilt.  Capital goods orders and light vehicle sales are increasing.  UPS and other shipping companies are reporting increased volumes.  The inventory of unsold new and used homes has fallen closer to average levels and new housing starts have come off their historic lows (5).   Companies will have to rehire to meet demands.  And the fear that this recession would turn into another depression has substantially subsided.

But the recovery will most likely be at a slower pace than in past recessions because of several reasons.  We still have a large number of people out of work.  Those out of work have decreased capacity to spend.  It will take years to put everyone back to work.  We have flipped from spending everything we make to a saving nation again.  When we save there is less money spent on purchases which create jobs.  Federal and state deficits are approaching World War II levels and will hang around for some time.  Taxes, in spite of any promises, will have to be raised to erase these deficits.  Taxes create a drag on incentives which lengthens the time it takes for the economy to recover.  Our higher deficits are causing our dollar to fall which helps exports but causes commodity prices such as oil to increase.  We will all pay higher prices at the pump as oil prices increase which acts like another tax slowing the recovery. 

Inflation could be a worry if the velocity of money (how often it turns over) picks up and the money supply is kept high.  However, money supply has already been lowered and if the economy is slower in recovering the velocity of money may remain low which could keep inflation and interest rates lower.   We don’t see inflation as a worry yet. 

What are our recommendations?
Long term we feel we are in the recovery process.  As of June 30^th and September 30^th there was more money in money market funds than there was in all of the US Stock Market (6).  As perception spreads that the economy is recovering, more and more of this money will find its way into the financial markets and real estate especially as investors tire of earning low rates.  We feel this bodes well for being invested in the financial markets.  In the past, small and mid sized companies tended to do better as we came out of recessions.  With our dollar falling investments with a foreign element could also do better.   

What are the short and long term consequences?
Any time there is a 56% increase in the stock market over the short period we have just experienced, there is always the chance that we will have a pull back or that the market will digest this growth by going sideways for awhile.  Much of this rapid up tick has been a rebound from the over sold condition that was caused from the fear and panic that we would have another depression.  Fundamentals will become more and more important going forward.  Please check with us so that we can determine your risk tolerance and the best approach to investing for you and your circumstances.  

Footnotes:

(1)     JP Morgan 4Q2009 “Guide to the Markets” page 5
(2)     Morningstar Indexes
(3)     Hartford brochure?
(4)     Bureau of Economic Analysis, National Bureau of Economic Research, JP Morgan Asset Management.
(5)     JP Morgan 4Q2009 “Guide to the Markets” pages 18 & 20
(6)     JP Morgan 4Q2009 “Guide to the Markets” page 4

Source: AD# C09-21938
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Business and Personal Planning Solutions, Inc. and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing in the markets mentioned may not be suitable for all investors. The S&P is an unmanaged index of 500 widely held stocks. You cannot invest directly in any index. Individual results will vary. Past performance is not guaranteed.

Tags: Advisor Commentary, Market Outlook, Our Recommendations

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