Economic & Market Commentary

 
 
"Panic" in Perspective:  6 facts to help dispel the fear and 10 key reminders - James Swanson, the Chief Investment Officer for MFS Investments.  
6 facts

1.        In January of 1970, a bear market started that lasted until May of that year. The market during that time fell 35.4%. In May, a bull market began that lasted until January 1973 and brought a 124% gain in stock values.

2.        In April 1981, another bear market commenced that lasted nearly a year and brought a 24.7% decline. Then, in March of 1982, the market began to rise and continued doing so until June 1983, bringing an overall gain of 71.7%.

3.        July 1990 brought a downward market that lasted three months, until October 1990, at which point equity prices had fallen 22.4%. Then, in the same month, a new, now legendary, bull market took hold and lasted nearly eight years, until July 1998, delivering a 330.7% gain for the market.

4.        Dating back to 1975, 8 of the last 15 bull markets have started in the autumn months of September, October, and November.

5.        Since 1957 there have been 15 bear markets, as measured from peak to trough, and on average they have lasted 10 months and brought an average decline of 29.4%.
 
6.        The duration and degree of these bear markets were significantly less than the duration and magnitude of bull markets. During the same period, there were also 15 bull markets, which lasted, on average, 30 months and brought average gains of 112.5%.
 
10 key reminders for investors

1.        Panics are based on emotion, and emotions can take on a life of their own. A herd-like mentality develops, and words that start to be used repetitively - such as "collapse," "endless," and "plunge" - only feed the frenzy. But it is important to remember that emotions are not your friend when it comes to making big decisions about your savings, retirement, or college money.

2.        Individuals and the professional managers they hire to oversee their long-term assets are investors, not traders. There is a big difference. For investors, what matters is the long run, not today's events.
 
3.        No one is alone in their concerns. We all have lots of company.

4.        Panics and downturns are part of the free market system. They have occurred throughout history. While this knowledge may not ease the pain, these sharp, sudden downturns still have to be recognized as part of a cycle that often includes years of slow and steady upward progress.

5.        Historically, bear markets, recessions, and market panics have been relatively brief in comparison with the duration of bull markets. Since World War II, economic expansions have, on average, lasted five times longer than recessions, and bull markets have been twice as long as bear markets.

6.        Cyclical downturns have historically been connected to credit excesses. This time is no different. Prudence in borrowing will be rewarded in the next cycle.

7.        Collapses do not bring everything to a halt. Even during the worst of down times, people still go about their lives, raising children, going to work, and planning for the future.

8.        Risk-seeking in the markets has vanished. But the pursuit of risk is a normal state for the markets. U.S. Treasury bills may look smart today, but at some point risk-seeking will return. It always has.

9.        The largest government bodies in the world have acted to lessen the severity of this crisis.
 
10.        You cannot control events. You can only control your response to them.   
 
 
 

 

The Fed is going to provide banks with interest on their reserves…what does this mean?
October 8, 2008
 
Under current law, Banks are required to keep a certain amount of reserves on deposit at the Fed. These reserves are used by the Fed, among other things, to help set the Federal Funds Target Rate, which is the rate banks use to lend each other money on overnight loans. Before October 1st, banks did not earn any interest on their reserves kept at the bank, so banks kept as little money there as possible. With banks currently hoarding cash and scared to lend anyone money, the Fed Funds Rate is dropping much below its target rate to encourage banks to lend to one another. If banks don’t lend to one another and money isn’t passed in the short term loan market, businesses can’t get short term capital needed to fund their daily business expenses. 
 
The idea of paying interest on reserves is nothing new. In fact, Congress passed a bill stating the Fed could begin to pay interest on reserves held at the bank starting in October 2011. However, under the current financial pressure, and the passing of the Emergency Economic Stabilization Act of 2008 (EESA), this was bumped up to this October 1st. So, the Fed is now able to pay interest on the reserves held at the bank, which is 0.1% below the fed funds target rate for the minimum reserve requirements, and 0.75% below the fed funds target rate on excess reserves (www.wsj.com).   The theory why this will help is this: if the Fed has more money on hand, they will be able to control their balance sheet and fiscal policy a little better because the interest rate maintains a floor on how low the Fed Funds Rate will drop, which also reduces the volatility of that rate. Since the Fed uses these deposits on their balance sheet to set the Target Fed Funds rate, if they have more money on hand, the Fed can pump more money into the system to help troubled banks on a microeconomic level, while maintaining the Target Federal Funds Rate for a bigger macroeconomic purpose. 
 
If you have any questions on this issue, please do not hesitate to call.
 
 
 
 
 
 
$900 Billion Bailout Plan – Pros and Cons
October 8, 2008
 
Problem: Too much lending for subprime borrowers, and too much lending on home values (up to 120% of home values). Financial institutions needed to create securities that were tied to mortgages, which are very tough to value, and are becoming worthless because of defaulting home loans and mark to market rules. Financial institutions have stopped lending and some are going bankrupt because they have such a significant amount of these worthless securities on their balance sheets. Without lending, business expansion more or less comes to a complete hault.  
 
Solution: Treasury wants to issue a $900 billion bailout plan that will allow it to assume these risky assets, which will free up financial institution balance sheets and allow surviving financial institutions to begin lending, albeit not immediately. 
 
Pros:
  • Hopefully restores confidence
  • Raises FDIC limits from $100,000 to $250,000 preventing run on banks.
  • Hopefully restores lending
  • Assumed assets could be a great investment – this depends on the pricing Treasury gets for these assets.
  • Hopefully buys time to come up with a better solution. 
  • Creates tax relief for 24 million households, saving them $62 billion in AMT taxes.
  • Suspends mark to market valuing of securities for a limited amount of time.
 
Cons:
  • Trickle Down Economics rarely works.
  • Opportunity cost – Could use $900 billion for many other issues.
  • Hyper Inflation possible.
  • Mimic Japanese economy, which has huge problems now.
  • Too much “pork barrel” spending with no matching budget cuts.
  • Does not attach specific root of the problem.
 
Other Points:
  • We’ve had a problem for roughly the past year. The Fed and Treasury had plenty of time to recognize a problem; however they waited. Now they are forced to throw a plan together in haste, which doesn’t necessarily address all the issues. 
  • Private Sector is sitting on the sidelines with cash waiting to jump in.
  • Doesn’t necessarily solve the root of the problem, which is home foreclosure. 
    • Plan to restructure mortgages to keep people in their homes may be a more direct and efficient way to begin to solve this problem. This still allows capital markets to flush themselves out. Recessions are necessary and healthy.
  • Yield curve is in a perfect position for banks to lend. Short term yields are low while long term yields are higher – roughly a 400 point spread between them. 

 

 

The Price of Oil About to Jump?  
October 8, 2008
 
With the shrinking global economy, the demand for commodities around the world has been declining, putting downward pressure on commodity prices, especially oil. This has been a big relief for the Federal Reserve because inflationary pressures have been reduced, giving them more flexibility with their Federal Funds Rate, which is the rate banks charge to borrow money from one another. Declining oil prices has also helped Americans at the gas pump. As oil prices decrease, so does the price per gallon of gasoline, which in this market has been more than welcome. However, that might change…..
 
Just like everything else, oil prices go through their peaks and troughs, and currently we are in a trough. However, oil prices are entering into what is known as backwardation. Backwardation is when spot (current) prices are higher than future prices, which also means, current demand is high pushing current prices higher. This is one of the major signs that a bull market in oil is coming, which unfortunately means higher gas prices and potentially higher inflation, which the Fed will have to deal with.
 
If you have any questions on this topic, please don’t hesitate to call. 
 
 
 
 
 
FOMC cuts the Federal Funds Rate and the Discount Rate in an Emergency move -  
January 22, 2008
 
 
In an unusual move, the Federal Reserve cuts both the Fed Funds Rate (the Fed’s overnight lending rate) and the Discount rate by 75 basis points (.75%). According to their press release this morning, “The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. With strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets” (Federal Reserve Press Release 1/22/2008). This reduction is the biggest cut since October 1984, when the central bank lowered the rate by 1.75%, and it’s the first inter-meeting rate cut since September 17, 2001, when the Fed lowered borrowing costs in the aftermath of the September 11th terrorist attacks (Bloomberg.com).
 
This effort by the fed comes on the heels of markets sell-offs around the world, on fears of the world’s largest economy (the US) going into a recession.  Federal Reserve Chairman Ben Bernanke signaled his growing concern about the economy when he last week endorsed fiscal stimulus to assist the Fed in heading off or moderating a recession. (WallStreetJournal.com). However, with recent data of higher unemployment and continuing write-downs by some of the worlds largest financial institutions, markets around the world have been selling off sharply.
 
Was this rate cut made in haste? Although unemployment is creeping up, we are still hovering around 5%, which historically has been very low unemployment. With the consumer driving roughly 65% of the economy, this is one bright spot amongst all the news about the poor housing and credit markets. However, consumer confidence has been declining swiftly, and although many Americans have jobs, if they don’t feel they’re stable, they’re likely to keep the wallet shut. 
 
What does this mean for the average investor?  As an investor, this particular volatility in the market is to be expected, and is a normal part of a market’s cycle.  It is during periods of volatility that investors especially need to remain disciplined and hold tight to their portfolio allocation and investment strategy. This volatility is why Wooden-Cornellier Group, LLC holds the philosophy that it is not advisable to investors who have time horizons of three years or less to be in the market. 
 
 
The FOMC cut rates by a quarter point – did they make the right move?
December 17, 2007
 
On Tuesday December 11th, the Federal Open Market Committee (FOMC) cut the federal funds target rate (rate charged by banks with excess loans held at the Federal Reserve to banks needing overnight loans to meet reserve requirements) by a quarter point to 4.25% and the discount rate (the rate charged by the Federal Reserve to member banks for loans) by a quarter point to 4.75%. Lowering these two rates make it cheaper for banks to borrow money to lend to businesses, increasing the liquidity in the economy (Bloomberg.com). A day later, the Fed came out and announced that to deal with the global credit problem, they will make up to $24 billion available to the European Central Bank and the Swiss National Bank to increase the supply of dollars in Europe, which joined with interjections from other European Central Banks totals $64 billion. The US is also scheduling a $20 billion auction on December 17th, another auction on December 20th up to $20 billion, two more auctions on January 14th and 28th, with more possible if needed. This move was made to simply alleviate pressures in the short-term funding market, not to avert an economic slump.
 
Despite Wall Street screaming for a half point rate cut in the fed funds rate and the discount rate, we believe the Fed made the right move. Although write downs seem to be getting larger in the major financial institutions, the rest of the economy seems to be doing fine, and inflation is even beginning to creep up. The CPI increased 0.8% in November (0.3% excluding food and energy), which pushes the core rate to 2.3%, which is out of the Fed’s comfort zone. The main culprits to this increase were gasoline, fuel oil, and electricity, with gasoline increasing 9.3% in November, fuel oil up 14.2% for the month, and electricity up 0.6% (econoday.com). However, rising gas and electricity prices didn’t seem to be taking much effect on consumers. With unemployment remaining low, retail sales increased twice as much as forecasted in November, increasing 1.2%, showing that the recession in the housing market and rising prices did not have as much effect as thought on consumers (Bloomberg.com). Also, the index of industrial production, which measures the physical output of the nation’s factories, mines and utilities, was up 0.3% in November vs. 0.7% drop in October. The rise was primarily due to stable orders in manufacturing equipment and foreign demand to capital goods, which is thanks to a weak dollar and global growth (econoday.com). 
 
So, we believe that the Fed made the right move by lowering rates a quarter point to promote “moderate growth” in the economy and then dealing with the credit markets a different way. Currently, with rising gas, oil and energy prices, the economy can’t afford to grow any faster than it currently is, without causing inflation to skyrocket. The Fed has already cut the fed funds rate by 1% already this year, which should be enough to maintain a goldilocks economy, one that’s growing not too fast and not too slow.
 
Thomas V. Cornellier and Robert M. Wooden are Registered Representatives of and offer securities and advisory services through, WRP Investments, Inc., member FINRA & SIPC. Securities and advisory activities supervised from a home office at 4407 Belmont Ave, Youngstown, OH 44505, (330) 759-2023. Wooden-Cornellier Group, LLC is not affiliated with WRP Investments, Inc. 
 
 
 
 
 
Inflation vs. Credit Crunch – What’s the Fed’s Next Move?
December 6, 2007
 
 
There are two conflicting items concerning the Fed meeting on December 11th: inflation and the credit crunch. Currently, The Federal Reserve is taking a very strong stance against inflation and has even hinted in the past that rates would remain stable to ward off inflation, although this has changed in the past week. The credit crunch, that is tightening lending standards, is causing a slowdown in many sectors of the economy, which is coming at a time when 3rd quarter real GDP was revised upward to an annualized 4.9% from the initial estimate of 3.9% (econoday.com). The Institute of Supply Management reported earlier this week that manufacturing growth has slowed to its lowest level in 10 months. The Institute of Supply Management’s Index fell to 50.8, down from 50.9 the previous month, with 50 being the dividing line between expansion and contraction (Bloomberg.com). Jobs growth is also slowing, however, unemployment remains very low and the economy is working at nearly full capacity. Oil prices, which plays a major role in the calculation of inflation, has also eased from its highs of nearly $100/barrel.
 
What does all this mean for the Fed? One thing Ben Bernanke and the Fed are realizing is that the subprime debacle, which has caused the credit crunch, has done more damage than they hoped. Rather than just domestic and international financial institutions being affected, defaults from the subprime mess has hit state pension funds, among other institutions, because they held much of their liquid cash in money markets that invested in many mortgage backed securities that were invested in subprime mortgages. Now, not only is it harder for businesses to grow because of the tighter lending standards, it is now hurting individual’s retirement funds as well. This coupled with reduced equity in homes and higher oil prices; the subprime crisis is weighing heavily on consumer sentiment, which is keeping the wallet closed. This is bad news for the Fed, especially since personal consumption makes up roughly 60% of GDP (econoday.com). As stated before, one bright spot is the unemployment rate remains low. 
 
But, there is some good news. The core inflation measure the Fed uses is staying within their tolerable range, and with a slowing economy, prices aren’t facing as much pressure to rise. This gives the Fed a little more room to reduce the federal funds rate December 11th, and reduce the rate further the first half of next year. Also, Henry Paulson and Ben Bernanke are developing a plan to try and help some of these subprime borrowers from losing their homes. Although it is not their job to save investors from mistakes they’ve made, this problem is spreading far beyond subprime borrowers and financial institutions and into other sectors of the economy, making it a problem they’re forced to deal with. If they can develop a plan that keeps individuals and families in their homes, they could keep the economy from slipping into a recession and just realizing a couple quarters of slower growth. However, as financial institutions get past their write downs, and the housing market stabilizes (which we believe a full housing recovery is at least 18 months away), the economy has enough bright spots to pick up steam and possibly escape recession.
 
With all this said, we have a more optimistic view of the US stock market. One telltale sign that markets have hit bottom is when CEO’s start getting fired, which we’ve seen in many of the big financial institutions. With oil prices dropping, it will help ease the pressure on household bills, which in turn allows consumers to spend more money. That, along with reduced interest rates, which should hopefully reduce rates on loans and other credit cards should further the ease. As long as the economy continues to operate at high capacity and employment remains high, we should avoid recession and be poised for good growth as the housing market gets through their recession and the write downs become a thing of the past. 
 
Thomas V. Cornellier and Robert M. Wooden are Registered Representatives of and offer securities and advisory services through, WRP Investments, Inc., member FINRA & SIPC. Securities and advisory activities supervised from a home office at 4407 Belmont Ave, Youngstown, OH 44505, (330) 759-2023. Wooden-Cornellier Group, LLC is not affiliated with WRP Investments, Inc.