Yesterday's business headlines were not for the faint of heart. AIG announced a $62billion loss - the largest in US history, Canada's GDP contracted at an annual rate of 3.4% in the 4th quarter of 2008 - the worst since 1991, the Dow is at it's lowest level in 12 years and the TSX at 2003 levels.
The ongoing global recession has taken a significant toll on investor confidence. Economic news from all the world’s major centres continues to paint a grim picture of corporate profitability. Consumers give every appearance of continuing their retrenchment as spending declines and savings rates rise. Recent employment reports from both Canada and the U.S. provided the weakest figures in a generation. Not surprisingly, these kinds of headlines focus attention away from the longer term as market participants dwell on reports of the most recent developments. Nevertheless, by looking beyond today’s market environment and paying attention to the bigger picture, investors can gain a useful frame of reference to gauge future prospects.
When digesting all this economic news, we need to be able to take a step back and distinguish the Stock Market Cycle from the Economic Cycle. The stock market is a leading indicator meaning it signals the direction the economy is headed. Most economic statistics are either co-incident indicators (signal what is happening currently) or lagging indicators (confirm what has already happened). Based on historical figures, the stock market traditionally moves 6-9 months ahead of the economy. For example, the S&P 500 peaked October, 9th, 2008 at 1,565 and June 30th, 2008 was the last positive growth quarter for US GDP (the beginning of the recession). This is close to a 9 month period. Historically , the average recession has lasted 15 months. Most agree that this is a more severe recession than normal so even if it lasts into 20-24 months this would mean the US would emerge from recession in the first or second quarter of 2010. Backing up 9 months would suggest possible market recovery beginning in the 2nd or 3rd quarter of 2009. Make no mistake, over the next 12 months we will continue to see a lot of bad ecomomic news in the areas of employment, bankruptcies, housing, etc.
The key challenge at this juncture is maintaining that longer-term view. This is particularly true when the financial markets appear to be at their worst. After surviving the market maelstrom of 2008, investors can be forgiven for having remained pessimistic entering the first quarter of 2009. Many had hoped that the move higher, seen on the world’s stock markets very late in 2008, would continue in the new year. So far, this has not been the case. Still, one positive trend has emerged: equity market volatility has begun to ease. While the light at the end of the tunnel appears dim and a full recovery remains elusive, the reduction in extreme levels of volatility will help establish the basis for more orderly equity markets moving forward.
Volatile trading is a normal reaction to an unexpected event in politics or the economy. The S&P 500 Index experienced trading days with a 5% or greater trading range1 on 41 instances between January 1, 1946 and September 14, 2008. Occasionally, these volatile days were clustered in groups. Until recently, the period of most frequent occurrence (nine trading days in total) appeared in the wake of Black Monday in October 1987. Nevertheless, over this entire 62-year period, on average one could expect to see this level of volatility during one trading day every 18 months. However, no one would describe the period between September 15, 2008 (when Lehman Brothers filed for bankruptcy due to the fallout from the subprime mortgage crisis) and December 14, 2008 as a typical market episode. During this three-month period,
there were 64 trading days of which 29 saw a 5% or greater trading range. A once-every-18-months occurrence had become an every-other-day event.
Canada' GDP contraction in the 4th quarter was a quicker and deeper decent into recession than the 1980's or 1990's when GDP fell less than 2%. With record low interest rates (as of 10am AST, the bank cut the rate to 0.5%) and hundreds of billions in government spending around the globe, Canada's recession may be be shortened. A few key factors remain, however, the ability of the stimulus package announced in the budget to offset the effect of the US recession on Canada and how quickly the US emerges from recession. One positive factor in the US is that the collapse of the housing market is stablizing with inventories leveling off, fewer residential construction is being completed and housing is becoming more affordable.
Taking a long-term market view is difficult, particularly when most of the recent news is dire. Still, history has shown that equity markets do recover and provide returns that give the best opportunity to grow wealth. We continue to reposition client portfolios to maximize the potential to fully participate in the market recovery. If you would like to discuss your portfolio specifically give me a call or send an email.
Chris
Source: The Globe and Mail, United Financial Corporation
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