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Credit Crunch Slams Global Stock Markets
The storm in the credit markets which began a year ago rapidly intensified over the past few weeks. A dramatic series of financial events included a long list of companies considered solid even a year ago: mortgage enterprises Fannie Mae and Freddie Mac, investment bank Lehman Brothers, insurance giant AIG, Merrill Lynch, Washington Mutual, Wachovia Bank, and others. Problems with money market funds “breaking the buck” (dropping below $1.00 per share) also erupted, causing chaos in the commercial paper markets. The ability of companies to transact in the global credit markets has been severely curtailed as bank capital liquidity has deteriorated.
News in other sectors of the economy has not been encouraging. Home prices and sales volumes continue to fall, despite lower mortgage rates. Jobless claims and unemployment rates are higher than earlier in the year. The second quarter GDP rate, although positive, was revised lower to a 2.8% annual rate. One very positive economic development, however, was the huge drop in oil prices, to less than $100 a barrel. Lower energy costs definitely will help keep inflation in check, and provide additional spending power to consumers—in effect, creating a tax cut of billions of dollars.
In reaction to the negative events in the financial sector and overall economic environment, global stock markets have fallen sharply over the past few months, and especially in September. The S&P 500 Index has lost about 20% year-to-date in 2008. International markets have been more severely hit than U.S. equities. Many European stock markets are down more than 30% year-to-date, as can be seen on the EuroTop 100 Index graph. (Note that graphs in CPIC Perspectives have changed; we have replaced the Value Line Index graph with the Euro-Top 100 Index to provide a more global view of stock markets.) Losses on many Asian stock markets were even greater than in Europe; China lost more than 50% in 2008.
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Government Response to the Problem
The Federal Reserve, Securities Exchange Commission (SEC) and U.S. Treasury all have been working aggressively to stabilize financial markets and keep liquidity in the economic system. The Federal Reserve has implemented a very accommodative monetary policy, keeping the federal funds rate at a low 2%. Additionally, they have instituted a dizzying array of new credit facilities for banks and injected money into financial markets. The SEC has responded to the crisis with new temporary restrictions on short-selling. The U.S. Treasury has spent billions of dollars on Fannie Mae, Freddie Mac and AIG, as well as use the Exchange Stabilization Fund to provide extra insurance for money market funds. Most recently, the Treasury proposed the $700 billion Troubled Assets Relief Program (TARP) for stabilizing the banking system by buying distressed assets from financial institutions. Although the proposal was shockingly rejected by Congress on the first vote, stunning the investment world, it is expected that a later version of the plan will be approved within a very short time frame. It should be noted that the U.S. government is determined to do what it takes to stabilize the nation’s financial system. Despite the pessimistic comments by many media commentators, it appears that financial Armageddon is still a long way off! There may be an extended period during which GDP growth could be sluggish, however.
Current Portfolio Strategy
CPIC continues to diligently monitor economic conditions, financial markets, and individual mutual funds. Over the past several weeks, we have significantly increased cash allocations in portfolios, by reducing portfolio exposure to international mutual funds. With forecasts for slowing economic growth in Europe and Asia, and a rising U.S. dollar, domestic funds appear to offer better investment opportunities when we redeploy portfolio cash We continue to watch economic data and events closely to identify a good time to reinvest cash in the next several weeks.
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