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2008 Third Worst Stock Year Ever
Stock markets fell off a cliff in the fourth quarter. Investors were already reeling from market losses of 20% by the end of the third quarter–and then October began. Investors sold into a “selling panic” as they read about bad U.S. economic data combined with an acceleration of financial institution failures and credit liquidity problems. In only three months, broad stock index losses doubled for the year–losing in the range of 20%-33% in this single quarter through December 31. An S&P 500 Index decline of nearly 38% is the third worst loss in the history of the index, after worse stock market losses in 1937 and 1931.
Fortunately, CPIC client investment portfolios performed much better than overall equity markets. Applying CPIC’s methodology of dynamic asset allocation, we proactively reduced account equity exposure earlier in the year, so CPIC accounts began the fourth quarter with less exposure. We continued decreasing allocation to stocks throughout the quarter. Below-normal stock exposure in this recent period of plunging stock prices is what helped deliver superior 2008 returns to CPIC clients. The benefit to CPIC clients was millions of dollars – in just a few months!
Wall Street Strategists Forecast Gains in 2009
In a recent Barron’s survey, several top financial strategists said the worst of stock selling pressure already occurred in 2008, and markets will start to recover in 2009. There is no guarantee these strategists will be right, but the consensus expectation is that the S&P 500 Index will end 2009 near an average of 1045, about 15% above the year-end close of 903. In the short-term, the surveyed financial strategists expect more bad economic news. The U.S. economy is likely to worsen as companies cut costs and continue to lay off workers, and economists project GDP declines of 4% or more for the fourth quarter of 2008 and early 2009. Indeed, the majority of firms surveyed expected a U.S. economic contraction for all of 2009.
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Why would strategists think stocks will move upward in light of this dismal view? The first reason is a stock market that has already fallen 52% from its 2007 peak to its Nov. 20 low has discounted much of the deterioration still to come. Second, with more than 37% of mutual-fund assets parked in cash and money-market funds (the highest level since 1991) there is ample cash for buying should stocks dip below a certain threshold. Third, cheaper energy costs can boost more consumer spending. Fourth, more liquidity has become available in credit markets than previously.
The U.S. government's aggressive policies should help catalyze a better financial picture overall. Morgan Stanley’s chief global equity strategist stated, "The size of global policy response to stabilize both the financial system and the growth outlook is virtually unprecedented. It does not appear likely to us that equity markets will fall substantially from here, given growth expectations have been substantially lowered, growth data are depressed and there is a high level of skepticism surrounding the ability of policy-makers to salvage the financial system and stabilize growth." If these strategists are correct, the 39% gain from the Nov. 20 low of 752 to 1045 could mark the start of a new bull market. On the other hand, perhaps it could be only a big bounce within an extended down market.
Current Portfolio Strategy
At this time CPIC client accounts have very high levels of cash and bond mutual funds (even in “growth” accounts). The immediate environment of financial uncertainty calls for this more defensive portfolio allocation, with a current goal of capital preservation. At the same time, we are acutely aware that the real return on cash after inflation is negative. We continue to monitor economic conditions, watching for an opportune time to increase equity exposure. Risk is at an extremely high level. Nevertheless, we are optimistic that 2009 will be a better year for portfolio returns than the year just ended.
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