Friday’s decline pushed the broad market down for the third-straight week – down 4.54% last week, which followed declines of 6.87% and 4.81% in the prior two weeks, respectively. The S&P 500 closed below the Asian Contagion low, hit in May 1997, to the lowest level since December 1996.
There are undoubtedly awesome long-term opportunities out there in the stock market, as valuations sit at the lowest levels in more than 20 years. However, investors remain spooked as the Obama administration has an overt disdain for business, makes clear they will raise tax rates – and in some ways has already begun to do so, continues to engage in policy that freezes private capital and sends signals regulations are going to much higher – instead of simply enforcing current regulations. The equity investor will need a lot of patience, but patience will pay off – in the meantime caution is the rule.
Financial and health-care shares got drubbed again on Friday as the latest government “help” to Citigroup simply put the “short banks” trade back in place and the Obama health plan puts the screws to private care and drug discovery.
The relative winners were consumer discretionary, technology and consumer staple shares.
Market Activity for February 27, 2009
On the Citigroup news, the Treasury Department will convert as much as $25 billion of preferred shares into common stock as long as private investors agree to the same terms. The government does not currently intend to inject additional money.
So let me get this right. Bernanke comes out and assuages concerns on Tuesday by saying nationalization is not in the cards. Then Geithner does an interview on PBS stating the administration has no intention of nationalization. Now, just two days later, the Treasury effectively makes a move in that direction – the decision to convert Treasury’s preferred shares to common is more an accounting change than anything (why not just eliminate mark-to-market?) -- but what if investors do not want to tender their shares, will the government force it upon them. And even if they do not need to force investors’ hands, you’ll still have the government holding nearly a 40% stake in the bank and in the meantime “encourage” them to do things like suspending foreclosures. And people wonder why the market is in disarray; there’s little wonder why capital is on strike.
And speaking of government rescues, the Treasury Department is into its fourth rescue plan for AIG, as the insurance giant will receive another $30 billion in TARP funds and interest rate modifications on government loans will ease borrowing costs.
On the Economic Front
The Commerce Department reported fourth-quarter GDP was revised down big to show the economy contracted at a 6.2% real annual rate – it was initially estimated to decline 3.8%. This figure is much closer to the -6% we were expecting when the initial reading was released a month ago as personal consumption showed a very big decline and inventories building was revised substantially lower.
The 4.3% decline in real PCE (personal consumption adjusted for inflation) occurred at the fastest pace since the 1980 recession, business fixed investment fell 21.1% (specifically, business equipment fell 28.8%, the most since 1958), residential fixed investment (housing) fell 22.2%. These are all quarter-over-quarter at an annual rate.
The main reasons for the large downward revision came from the personal consumption decline, originally estimated at -3.5%, and the change in inventories, down $19.9 billion -- originally estimated to have increased $6.2 billion. This downward revision in inventories accounted for 1.2% point of the 2.4% points of the revision to overall real GDP.
So what we have here is the worst decline since the spring of 1982 (a period with which the Volcker Fed was quashing the insidious inflation of the 1970s by the necessary jack-up in rates). We are indeed looking for GDP to contract at a 5% pace this quarter, although it is too early to truly gauge, which will make this the deepest recession since the 1957-58 contraction (a 4.2% decline in Q4 1957 followed by a massive 10.4% contraction in Q1 1958).
The export data shows the nature of the global downturn (yes, global growth remains dependent upon U.S. activity – those piping about “decoupling,” or how the emerging markets do not need U.S. growth need a lesson in how the global financial and economic world works, to say the least). U.S. exports declined at a 24% annual rate.
Such large back-to-back declines (fourth and first quarter GDP) should signal a bottoming out process. Personal consumption should begin to rebound, a bit, by the second quarter (we may be a bit optimistic here) as we see the cash savings rate approaching 4.5% by that time. As we’ve discussed for a couple of months now, since the two primary savings vehicles (homes and stocks) have been hit hard consumers will need this level of cash savings to feel better about spending.
Also, the inventory liquidation dynamic should provide a production boost by late spring/early summer and housing activity has become so weak it should stop subtracting from GDP – at the least it will not cause such a drag on the figure as this segment makes up just 3% of GDP, down from just about 7% back in 2005.
In a separate report, we also received the Chicago Purchasing Managers’ Index (the most important regional manufacturing gauge that gives us a look at what nationwide ISM will post) and the index improved a bit to 34.2, but only from the very weak level of 33.3.
We really need to see the index rise to the 40s before feeling strong that the economy will bounce by mid-year. ISM and these PMI indices (again ISM is the manufacturing gauge for the nation and PMI surveys should be viewed as preliminary report for ISM) are great initial indicators as to the direction of economy activity so we’ll continue to watch them closely.
This morning we get personal income and spending for January and the ISM manufacturing reading for February. The previous ISM report led many to believe the economy had hit bottom – and who isn’t looking for evidence of a bottoming process – as the figure improved mildly. However, the preliminary factory reading (figures such as the Purchasing Managers’ indexes – like the Chicago survey touched on above) show we’re not there yet. This morning’s ISM number should take another turn down.
Again though, inventory levels went into this recession at a low level and businesses have scaled back stockpiles even more over the past two quarters. It should not be long before this inventory dynamic offers a boost to growth as firms must ramp up production. However, the government has to stop scaring the tar out of the private sector, and unfortunately we see no evidence of this waning just yet.
Have a great day!
Brent Vondera, Senior Analyst
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