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Most recent events
The continuing market gyrations of the last several months could easily compel some to seek calm on the sidelines.
- Those sideline seekers would have missed the stunning and unpredictable 10.79-percent rally on Tuesday, October 28.
- A total flight to safety is typically an ill-advised move for long-term investors.
- The time will come when the market bottoms, but that will come with neither warning nor fanfare.
Financial markets continue to be very jittery, but as several key themes continue to unfold, investors who find the fortitude to be contrarian may well be rewarded over the long haul.
Key developments
- Central banks in the U.S. and around the world continue to take steps to support and restore normalcy to global credit markets, which will allow deserving businesses and consumers to access credit at reasonable rates.
- Initial results from all actions taken thus far look promising, as interbank lending rates—the rates at which banks loan funds to each other—have trended lower in recent weeks.
- Policy responses continue to evolve.
- We expect the Federal Reserve (the Fed) to lower its target federal funds rate at the conclusion of its October 28–29 meeting.
- Congressional rhetoric has increased calling for a new round of fiscal stimulus.
- On October 20, in testimony before Congressional committees, Fed Chairman Ben Bernanke opined that a second fiscal stimulus package "seemed appropriate."
- Deleveraging—or selling assets to repay borrowed funds—continues across the financial spectrum.
- Banks and other financial institutions are selling assets of all types to deleverage themselves.
- Many leveraged hedge funds find themselves in a perfect storm, where:
- Lenders are unwilling to extend them new credit.
- Investment losses have reduced available capital while also requiring them to post additional collateral to existing lenders.
- Investor redemptions and collateral calls have forced them to sell holdings. A whole host of such funds will likely close their doors as a result.
- Consumers are also deleveraging in many cases, for example by selling homes that they have found themselves unable to afford.
- This widespread deleveraging activity has:
- Put downward pressure on the prices of all types of assets—stocks, bonds, houses, and others—in the short term.
- May also present opportunities for long-term investors who are not under any immediate pressure to sell.
- Many longer-term investors have also been selling stock- and bond-related assets in favor of cash and other ultra-conservative investments. This selling by fearful investors exacerbates the supply-demand imbalance created by forced sellers and has contributed to the sharp price declines we have experienced.
- Beyond forced liquidations and emotion-driven selling, even rational investors might well have sought a safe haven from what they perceive as a deep, impending recession. These fears are not completely unfounded, as evidenced by:
- Slumping consumer sales in September—overall sales fell by 1.2 percent—and troubling unemployment.
- The nation's unemployment rate in both August and September was 6.1 percent—the first time since 2003 that it has been 6 percent or higher for two consecutive months.
- Layoff announcements from Goldman Sachs and Chrysler are high-profile examples of the underlying trend of rising unemployment, which would only serve to intensify the theme of reduced consumer spending and higher savings rates we expect to see going forward.
Have we gone too far?
Are current market valuations a reasonable reflection of the expected economic conditions going forward? Or, even after the rebound on October 28, do they reflect a doomsday scenario that is fairly unlikely to play out, and do they therefore represent a potentially attractive opportunity for long-term investors?
At times of extreme investor pessimism, it is important to remind ourselves that underlying the "stock market" are real companies selling real goods and services. A company's stock price is, at best, a snapshot approximation of investors' aggregate expectations for the future earnings of that company—and, at times, investors can overshoot on both sides of the mark.
We have monitored third-quarter earnings closely, and have undertaken an analysis of year-to-date earnings for all S&P 500 companies as compared to earnings for the same period in 2007. As a result of our analysis, we do not believe, given current conditions, that the fourth quarter holds in store a drastic economic recovery. As such, it appears feasible that stock indices may yet retreat a bit from current levels before all is said and done.
Investors with short time horizons, less tolerant to market swings
- It makes sense to hold a more risk-averse portfolio of assets.
Long-term investor response
An analysis that concludes that stock prices in aggregate might fall further could theoretically spur an investor to retreat from all such investments. We espouse the exact opposite approach.
- The key to the long-term accumulation of wealth is to continue to accumulate investments that are well suited to your individual risk tolerance and time horizon.
- We view the current environment as an attractive time for true long-term investors to continue along the path of building long-term wealth.
- Those assets might well fluctuate a bit in the short run, but in the long run, we believe those investors will be rewarded for their persistence.
In the words of legendary value investor Benjamin Graham:
- The intelligent investor is likely to need considerable willpower to keep from following the crowd.
- In the short run, the market is a voting machine but in the long run it is a weighing machine.
- Individuals who cannot master their emotions are ill-suited to profit from the investment process.
- By John Blood, CFA, Chief Market Strategist, Commonwealth Financial Network
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks.
© Copyright 2008 Commonwealth Financial Network
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