Bears Still in Control
By Gus Krafve
The numbers are in for the first half of 2008, and it will go down as the worst first half since 1970. Virtually all broad equity indices have posted at or near double-digit negative year-to-date returns. Additionally, nine of ten S&P 500 sectors have posted negative year-to-date returns. Only energy has a positive return (+8.9%). Tighter credit standards are gradually migrating their way out of the mortgage market and into numerous aspects of consumer lending. Housing wealth is steadily shrinking: using Case-Shiller national data, housing wealth has already dropped from a peak of $22 trillion in second quarter 2006 to $19 trillion in first quarter 2008 and is expected to bottom at $16 trillion at the end of 2009. Stock market wealth has also declined by more than $3 trillion over the last year.
A common argument is that the economy has dodged the bullet in the first half of the year, avoiding negative GDP growth and setting itself up for a gradual recovery. We would point out that we are not out of the woods yet and are at risk of negative GDP growth later this year as the tax rebate stimulus fades in the fourth quarter. It appears the risks of a classic recession, with two or more consecutive quarters of negative GDP growth, are rising.
Pessimism continues to proliferate. Consumer sentiment continues to decline and has only been this low three other times in the past forty years: the oil shock of the mid-70s, hyperinflation in the early 80s, and the recession and housing correction of the early 90s. However, it should be noted that the gap between what consumers are saying and what they are doing keeps growing. Consumer spending has declined but is actually up 2% year-over-year. It should also be noted that extreme levels of consumer pessimism were a harbinger for the bull-run in stocks in the 80s and 90s.
Despite all of the pessimism, we do see good reasons to remain invested in stocks.
1. Inflation and interest rates are still low.
2. The Federal Reserve is accommodative, although they seem confused.
3. Corporate balance sheets are in very good shape.
4. Corporations have very lean inventory levels.
5. Dividend yields on the S&P 500 are high relative to Treasury Bonds.
6. Valuations on stocks are very reasonable.
7. Investors are hoarding record amounts of cash which should bode well for
stocks in the future as that money gets invested in the market.
It is important to keep in mind that the stock market typically forms a bottom during periods of extreme pessimism. Thus, history tells us we are likely closer to the end than the beginning of this current correction. In the meantime, we want to remain conservative and defensive by owning high-quality investments across our equity and fixed income portfolios and remaining very well diversified.