Rally in
financials leads US stocks to best monthly return since October 2002
Millions of
individual investors opened their February statements, saw that their
stocks were down 19% on the year and sold out, driving the S&P 500 on
March 9th to the lowest level since September 1996. As hedge funds already sold stocks last
fall, and institutions sold stocks over the winter, individual sales
marked the final exhaustion of the selling which began with the September
15th bankruptcy of Lehman Brothers.
Financial stocks, which include banks such as JP Morgan and
Goldman Sachs, insurance companies and REITS, fell as much as 52% between
the end of last year and March 9th, but gained back half that loss by
month end - the best performing sector in the S&P 500 for the month
of March. Overall US stocks
delivered the best return since October 2002, which coincidently marked
the end of the last bear market. So far, the rally is continuing into
April.
Why the sudden
change of sentiment? With US
stocks down 57% from the October 2007 peak, valuations were at the lowest
levels since 1982. Many top down
analysts feel that the S&P 500 is still overvalued at these levels,
because losses in the financial sector crushed earnings estimates for the
S&P 500. Outside of financials,
however, the earnings picture is by no means as bleak. Technology companies, for example, are
doing fine simply on replacement spending by companies and individuals -
that sector is UP nearly 10% on the year.
Worldwide demand for commodities has bottomed (oil for example is
30% higher than the low of $39.72/barrel touched mid-February.) Energy stocks are still down 7%/YTD but
the Materials sector is up 3%.
Also reflecting an uptick in demand for commodities and basic
manufacturing, the Bombay (India) stock market is up 4%, Brazil is up
16%, and China is up 45% on the year.
In the US, the NASDAQ is up 2.4% on the year, while the NASDAQ 100
(the largest cap technology and medical stocks) is up 7.4%. The S&P 500 is still negative on
the year, but the loss is trimmed from down 25% to down 6.6%.
So bottom line,
plenty of investors see opportunities even though the world's financial
system is still mired in problems.
Is it too late to get invested?
At current levels, the S&P 500 is back to the level of January
31st of this year and has to rise another 7.5% just to get to breakeven
on the year. Stocks must gain
48.9% to eclipse the level of September 12th, 2008, right before the
financial melt-down, and rise 86.2% to break the October 2007
record. At the post 1945- average
return of 10.4%, US stocks wouldn't make a new high for 6-7 years.
The World's
Financial System
For months, the US
and international governments have been grappling with a dysfunctional
world banking system. As has been
described "ad nauseam," US and European banks and hedge funds
gorged on highly risky debt securities purchased with borrowed money
through mid-2007. Once the selling
started, these securities had to be marked down from par (100) to as low
as 20 cents on the dollar. Nearly
a trillion dollars in value has been written off so far, and the
reduction in "regulatory capital" caused banks to suspend
normal lending to corporations.
For industries such as housing or car manufacturing, inability to
finance customer purchases caused production to fall by 40% with
corresponding losses of jobs.
Why has it taken 6
months for things to turn around?
The current problems have their roots in bank deregulation enacted
12 years ago during the Clinton administration and accelerated during the
Bush administration. Safety
mechanisms established after the Great Depression were systematically
dismantled. Regulators with a free
market philosophy such as Alan Greenspan refused to regulate new
investment products such as Credit Default Swaps. The banks themselves demanded an
increase of leverage far beyond that which destroyed Long Term Capital in
1998. The rating agencies
certified as investment grade securities which we now were junk all
along.
Such a systematic
failure, encompassing tens of thousands of public agencies and private
financial firms, is not turned around in a heartbeat. The US government, primarily the
Federal Reserve and Treasury, has at most a couple of hundred employees
to address the issues. As fast as
these individuals came up with plans to address the crisis hundreds of
economists and portfolio managers rushed to the airwaves to explain why
these plans wouldn't work. Even
so, trillions of dollars in the US and in Europe are being brought to
bear on the problem, pushing capital to the banks through, for example,
the TARP program, while setting a floor for regulatory capital by buying
up junk securities. Probably half
that money will be return to government coffers over the next decade,
while the rest is the cost of saving the system.
A hint of
spring in economic reports
For the past year,
hundreds of economic reports showed nothing but deterioration, taking
most indicators to generational if not all-time lows. In the last month or two, many reports
have leveled off and some have ticked higher. For example, US Factory production,
which 
fell off a cliff
in the 4th quarter of last year, gained for the first time since July
2008. Even though corporation and
individuals have cut spending to the bone, there's still a basic amount
of replacement spending that must occur.
Housing prices are still falling at nearly a 20% year over year
rate, reflecting in particular foreclosure sales of 40-50% in total
sales, but inventory levels are falling as total sales are
increasing. Job losses
unfortunately will increase through at least mid-summer with unemployment
rates in the US hitting generational highs. Hiring and firing is expensive, so
employers resist layoffs as long as possible; and then resist hiring back
as long as possible. US GDP for Q4
2008 declined at a 6.3% annualized rate.
Expectations for 2009 are:
Q1 down 5.1%, Q2 down 2.0%, Q3 up 0.5%, Q4 up 1.9%. Stock markets tend to lead the real
economy by 6-9 months, so the recent move up in stocks reflects
anticipation of a return to growth in the second half of 2009. For the whole year, US GDP is expected
to decline 2.5%, and gain just 1.8% in 2010.
