The following are Nate’s notes from our January 30th conference call. Thanks to those who were able to dial in and contribute questions and comments.
Despite some recent stabilization, stock markets worldwide have gotten off to a shaky start this year, continuing a decline that began in late 2007. Fears of an economic downturn and the consequences of a lengthy period of imprudent lending have driven the markets downward. No one can accuse the government of standing idly by in recent weeks. The Federal Reserve took a very drastic measure last week via a 75 point reduction in the Fed Funds rate in the interim between meetings, a tactic that had not been used since September, 2001. Not to be outdone, the administration and selected leaders of Congress have been working on a package of tax cuts and rebates designed to give the economy a short term boost.
Are all these actions warranted by the data? And are things truly that dire to require such an urgent and chaotic response?
First, let’s assess where we are and how we got there. The period of reckless lending – now broadly and improperly described as the “subprime mortgage fiasco” – has left many of the leading banks and financiers highly vulnerable. As we know, there is no shortage of explanations or villains to explain why a gulf the size of the Grand Canyon opened between prudent standards of lending and what was occurring from 2004-2006. Finger pointing aside, it is undeniable that the weakened housing market and the perilous financial condition of the banks pose a systemic risk to the economy. But it must be noted that – to date – deleterious effects on the day-to-day economy from the housing difficulties have not been very noticeable. Unemployment is at 5%, spending has continued – albeit at a reduced pace – and economies worldwide have been relatively immune to what’s occurred here. So again we ask, is the urgency in Washington warranted??
Our answer…maybe! Some key statistics from manufacturing did enter worrisome levels in December and January, and consumer spending did slow noticeably in late 2007. And perhaps the Fed is aware that there is much worse to come that will be appearing in the data in current months. We don’t know right now. However, I don’t think I could be accused of absolute cynicism to point out that 2008 is an election year, and it is in the best interests of nearly every party concerned to be seen as “doing something” to spur the economy before November.
My personal belief is that the policy responses are targeted more towards the stock market than anything else. I have been struck by the extent in which the level of the stock market is now commonly assumed to be equivalent to the state of the economy. When politicians and commentators note the sharp downturn in the economy in recent weeks, what exactly are they talking about? The stock market! The fact that it is now so commonly accepted that the stock market IS the economy is an amazing consequence of how the “democratization of investing” and the “ownership society” has so completely changed the importance of the stock market to people’s perception of the economy and their own personal well being.
To me the true irony is how everyone has reacted to what’s been happening. For years, it seemed there was a broad consensus that the American consumer needed to stop thinking of a home as an ATM, that there needed to be a spending retrenchment and a re-discovery of savings as a way to build wealth….and ironically, at the very first signs that might be happening, Washington enters a panic and does what Washington does these days….rushes to borrow money from the nations that ARE saving and accumulating wealth to reward our indulgences with a rebate check. Nothing to worry about, the next generation will take care of the bills, just as they will for all the other borrowed extravagances of recent years.
But what does any of this mean for us here tonight? Well, as investors, we can take some encouragement that the actions of so many are indeed targeted at maintaining corporate profits and, thus, stock prices. Whether this is good, bad or indifferent for the overall economy and for the relative strength of the US in the world is a topic best left for greater minds than my own.
And finally, what has been happening to portfolios in recent weeks? Well, obviously there has been little good news for those of us invested in stocks. Balanced portfolios are being cushioned, however -by bonds, both US and international - which have indeed gained as stocks have swooned. And for those who remember our last call, this was our projection; that stocks and bond performance would continue to diverge in the absence of inflation and that would provide support to portfolios in any circumstance. This negative correlation still seems likely to continue and is the cornerstone of a diversified asset allocation plan.
Posted February 6, 2008 by Nathan Gendelman
