The global financial markets continued a downward slide through the first two months of 2009, but rallies in the U.S. and many other markets during the last weeks of March prompted some optimism that the recession may have bottomed out. How realistic is such thinking? Thomas Dillman, Executive Vice President of Mutual of America Capital Management Corporation, takes a look at the first quarter of 2009, provides insights into why the bear market rally during March might be unsustainable, and highlights how Mutual of America continues to properly position itself.
As the first calendar quarter of 2009 came to a close, a few glimmers of hope emerged in the midst of the gloom that had enveloped global markets and economies since last September. After plummeting during January and February, many markets around the world, for both stocks and commodities, staged impressive rallies that have begun to prompt tentative talk of economic recovery and, among the most hopeful, a new bull market.
Tempering Positive News
A variety of positive economic data in the last few weeks of the quarter provided a bit of support to such sentiments. For instance, new home sales in February advanced nearly 5% on a month-to-month basis instead of an expected −2.9% decline. Durable goods orders for that month also surprised the forecasters, advancing 3.4% against a projection of a −2.5% decline. Retail sales for the month, as reported by the operators, were generally a bit better than expected. And the length of the current U.S. recession, on the verge of entering its seventeenth month—the longest since the 1930s—suggests an end could be close.
In the meantime, the first three months of the year have witnessed global policy initiatives that, in terms of scope and magnitude, are unprecedented. One observer has counted over 450 separate global policy initiatives during the past six months, including interest rate reductions, fiscal stimulus legislation, central bank liquidity programs, bank bailouts, and monetary pledges to other countries and international monetary agencies.
In our last Perspective, we showed a chart documenting that total global spending during the current crisis through the end of 2008 had exceeded the sum of spending on a list of all the largest fiscal expenditure programs in our nation's history. The gap has widened significantly since then, and will continue to grow.
However, we believe that the global financial system and the global economy have a long way to go before stabilization, let alone recovery. As a result, we also believe the recent enthusiasm in the stock markets will probably prove to be unsustainable.
Bear Market Rallies
The other chart we presented showed how the bear market of the early 1930s was characterized by a number of sometimes very powerful rallies. From the last day of 2008 until March 6, the S&P 500 declined 25% to a new current bear market closing low of 677. Then, over the next 14 trading days, the market advanced 21%. All other U.S. stock markets, and many global markets, showed similar rallies.
We believe there are a number of reasons why this rally should prove unsustainable. First, it took off from what technical analysts refer to as a "divergence" from trend, and was the most extreme on record since a similar one that preceded a robust bear market rally in 1938. While we do not make investment decisions on the basis of such technical indicators, we do look at them to help us get a perspective on market behavior and trends. Other non-fundamental indicators, such as investor sentiment, were indicating extreme pessimism and fear, while stock valuations had reached lows not seen in decades.
Second, and more important, the trajectory of economic data remains overwhelmingly negative, although in some cases the rate of decline is slowing and, as noted above, we have had a few surprising positive readings. And while it is true that the U.S. economy entered a recession in late 2007, most of the world did not experience the beginnings of recession until the third or fourth quarter of 2008. The global recession remains in the early innings.
Third, credit market behavior does not support the recent enthusiasm of stock markets. It is true that interest rates have returned to more "normal" levels within markets where the Federal Reserve and the U.S. Treasury have intervened with a heavy hand, such as the commercial paper or the mortgage markets. But in the corporate debt markets—whether investment grade or "junk"—spreads remain at extreme historical highs, even after some modest retracement from all-time highs late last year. The one exception is of newly issued debt of financials with government guarantees.
Fourth, the flood of policy actions announced by the U.S. government over the past six weeks, while astounding in terms of the complexity, breadth and cost, has only just begun to be implemented. In all cases, the odds of success are still out, and will remain so for an extended period of time, especially given the risks of unintended consequences that are likely to attend such unprecedented and sweeping actions. Opinions remain divided, although it is probably safe to say that everyone but the most cynical at least hope the programs will ultimately work to fix the global financial system, and reverse the economic decline.
Finally, we are about to enter the first quarter corporate earnings reporting season. The results are not expected to be good. In late September, when the financial system first began to spin out of control, consensus estimates for S&P 500 first quarter 2009 results were running at a positive 22% year-over-year gain. The current expectation calls for earnings to decline by as much as 30% versus the first quarter of 2008. Corporate pre-announcements of gloomy results are running at record levels versus history. Those two facts suggest that a lot of the bad news to be disclosed is probably well anticipated.
However, the more significant element of the upcoming reports will be comments by management about what they see ahead for their businesses. One of the more disconcerting facts regarding such so-called "corporate guidance" of late is that more and more companies are declining to provide any, explaining that they have limited or no visibility regarding their companies' prospects and, therefore, will not hazard a guess. And, in most cases where guidance will be given, the likelihood is that it will not paint a rosy picture. Stocks generally don't react well when the managements of companies are pessimistic about earnings prospects. It will be difficult for the current rally to continue in the face of such a headwind.
Maintaining a Disciplined Approach
That said, markets can, and do, get ahead of the fundamentals—both on the upside and downside. In the meantime, we will continue to manage portfolios in a consistent and disciplined fashion with a focus on security selection determined by our proprietary research.
For equity funds, that means we own stocks of companies that we believe are the best positioned within their industries and sectors to deal with a continued difficult economic environment and heightened uncertainty regarding the impact of recent policy initiatives. For fixed income funds, that means owning bonds that provide attractive income and a very high probability of paying back our principal at maturity.
The
views expressed in this article are subject to change at
any time based on market and other conditions and should
not be construed as a recommendation. This article contains
forward-looking statements, which speak only as of the date
they were made and involve risks and uncertainties that could
cause actual results to differ materially from those expressed
herein. Readers are cautioned not to rely on our forward-looking
statements.
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