September 2008
The third quarter was dominated by the expanding problems in the credit markets. As the quarter came to a close, the Federal Government's rescue plan was moving towards passage. The $700 billion plan takes direct aim at the root cause of the turmoil, which is bad (mostly housing-related) assets that have choked off the flow of credit to businesses and to consumers. In addition to the massive infusion of fresh capital into the banking system, the plan also has other provisions to prevent foreclosures, provide oversight, and minimize the cost to the taxpayer.
As a result of the excessive fear and emotion-driven trading, global stock markets sold off. The S&P 500 shed over 8% during the quarter, which brought its year to date loss to 19%. Consumer staples stocks were the only area of the market to post a positive gain for the quarter. Energy and materials stocks led a sell-off where over half of the market's sectors experienced double digit losses.
The bond market was a tale of two cities. The reduction in liquidity coupled with heightened uncertainty made treasuries the favored asset class for investors. Longer maturity treasuries gained almost 4% for the quarter. However, corporate and municipal debt experienced a different fate. The flight to safety led to selling in both markets as concerns grew over the reduced access to credit for both corporations and municipalities.
Despite the continual drumbeat of negative news from the media, the actual economy turned in mixed results. On the worrisome side, the economy continues to shed jobs. The unemployment rate reached 6.1% as the economy lost nonfarm payroll jobs for the ninth consecutive month. In addition, foreclosure rates continue to increase as many homeowners are finding it difficult to refinance out of rising monthly payments. Unfortunately, these are trends that will probably continue through the fourth quarter.
On a positive note, commodity prices have retreated significantly due to an anticipated decline in global demand. The reduction in food and energy costs for consumers will ease the impact of any economic slowdown and it will lower the threat of inflation in the near term. This, in turn, will enable the Federal Reserve to focus its energy on reviving growth and employment in the economy. This should be an easier task for the Fed since several signs have emerged that the housing situation may be taking a turn for the better. New and existing home sales have increased and the pace of home price deterioration has slowed.
There is little doubt that we are facing a challenging economic environment. Markets are, however, forward-looking and the worst market upheavals generally occur before a recession starts. When the recession arrives, markets tend to be in recovery.