The First Quarter of 2009 resumed the downward trend of 2008 as the financial crisis continued on Wall Street.At one point the S&P 500 was down 25% for the quarter but a good recovery in March reduced this loss.
As we began the new year, market expectations and hopes revolved around the new administration’s ability to provide direction and solutions to the economic crisis.Investors knew that corporate profitability had suffered in 2008.In fact, profits fell 32% last year with earnings per share at a low that was not seen since 2003.Much of this bad news was discounted early in the quarter in anticipation of improved economics going forward.
This optimism faded on February 10, however, when Treasury Secretary Geithner disappointed investors with an outline of a plan to rescue the banking system that was short on details.This started a market free-fall as confidence evaporated.Fears about the fate of the nation’s largest banks drove the S&P down to 667 in the first week of March.This dropped the averages down 25% for the year and a decline of over 50% from the record highs in the fall of 2007. At the same time, the Administration continued to “talk down” the economy which drove both investor and consumer confidence even lower.As we have discussed in the past, attitude is often as important as actual facts when it comes to market direction.
Fortunately, this marked the most recent low in the stock market.Unexpectedly good news started to filter out of the financial community.Citi-group announced that the bank had been profitable in the first two months of the year.This was followed by similar statements from both Bank of America and Morgan Chase.President Clinton came out and chastised the Administration for its negative outlook.This helped change the tone emanating from the White House and President Obama started to be positive about economic prospects.
More importantly, the Federal Reserve announced plans that it was going to pump additional money into the economy and home sales showed improvement as buyers started to react to the steep drop in prices.Finally, Secretary Geithner came out with a much more detailed plan whereby the Treasury would buy bad or “toxic” debt from banks and Wall Street firms.This was a variation of the “bad” bank theme which had been discussed months earlier.
These positive developments propelled the market strongly upward.Within a two week time frame, the market had gained over 20%, the fastest rise since the gains that occurred in the Great Depression.
The strategy that we employed last year was to move assets from those sectors that were most affected by the credit crisis into safer areas.This meant moving more dollars into short-term investments in money market accounts.This was done to minimize overall investment damage and to preserve capital.Given that we are in uncharted economic territory this was a prudent thing to do.
As the market started to grind lower in February, we moved additional dollars into the money market.This was done as a safety measure.We sold portions of the value funds that were still in portfolios because these remained most exposed to problems that had been exposed to the banking crisis.Although all funds were declining, those in the growth area, such as technology, were holding up better.The balance sheets for these companies were stronger and they were less exposed to overall credit problems.
We also moved some dollars into the gold fund at AIM.This was a done as a safety measure as well.Gold funds can provide a hedge in bad markets.The cost of producing an ounce of gold in 2008 was higher than the base value of the precious metal itself. This has turned around, however, as the price of gold has increased.With prices in the $990/ounce range for gold, mining companies can now make good profits.As you can see the gold fund went up in value in the first quarter.
At the same time we moved a portion of those value fund dollars into the energy sector.Crude oil hit a low of $35/bbl. in February.Many pundits felt that the dollar would remain strong as a safe haven currency.As oil is dollar-denominated, i.e. sold in dollars, a strong dollar keeps the price of oil down.Oil nations do not care as much if the price of oil is down as long as the dollar is strong and purchases more.If the dollar weakens the price of oil goes up.
We do not share the viewpoint that the dollar will keep its value.Given the record stimulus and bail-out packages, as well as a $3.6 trillion dollar budget and $1.2 trillion dollar deficit, it is hard to imagine that the dollar will not weaken. Despite the fact that we have had falling prices over the last two quarters, (a deflationary environment), the world economy will reflate over time.In fact it is a goal of the U.S. Government to get on an inflationary track again.In this environment, commodities, and oil will start to rise.They will be one of the leaders in the market as the global expansion begins again.
The timing of this move provided a profit in the quarter as oil prices rose substantially from their lows.
As we neared the end of March and it appeared that markets had stabilized, we moved dollars into the growth area via the Vanguard Primecap Core fund.This fund invests in companies that are growth oriented and can be found on the NASDAQ exchange.The NASDAQ has held up much better than other markets and has turned positive in early April.
Unfortunately we are not out of this mess yet.Much depends upon the effectiveness of government plans to contain the financial crisis.One of the larger problems for business is the uncertainty that has occurred because the government keeps changing rules as we go along.Business is less likely to invest if they fear that their investment dollars are at risk because of tax or policy changes.
Clarity relating to corporate earnings also creates uncertainty.Profitability was boosted in recent years because of financial leverage and the housing bubble.With this deleveraging in the financial area, and lower housing prices, it is less clear as how to value future earnings and thus come up with appropriate stock prices.Current expectations for the first quarter are for a 36% drop in corporate profits from the same time in 2008.At the beginning of the year, this decline was expected to be only 13%.For the year, the decline is expected to be 7%, but this is substantially lower than a forecast of a plus 22% just three months earlier.
With substantial assets in the money markets, portfolios remain very liquid. This is good as it gives protection and the opportunity to invest down the road once the economy has stabilized more.
Written by Bruce A. Kraig, April 1, 2009
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