The stock market declined precipitously in the fourth quarter as the worldwide financial system teetered on the brink of collapse. The S&P 500 Index declined 22% in the quarter and produced its worst performance for the year since 1937.
S&P 500 Index -37.0%
Average Diversified Mutual Fund -38.7%
Analysis: 4th Quarter 2008:
The fourth quarter continued the dramatic decline in financial markets that had begun in mid-September with the bankruptcy of Lehman Brothers. The leveraging of loans in the sub-prime mortgage market wreaked financial havoc across the entire system. Institutions which had been around for decades were sold or propped up by massive loans and capital infusions from the government. These included:
•Merrill Lynch was sold to Bank of America. •AIG, the insurance company, increased its loans from the government to $150 billion (from $85 billion) with the government taking partial ownership. •The government, with its initial $350 billion bailout, extended loans to a broad range of banks in exchange for warrants. •Financial institutions, such as investment banks, registered as banking institutions so they could get a piece of the bailout money. •General Motors (GM) and Chrysler received governemnt loans of $14 billion as they approached bankruptcy. •A ponzi scheme by Bernard Madoff was exposed with the potential loss of up to $50 billion for unsuspecting investors.
Volatility reached all-time highs prompted primarily by hedge funds (and some mutual funds) which were forced to liquidate their positions to meet investor redemptions. Drops and gains of 900 points in the DOW occurred several times. In particular, the last thirty minutes of the trading day were chaotic as program trading kicked in following the direction of the market. These moves were magnified further by ETF trades which were leveraged to provide more movement. The commodity bubble broke dramatically in the fourth quarter. Oil dropped further to below $40 dollars a barrel, from a peak of over $140 just four months earlier.
In a market such as this, everything, unfortunately, went down. Even making moves that had solid rationale did not keep good stocks and funds from declining. The violent swings in the stock market, and particularly the end of the day gyrations, emphasized the fact that it was a trader's environment...large sums of money moved quickly in and out of the market to obtain momentary gains with little regard for longer term considerations. The only good news was that the market stabilized, the S&P was down 50% for the year at one time in December with slight gains in that month.
The stock market did not differentiate between types of stocks and funds in the fourth quarter based on future performance. Investors were not being rewarded based on earnings expectations or fundamentals. With this in mind, moving to the large-cap area, such as the S&P 500, was a reaction to the overall level of fear in the market. Investors tend to move to the large-cap area in times of great anxiety such as this. This is why the large-caps did better than small-caps over the last ninety days.