Wednesday, December 5, 2007

News - November 2007

Another quarter, another correction for the stock market – or at least the first official correction by traditional definitions – although we have seen correction-like action in the stock market two other times this year. The monotonous, troubling news concerning falling home prices and falling valuations of securities backed by mortgages sometimes feels very unnerving. We are all undoubtedly growing more familiar with terms such as “CDO,” “CMO,” “sub-prime,” and “credit crunch.” In financial publications and our local business pages, there are several articles devoted to the subject each day. The one reaction that continues to strike us is how so many lenders, borrowers, mortgage brokers, and self-proclaimed Wall Street geniuses could be so completely foolish.

For years, specifically from 1992 through 2006, Americans had seen their home values steadily rising. In stark contrast, the S&P Case-Shiller U.S. National Home Price Index measured the national average of home prices falling 4.5% from the 3rd quarter of 2006 to the 3rd quarter of 2007. This marks the largest annual national decline reported in the survey’s 21-year history. Florida and California are the two notable regions where housing prices are suffering the worst, showing some locals with home prices over 10% lower than a year ago. This is not totally surprising since those locations also showed some of the largest gains before the real estate markets turned soft. It’s not unthinkable that poor real estate markets in these very populous states could have an affect on the economy as a whole.

There are some exceptions to the housing price declines, notably in parts of the Pacific Northwest and the Southeast, including Atlanta. Home prices in Atlanta, as reported by the S&P Case-Shiller report, continue to buck the national trend. Not only are prices not showing a year-over-year price decline, but they are actually still showing slight gains year-over-year. The survey shows prices gaining 0.4% over the past year compared to prices reported in the 3rd quarter of 2006. The rate of increase in home prices in Atlanta is slowing, however.

Stock market volatility continues to flow more than ebb this year largely in response to the saga surrounding real estate prices and those securities associated with mortgage debt. The ebbs and flows of the market and volatility are becoming more regular and are in stark contrast to the tranquility experienced in the early part of the recent bull market from 2003 through 2006. The VIX, an index which measures market volatility, had been very tame in recent years following the tech bubble and burst culminating in 2002. We are seeing regularly occurring spikes in this measure this year as the bull market shows its age a bit.

During the late 1990’s and into the early 2000’s, the stock market was experiencing much greater volatility than we have experienced recently. The levels of volatility this year are still relatively low compared to what we had experienced in the late nineties and early in the 21st century. Only recently, as the market has dipped three times this year while rebounding in the spring and earlier this fall, have we been getting the volatility levels that were commonplace from 1997-2002. The troughs in volatility during that period are coinciding with peaks in volatility of this year. How did we manage sanity during those volatile boom and bust periods? The numbers are larger now, because the indexes have grown to such high levels, which may make us feel as though volatility is even greater than it really is. The Dow Industrial Average needs to move about 130 points today to make a 1% gain or loss, while 10 years ago the 1% threshold was only 70 to 80 points.

For the month of November, the Dow Jones Industrial Average lost 3.8%, the S&P 500 lost 4.2%, and the NADAQ lost 6.9%. Again, financials and real estate related stocks have fared worse than the broader market. A popular Financial ETF lost roughly 8% of its value during the month of November and has lost 15% for the year. Large, and historically highly regarded, financial institutions like Citigroup, Merrill Lynch, Bear Stearns and Morgan Stanley have all lost between 30% and 40% of their market values since the first of the year.

The trend favoring international investments has remained intact, partly aided by the continued weakness in the U.S. dollar. The dollar has lost about 10% against the Euro this year, including a 1% drop in November. The dollar, like the stock market, did rebound some at the end of the month minimizing the losses for November. Emerging markets performed roughly in-line with the U.S. markets, while the developed international markets lost a relatively impressive 3.7% for the month of November.

The performance of the emerging markets is interesting in that during the previous market sell-offs, the emerging markets index had an exaggerated move down. Some analysts have questioned whether emerging economies can prosper even as the U.S. economy shows some signs of an impending slowdown. And if so, then investments in those markets may provide diversification benefits beyond additional risk and return potential.

The market would have been significantly deeper in the red had the market not rallied over a couple days near the end of the month. The Dow 30 Industrials tacked on gains of roughly 550 points, or roughly 4.3%, in two days of trading during the last week of the month. Despite the financials suffering losses, the broader indices are still safely in positive territory for 2007.

Technology, Materials and Energy stocks have exceeded the gains of the broader market, helping to boost the indices. Some have opined that these high-flying sectors could be vulnerable if the problems in the financials and real estate do, in fact, spill over to the economy and cause a recession or major slowdown. The fact that these sectors are holding impressive gains for the year could in itself be signaling that the economy will withstand the aforementioned headwinds.

The catalysts for the rebound over the last few trading days of the month were clear and numerous. It appears that the government is about to take a more active role in trying to mollify the financial markets. It has been reported that the Bush administration will try to broker a deal freezing some of the adjustable rate mortgages, allowing borrowers to keep their lower introductory rates on adjustable mortgages for up to seven more years. The Federal Reserve, including chairman Ben Bernanke, appear to be developing a more accommodative stance, signaling that further interest rate cuts are a good possibility. These developments late in the month of November helped diminish some of the losses in the stock market since the end of October.

Oil has dropped about 10% from the highs earlier this month and is hovering around $90/barrel as opposed to closer to $100/barrel. It seems difficult to comprehend the extreme volatility in oil lately without the explanation that speculation is taking control of that commodity price. Regardless of the explanation, it probably supplies the Federal Reserve with confidence that inflation will not explode if and when they reduce interest rates further.

GDP has continued to stay surprisingly strong as well as employment. The revised estimate for 3rd Quarter GDP came in at 4.9%, which would be the highest quarterly growth rate in four years. One component cited in the government report is the impact of an improved environment for exporters, which is one of the benefits of a weaker dollar.

We would think that some effect of the housing and sub-prime issues would have shown up in the 3rd quarter, although, according to the government statistics, that seems to not be the case. Such a good estimate for 3rd quarter growth is encouraging in that it points to the possibility that recession can be avoided, while a slowdown in growth still seems to be the most likely scenario.

Thank you again for visiting RollinsFinancial.com. We hope this update has been useful to you. Please email us and provide us with your thoughts and comments.