Saturday, September 6, 2008

News - September 2008

September is the month where baseball teams jockey for position and make that final push towards the playoffs. Those that succeed head for October baseball, while the rest gain comfort in the “there’s always next year” mantra. For a team like the futile Chicago Cubs franchise, this year may actually be “next year” after enduring 100 years since their last championship. For our hometown team, the Atlanta Braves, it’s more about looking towards the bright prospects of 2009. Unfortunately for investors, 2008 is looking more like the season of the Braves, although we’re not mathematically eliminated from playoff contention just yet.

For investors, success comes much more often than the average baseball franchise. Four out of every five years produces a positive return, with an historical average gain of 10% including the down years. We have had substantial gains from 2003 through 2007, so the pullback here in 2008 isn’t all that unusual, although undoubtedly unpleasant. We’re still hopeful for a year-end rally as we believe the economy has the potential to stave off many of the challenges encountered over the past year. And, we still feel that many of the dire predictions for major recession and further significant losses in the equity markets are overblown. The stock markets will rebound and head higher although the timing of a rebound is likely to occur when it is least expected.

The recent economic news continues to plague the stock markets even though some of the news is coming in stronger than most were predicting several months ago. GDP for the 2nd quarter was revised higher to 3.3%, which is a very strong number considering that many had predicted negative growth for the quarter just a few months ago. Some economists see flaws in the GDP figure, which is why we haven’t seen a stronger market reaction to that very positive economic growth. The naysayers have posited that factors like very strong exports and the government stimulus payments are temporary additives to growth and merely have delayed the negative economic influences from being represented in the GDP figures. There is also a growing concern that other developed markets across the globe will move towards recession, while emerging markets may see significant drops in the rate of growth.

While GDP figures continue to exceed expectations, the employment numbers have been disappointing. The unemployment rate for the month of August rose to the highest level in five years at 6.1%. Today’s unemployment rates are very near the top unemployment rate of 6.3%, recorded in 2003 just as the technology bubble reached the low point and the markets began to recover. It’s impossible for anyone to know for sure whether we will eclipse the unemployment mark of 2003 in the ensuing months or not. However, the sharp spike in unemployment seen over the past several months is indicative of a turning point for the economy and, specifically, equity markets. If there is any solace in the employment scenario now and over the past few decades, it is that we are nowhere near the spikes in unemployment seen in 1975, 1982 and 1992. The readings during those difficult economic times were at much higher levels than we have today at 9%, 10.8% and 7.8%, respectively.

Despite all of the economic news, the widely followed indexes showed positive returns during the month of August. The S&P 500 gained 1.5%; the Dow Industrial Average posted an increase of 1.7%; the NASDAQ rose 1.9%; while the Russell 2000 (small cap stocks) bested them all, booking gains of 3.7%. All of these closely followed indexes have significantly negative returns for the year, while the Russell 2000 has lost a relatively benign 2.6% for all of 2008.

One factor in the major indices’ positive performance during the month of August was the falling price of oil which continued its downward descent, even in the face of new geopolitical developments and an increasingly active Atlantic storm season. Not even the evolving skirmish between Russia and Georgia or Hurricane Gustav bee-lining towards New Orleans, invoking memories of Katrina and Rita, could keep energy prices from sinking. Oil prices retreated nearly 7% for the month of August as commodity prices corrected across the board, including gold, which fell 9.3%.

There are three segments of the market whose positive performance for the year might be unexpected given the related economic news: Retailers and homebuilders posted gains of 7.12% and 10.84%, respectively, for the month of August and have gained 2.64% and 2.98% for all of 2008. The last example is Real Estate Investment Trusts, which is often thought of as its own separate asset class as it has distinct characteristics compared to traditional equities. REITs posted gains of 2.13% for the month and 1.59% gain for the year.

Many investors would have been more than skeptical had they been encouraged to make investments in any one of these particular groups at the beginning of the year. Given the rising unemployment and decreasing home prices, it would have been easy to assume that any investments in consumers or real estate would have been a poor choice. While we don’t always suggest major investments in specific sectors like Retailers or Homebuilders, the performance underscores our reluctance to banish equities altogether; equities typically rebound even while the economic outlook looks cloudy.

Stocks have generally priced in the uncertainty and economic challenges we are currently experiencing, which is why we are loathe to abandon our long-term investment strategy in the face of some economic weakness. Likewise, REITs, Homebuilders and Retailers, which all underperformed the market significantly in 2007, have rebounded and could be forecasting stronger days ahead for those sectors. While the economic data available last year may not have corroborated the weak performance of these sectors, the market was remarkable in anticipating weakness in home prices and higher unemployment seen this year.

There is some debate as to whether inflation is a net positive for stocks or not. One possible positive catalyst for better stock performance could be the retreat of commodity prices over the past few months. Permanent commodity price reductions may positively affect the bottom lines of companies producing goods and services. Many companies have had to raise prices in order to compensate for the rising input and commodity costs seen over the past couple years. While this is unpleasant for some consumers, companies may be reluctant to lower prices even if input prices stay lower or even continue to fall. The result would be higher profit margins which could ignite a significant rebound in stock prices.

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