Stocks endured yet another tumultuous week influenced by new data indicating the U.S. economy is in recession as well as sweeping changes in the political landscape following a historic election. After enjoying a 4% rally on Tuesday (the biggest election day rally in history), stocks proceeded to lose 10% over the next two days for the worst two-day decline since 1987. A modest rally on Friday left the major market indices down roughly 4% on the week.
While it may be tempting for some to blame the post-election market decline on Democratic domination at the polls, I would argue that the markets discounted the election result long before Tuesday’s events. Virtually every poll taken since mid-September indicated a solid Obama victory. In fact, the failure of the Democrats to capture a filibuster-proof 60 Senate seats is likely a relief to the markets. So what caused the mid-week market decline? First, the market had rallied nearly 20% from the October 27th low over just six trading days, so traders simply booked profits. Second, fresh data indicated the economy is getting worse. Finally, fund redemptions continue to drive forced selling, increasing volatility and exacerbating the declines.
Weekly Economic Data
Economic data released last week pointed to an economy that is firmly in recession and is getting worse. The government reported that the U.S. lost 240,000 jobs in October, and increased the previous estimate of August and September job losses by 179,000. The economy has lost nearly 1.2 million jobs this year. The unemployment rate jumped to 6.5%, the highest level since March 1994. In addition, the ISM Non-Manufacturing Index (an indicator of the service economy), tumbled to its lowest reading ever.
News from the corporate sector was gloomy as well. Auto sales have fallen to the slowest pace since 1983. The automakers are attempting to force a government bailout, with General Motors stating that it may not have enough cash to survive through the end of the year. Monthly sales for retailers in October were the worst in eight years. And a Federal Reserve survey showed that bank lending standards are tighter than at any time since 1983.
Amid the barrage of weak economic news, it is difficult to have much confidence in any significant near-term rally for stocks. In addition, uncertainty over the new Obama Administration’s policies and continued forced selling by hedge funds should result in high volatility into early 2009.
However, we continue to believe that October marked an important short-term low for the equity markets. Many of the factors that have historically indicated a market bottom are present today, including a selling climax on October 10th. Sentiment has reached extreme levels, and the low valuations of many high quality stocks suggest much of the bad news has been priced into the markets. Unprecedented global stimulus, including additional central bank interest rate cuts last week and the weekend announcement of China’s $586 billion stimulus plan, should allow the economy to recover late next year.
The market continues a process of establishing a bottom. S&P 900 now becomes the level to watch as it marks a “higher low” following last week’s selloff. If S&P 900 holds, market psychology could improve and coax some of the massive cash sitting on the sidelines to move back into equities.
Whether the October low proves to be the ultimate low depends on the degree of improvement in the credit markets and the depth of the corporate earnings recession. As the answers to these questions remain skewed to the downside, we continue to recommend a defensive positioning for most portfolios.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.
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