One Year Later: To hell and (almost) back?
Filed under: Economy, Investing, JP Morgan Chase, Fannie Mae, Bank of America, One Year Later
Remember when markets were efficient and self-correcting, the subprime crisis was contained, the U.S. economy was decoupled from the rest of the world -- and all you needed to be Fed chairman was an abiding love of Ayn Rand?If nothing else, the market's movements over the last year -- or ever since the global financial system went down like the Hindenburg -- have disabused us of such quaint notions regarding the wonderful world of equities. Forget about trading on technicals and fundamentals. The market runs on Fear and Greed.
About this time in 2008 the Dow Jones Industrial Average and broader S&P 500 were down roughly 15 percent for the year. Those were some seriously painful declines -- but, brother, does a measly 15 percent shellacking look good right about now.
So let's recap the last year of trading, beginning, of course, with Fear. The trading day before Lehman Brothers blew up (Friday, Sept. 12), the Dow stood above 11,400. Less than a month later it was struggling to regain 9,000 -- and was swinging by a thousand points or more on some days. (Efficient market theory, indeed.)
Kim Caughey, senior equity analyst at Fort Pitt Capital Group and the Fort Pitt Capital Total Return Fund (FPCGX), did what probably every market pro was doing during those terrible weeks in September and October of 2008: She was getting up in the middle of the night to watch Bloomberg Asia TV, trying to get a bead on what new horrors the overnight action would mean for the U.S. markets in just a matter of hours. "It was a tense time," she says, using understatement to good effect.
After all, in a whirlwind of days, mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) were put into government conservatorship, Lehman went bankrupt and insurance giant American International Group (AIG) largely became the property of U.S. taxpayers. Washington Mutual, once the biggest savings and loan in the nation, was consumed by JPMorgan Chase (JPM). Bank of America (BAC) was strong-armed into buying Merrill Lynch and -- perhaps worst of all -- a giant money market fund "broke the buck," something that is just not supposed to happen. Ever.
"We finally understood how linked together the world of finance is," says Caughey. "The quick shut down of the credit markets was remarkable, especially when there was the specter of a run on banks with respect to money market funds and the fear of 'breaking the buck.'"
Once the enormity of counter-party risk in the financial system became apparent, there was no stopping the slide. Financial stocks cratered, taking the rest of the market with them. (Counter-party risk is kind of like betting on a football game in order to make your mortgage payment and winning big, but when you go to collect, your bookie is broke.)
By mid-November the Dow touched 7,500, and if you wanted out of stocks, there was no place to hide. The bedrock concept of asset allocation gradually grinded to a halt. Domestic and foreign stocks, bonds, oil, real estate? Forget it. Supposedly uncorrelated assets became correlated -- meaning nearly everything went down at the same time. (Except the longest-dated Treasurys. Fear flooded that market with cash, allowing the bonds to return more than 20 percent in 2008. In other words, investors were willing to pay 120 bucks for a $100 bond).
"We were banging the drum on counter-party risk a year ago and no one cared," says Keith McCullough, chief executive of ResearchEdge, a New Haven, Conn., research outfit. "The entire world never worried about it until it was too late."
By mid-February of 2009 total panic gripped the market. On a technical and fundamental basis, the market was broken. Forecasts for Dow 5,000 and S&P 500 were no longer seemingly crackpot calls. Heck, both indexes came way too close for comfort. The S&P notched an intraday low of 666 (the Sign of the Bear, er, Beast) on March 6 and the elusive bottom (fingers crossed) was presumably found.
Which brings us to Greed. Steve Scruggs, portfolio manager of Queens Road Small Cap Value fund (QRSVX), was a hero in the mutual fund world in 2008, having lost only 24 percent that year. He's a hardcore value investor. He bought a lot of stuff on the cheap in February and March, booked the gains, and is now back to holding about 20 percent cash.
That's because the market's remarkable 50 percent rally off the March low is being driven by faith or greed, not fundamentals. Market pros are riding price momentum, buying high and selling higher in order to recoup last year's losses as quickly as possible, he says. After all, missing a benchmark in a meltdown is less likely to get a fund manager fired than missing it on the way back up.
And let's also not forget the accounting changes that prettified the toxic balance sheets of so many of our most distressed financial institutions, Scruggs says.
"Fear came and went, but many of the same problems with the banking system remain," says Scruggs . "There's a lot of smoke and mirrors. We're making many of the same mistakes made during the S&L crisis and the Japanese malaise, which really just kicks the can down the road."
So where do we go from here? Wall Street's average price target for the S&P 500 by year's end stands at 1,022, according to Bloomberg, which is actually below where the market is now.
So be prepared for a range-bound market, at best. Equities are not particularly expensive by historical standards right now, but they're also by no means cheap.
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Reader Comments (Page 1 of 4)
9-14-2009 @ 9:15AM
haveletgothecoat said...
Of course greed is a component to all of this. But so is the political correctness of Clinton and Bush - both of whom pushed mortgages for those who couldn't afford it. The sub-prime mess was as much political as economic.
This is the lesson we need to learn: the government should stay out of the business world. No one in government understands business - or health care. Once they get their hands on our medical system, the same crash will happen and our lives (not just our money) will be at risk.
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9-14-2009 @ 9:01PM
oscar said...
Something you overlook: most of the damage came about from deregulation, beginning in the Reagan years and steadily progressing. Corporations are driven by greed, hiding behind the excuse of "shareholder value" when taking their ill advised gambles. In the absense of regulation, corporations will wreck anything, including themselves to gain a penny in share price.
9-15-2009 @ 7:06AM
REDINER said...
UNLAWFULL PRACTICES BY THE BY BANKERS MAKING MONEY OFF FIRST THE POOR POEPLE THAN GOVERNMNT KICKIN MORE MONEY
9-14-2009 @ 9:24AM
Kim said...
DUH !!!!!!
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9-14-2009 @ 9:37AM
Tech said...
It's been a dead cat bounce since March driven by false premature hope and hype. Yes you had a boost by more government spending but employment is still going down, jobs are difficult to find, banks are still getting weaker, and flushing trillions in paper will only supply more fuel to the fire in the end. Fundamentals don't matter to short term trading only technicals. Play the trends using stops up and down or cash producing stocks, MLP's etc. for value and only the best most stable firms. The primary concern is the dollar and all profits are in terms of dollars here so you have to look at that first. We live in a country that loses money daily, monthly, yearly and constantly borrows. The reality is we are over 100 trillion in the hole now. (when you add the debts and unfunded liablities.) Looking at the USA as a business would you buy their paper? The fundamentals say no except for our size and military forces occupying hundreds of bases globally. Also as the dollar is still the reserve currency and backed by oil while we use our military to control foreign oil pools this forces others to purchase oil in dollars further backing it despite the crazy balance sheet. But how long can this last? Who knows? Gold, silver and real commodities have been soaring for the last eight years because of the dollar's fundamentals. I see the greatest danger long term to our currency and inflation headed our way with no real recovery until the global imbalances work themselves out.(one way or the other)
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9-14-2009 @ 9:36AM
spugadiccio said...
I must disagree with the previous comment , blaming the problems on both clinton and bush....l was investing in real estate since the last 1980's - there was a big difference in loan qualifying between the two administrations. in 1998 when I needed a " no doc" loan I could not get it - no way- without a 25% down payment . It was the same until around 2001-2002 - when I looked for loans after that period I could , if I wanted , easily get a no doc loan with little or no down with a high credit score . HUGE difference , I cant really blame it on a president but lets just say the rules on the books were not enforced under the time Bush was president . Problem is .... now things are bad again - people with 50% down cant get a loan without a "paycheck'' job , but people with no money down can still get a loan as long as they have a "paycheck job"- problem with this is the american jobs have never been as precarious as they are now .
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9-14-2009 @ 11:31AM
vaughnvdg said...
EXCELLENT POST!!!! I was just trying to explain this to a young guy yesterday. I bought my first house in 1998 UNDER CLINTON and had to go THROUGH THE WHOLE PROCESS and could not believe HOW MUCH MORE house they were letting people buy less than 10 years later without going through HALF of what i went through under BUSH.
9-18-2009 @ 5:36PM
Matt said...
I remember how excited people were when "book to value" came to be, with the result that perfectly sound mortgages were forced to "toxic" because the real estate market was correcting itself. Not a result of presidential action, by the way. Then, the ridicule heaped on McCain and the chairman of the Fed by Barney Franks and Charles Schumer, (financial geniuses that they are) when they challenged the "fair housing" signed into law at the insistence of President Clinton, resulting in Fannie Mae and Freddie Mac meltdowns. The real estate market correction was caused by artificially high selling prices, enabled by mortgage companies, backed by the banks, (Not to mention the FM twins, with the insistence of Congress.) Had the banks behaved differently, they would have been subject to fines, suits and possible criminal penalties. Insisting that people demonstrate the capability to repay a loan before granting it was viewed as evil and discriminatory by Congress, apparently.
The problems be came more integrated, when mortgage backed securities went into the market at a nominal value that almost immediately was reduced, under book to value, resulting in significant write downs, and the avalanche was triggered. That's not all of it, but it sure is a lot more complicated than "greedy bankers" and "obscene salaries." Bankers were horrified by some of the loans they were forced, yes forced to grant, and raised the warning flags in Congress as early as 2003, where they were ignored. Government was the single biggest CAUSE of the problem, and relying on Government to solve it is manifestly insane. Hence the cosmetic, feel good proposal to regulate derivative markets, that only affect small investors, while the big players operate outside of that market anyway, free of regulation or control.
9-14-2009 @ 9:41AM
Paul said...
The appetite for risk was much too large in the 1980s through 2006. Developers and Builders were wreaking havoc on the Financial system. Residential and Commercial Real estate went completely out of control. Developers were allowed to totally disregard Local Planning decisions that did not favor them. They destroyed Much of Our Natural and Financial resources on mere speculation that is based on Greed. The Jobs they create are Only Temporary, without benefits and does Not benefit the Local Community but Only lines the pockets of County Commissioners. I know, I attend Planning Meetings on a Regular basis and I encourage Everyone to Make Your Voice Heard Loud and Clear and run these Developers Out of Town once and for all. Otherwise we Will have learned Not one damned thing from this Economic Meltdown and the same thing Will happen again in a Very short time
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9-14-2009 @ 9:51AM
Jim in AR said...
If an American general in WWII summarized the first two years of the War and then asked the question "Where do we go from here?," I doubt he would have said "be prepared for a range-bound market." When will the pencil-headed no-nothings stop writing columns? Can we get someone else in here who has an opinion about the best course for future investments?
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9-14-2009 @ 9:53AM
jj said...
Government intervention is important in a coutry's economy. If you think the government has no experience think twice, as the Gov. is the regulator and the monster that private sector has fear off. But the deragulations for favors in our Nation, have with vast force sink the little we had gather for our nest.
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9-14-2009 @ 12:06PM
Ken N. said...
Government intervention can play a major role in our economy. But so far all the government intervention has done nothing but allow large companies,banks, and utility companies rip off the American people made room for increased taxes. The question is when will congress use this power for the good of the american people and not wall street and special interest groups.
Examples
1. they passed a stimulus package that helped save the banks and was supposed to loosen credit and allow banks to negotiate with home owners to help save their homes.
Foreclosures are at an all time high, credit card interest excessive and credit limits cut . This plan really worked
What they should have done is place a 2year freeze on foreclosures and forced banks to work it out. placed a freeze on interest rates and bank fees. Force banks it make money the old fashioned by granting loans not through stupid fees.
There are many good sense legislation congress could pass if they would stop taking pay offs from special interest groups and large corporations.
9-14-2009 @ 9:57AM
B. Franklin said...
It was Clinton's administration and a Republican Congress that turned over the Glass-Steigle act which allowed the Banks to stick their hands in the cookie jar. Now we have Chris (had no idea that I was getting special treatment on my mortgage) Dodd in charge of Bank reform. Now Congress is being bought off again by Lobbyists to ignore new regulation on Wallstreet. Keep it up boys, and we'll be dragging you out of the halls of congress by your feet to tar and feather you. That day isn't far off. You have put middle America on our knees and are pointing a gun at the back of our heads.
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9-14-2009 @ 12:14PM
CLEM said...
nice post but be careful of the terroist watch list, nobody rather only a few knows how many are on it or for that matter what it takes to get put on it
9-14-2009 @ 10:01AM
Ken said...
I'm looking to see the take a dump; down to about 6,000.
It hasn't corrected enough.
October can get ugly!
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9-14-2009 @ 10:10AM
dajt57 said...
the market was completely flat for 8 years during the bush administration.
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9-14-2009 @ 10:19AM
jeff said...
Truth is Goldman, JPMorgan, Wells Fargo, Citigroup and Bank of America who posted second-quarter profits totaling $13 billion caused this recession/depression. Read the Rolling Stone magazine on Goldman and see their pyramid schemes, and look up JP Morgan on the internet and see how they started the FED. Obama has sought tougher capital requirements for banks, arguing that banks' buying of exotic financial products without keeping enough cash on reserve was a key cause of the crisis. Treasury Secretary Timothy Geithner ! Truth is up until Regan the Banks had to keep 50% reserves but they caused a recession then to force the governments to lower that to only 10%! Geithner is a former FED boy and surely will not suggest the real answer getting rid of the FED which is run by the BIG BANKS and replacing it with a Government run Reserve!! Nor will the abolish energy futures and HEDGE FUNDS which caused prices to increase by manipulation of the Markets! GET RID OF THE FED
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9-14-2009 @ 10:21AM
dano said...
Maybe the Presidents plan isn't working? If business liked it, we'd see a much faster recovery. Of course the new war in Afghanistan is costing us a small fortune now as well.
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9-19-2009 @ 1:21AM
James said...
What 'new war' in Afganistan are you referring to? That and the war in Iraq have been going on longer than we were fighting WWll. During that time President Bush gave American's a tax cut. You never give a tax cut in time of war. We've had 100's of Billions of dollars going to wage war each year, and with the tax cut, 100's of Billions less coming into the Federal Government. How did we finance the war? Printing up money like it was a game of Monopoly.
The devaluation of the dollar and a National debt that got out of control. This is only part of the problem. Why Obama wants to send more troops into Afganistan is beyond me. It's not a war we are going to win. Go figure out the Iraq war. That just fueled the recession....printing up and borrowing more money.
The economy is getting better. Very slowly, and it will recover.....but don't look for the Dow to reach 14,000 + again like it did in 2007.
9-14-2009 @ 10:19AM
Chuck said...
Let's just face the facts that greed caused the economic problems of today. That has not changed and will not chance until investors take control of their own money. The SEC and NY Attorney General has failed the American people. The investments that brought down the nation were at best fraudulent. Who makes a bet that your neighbor won't pay their bills? The next bets to come is when you die, how much of your life insurance will you have paid up. This will only stop when we the people put our foot down. Not enough have gone to jail!
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