The Fourth Quarter 2008 ended with a strong equity market rally off the November lows, prompting optimism that perhaps the worst of the bear market was over. As we now know, that was not the case. The equity markets resumed their decline and established a new low for the current bear cycle in early March.
We find ourselves in a similar position at the end of the First Quarter 2009, as March ended with a strong rally – in fact, posting 8.76% for March, measured by the S&P 500 Index the best month in six years. (For the quarter, the S&P 500 Index returned -11.01%.) Just as at the end of the Fourth Quarter 2008, investors are asking is the worst behind us? Or will we resume the bear market decline?
Only time will tell, but cautious optimism may be more justified this time. While no one is willing to declare the bear finished or promise an end to the current recession, there are several interesting observations to be made as we conclude the first quarter:
Market volatility
While market volatility was double its normal level through most of the first quarter, it is roughly half what it was during the market shocks of September and November 2008.
Changing themes
The markets and the real economy still face considerable challenges, but they are significantly different than the questions lingering over the markets three months ago. The major themes at the end of 2008 were the deflating of the housing bubble, the stability of the financial system and the clogged credit market. Concerns remain about all three, of course, but there seems to be greater clarity around these issues:
-With housing prices substantial off their peaks, it is possible to argue, as does JPMorgan’s Dr. David Kelly1, that the “bubble” no longer exists. Surprising housing data about increased sales and housing starts supports the idea that the worst may be over, even if prices still have room to fall.
-The Obama Administration’s plan for getting “toxic” assets off bank balance sheets – and thus stabilizing the system and unclogging the credit markets – was well received by investors, as evidenced by the positive response on March 23.
Signs of economic improvement
In addition to the surprising housing data already mentioned, retail sales were better than expected, especially in January, and consumer sentiment numbers were also improving. Orders for durable goods manufacturing also exceeded analyst expectations for February.2 Several analysts have begun to suggest that the economy may begin to emerge from recession by the end of this year.
Government stimulus ready
The signs of improvement already mentioned manifested themselves before the government stimulus packages were complete and their impact felt. History suggests that government stimulus programs are more effective in accelerating a recovery than sparking one.
The Outlook for Asset Allocation and Diversification
Perhaps one of the most interesting differences between the Fourth Quarter 2008 and the First Quarter 2009 is that the correlations between asset classes are beginning to diverge again. Why is this important?
Correlation is a measure of the degree to which asset classes move together. During the height of the market shocks at the end of 2008, correlations were extremely high. In effect, asset classes were declining together, limiting the ability of Portfolio Strategists to add value through diversifying portfolios or by shifting asset class exposures. It is often said that there is always a bull market somewhere; September/November
2008 may have been the exception.
As the first quarter progressed, however, correlations began to decrease. One surprising example is Emerging Markets, which had the strongest showing, with a 14.38% return in March, and a -0.49% loss for the quarter, as measured by the MSCI Emerging Markets Index 3. (Strong performances from Latin America and Asia, particularly China, drove the index.) Returns within the fixed income sectors also began to show decreasing correlations, with high yield and Treasury Inflation Protected Securities offering attractive returns.
If correlations between asset categories continue to return to more normal levels, it may create an opportunity for tactical asset allocation shifts to capture returns or manage risk more effectively. From a strategic asset allocation perspective, the core diversification benefits achieved through optimally mixing asset class exposures based on long-term capital market projections may also improve.
Thank you for your trust
We recognize that the bear market has been long, steep and severe, and we will continue to closely monitor the economic and market environment, as well as your portfolio. While the general outlook for the next 12 to 18 months is anything but certain, we do see increasing clarity and focus around the issues at hand. We look forward to discussing your portfolio, financial plans and objectives in our next update meeting. We thank you for the trust you have placed in us during this difficult time and we look forward to continuing to help you meet your financial goals.
Endnotes:
1 Market Insight Series, Waiting for a Recovery, March 9, 2009 JPMorgan Asset Management
2 Source: Bloomberg
3 Source: Bloomberg
At the end of the first quarter of 2009 the Dow Jones Industrial Average closed down -12.48% . The S&P 500 index finished with a decline of -11.01 . Within U.S. equity markets, large-cap stocks generally fared better than small/mid-cap stocks for the quarter. Growth outperformed value across the size spectrum. In the international arena, the MSCI EAFE Index (a proxy for developed international markets) posted a return of -13.85% . The MSCI EAFE Emerging Markets Index posted a gain of 1.02% during the quarter. The Dow Jones Select REIT Index was down -33.92%. In the bond markets the Barclays Capital Aggregate Bond Index returned 0.12%.
The U.S. Economy contracted 6.30% during the fourth quarter of 2008 (that is, from the third quarter to the fourth quarter of 2008). The Federal Reserve (“the Fed”) decided to keep the Fed Funds rate at 0.25%. Measured by the Consumer Price Index, inflation for the month of February, 2009 was 0.20% on a year-over-year basis . Unemployment, as measured by the jobless rate released by the Bureau of Labor Statistics in March 2009 was 8.50%. Oil futures closed at $49.66 per barrel, an increase of 11.35% in price from its close from 2008 . The U.S. Dollar appreciated 5.20% against the Euro and 9.08% against the Yen for the quarter.
i Bloomberg.
ii Ibid
iiiIbid
ivBureau of Labor Statistics
vBloomberg
vi Ibid
The opinions and forecasts expressed are those of Genworth Financial Wealth Management, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. The representative does not guarantee the accuracy and completeness, nor assume liability for loss that may result from the reliance by any person upon such information or opinions. Past performance does not guarantee future results. The S&P 500 Stock index is a widely recognized, unmanaged index of common stocks. Average annual returns assume the reinvestment of all distributions and/or dividends. Indices are unmanaged, statistical composites and their returns do not include payment of any sales charges or fees an investor would pay to purchase the securities they represent. Such costs would lower performance. It is not possible to invest directly in an index.
