The joyride global financial markets took over the last three months is one for the record books. The 9.3% decline of the Standard & Poor's 500 Index was the steepest first-period tumble in modern financial history, save only for the first three months of 2001. Toward the middle of this first quarter, it and the MSCI EAFE (developed foreign markets) index were down nearly 15%, and emerging markets tumbled even more. Only bonds defied the tumult, but even their journey was upsetting, as they rallied briskly in January, gave back all of those gains in February, and then rallied again in March.
The cause of all this anxiety was the same: credit cholera. The whole world is infected with a terror of lending. Bear Stearns, the most notorious subprime mortgage lender, collapsed because customers that had trusted it for decades suddenly didn't. Governments very publicly have been desperately shoring up their banks from New York to London and beyond. In fact, the dose of medicine that broke the markets' fever was the willingness of the Federal Reserve to leap into the fray the way Ben Bernanke argued as a college professor that it should have done in 1929. Before the Fed's rescue of Bear Stearns, by engineering its takeover by JP Morgan Chase, the spectre of depression, rather than recession, was abroad in the land. Indeed, last November William H. Gross, the Bond King boss of Pacific Investment Management Co., predicted Fed action would become necessary "to stabilize the potential growth contraction in lending not witnessed since the early 1970s or, to be honest, Roosevelt's depressionary 1930s." Read more...
I hope February didn't make you too comfortable. Markets set us up for another spanking in the first week of March.
The stars are aligning for another down leg in the bear market for equities. Despite dramatic cuts in interest rates, and substantial tax incentives, unemployment is rising. What's more, various economic indicators are getting positively whacky. What forces markets out of logical boundaries is panic, and it is spreading. Here is some evidence:
- Credit markets are disheveled. Despite falling interest rates, bond prices are falling, as well. In February, Vanguard Total Bond Market (BND), used in all of our Model Portfolios, was ahead only because of its dividend; the price was lower.
- Credit panic is so extreme that municipal bonds are yielding more than taxable bonds of similar maturity and credit quality. On an after-tax basis, their returns are approaching junk-bond proportions.
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We are in a hell of a fix. The U.S. stock market is down in the range of 15% to 20% since its peak last year, depending on which benchmark you follow. But is that a problem or the solution to a problem?
Solution? By that I mean a flushing-out of an overhyped market that had gone up for five straight years. If you follow markets closely, you know pundits have been expecting a “correction”—a 10% decline in a broad benchmark, like the Dow or the S&P 500—for two years. Well, now we've had one. Bingo: Problem solved. Equity prices were too optimistic; now they've been pared back to more-reasonable territory.
But here's the thing: You can't possibly know how the future will unfold. This could be the initial stage of a bear market, which is a decline of 20%. From their peaks, both the Russell 2000 small-cap stock index and the Nasdaq 100, whose ETF form is known as PowerShares QQQ (QQQQ), have touched the minus 20% mark. Read more...
Signs of economic weakness are compounding. Financial markets, as usual, are the most reliable indicator of a downturn because they reflect the cumulative judgment of people whose careers depend on interpreting these signs correctly. Despite a surprisingly strong economy in 2007, the domestic stock market managed to advance only 5.1%, as represented by SPDR S&P 500 Trust (SPY). Small domestic stocks, the ones most sensitive to the pace of economic activity, actually declined, with iShares Russell 2000 Index (IWM) falling 1.8%.
Over in the bond market, the yield curve is inverted—long-term interest rates are lower than short-term ones. Bonds are actually a more reliable indicator of economic weakness than stocks. I suspect that's because stock investors are natural optimists, whereas the best a bond investor can hope for is to get his money back, and so by habit is more skeptical. At year-end, the 10-year Treasury bond was yielding 4.04%, whereas the overnight Federal funds rate was 4.25%, and it had been 4.50% until Dec. 11. The Federal Reserve sets the short rate by fiat; the market itself sets the long rate. The bond market was saying interest rates will decline further because they have to in order to avert an economic crisis. Read more...
We're in the usual whorl of emotions in today's market because we're clanking through a transition from six years of economic growth to a new, slimmed-down order. That creates volatility, and we've had an extra serving. The last three months have included the two best and the worst of the year.
And I expect the volatility will continue for at least several more months. In the real economy money is very tight, due to the fallout from the subprime lending mess, and vitality is already waning. T. Rowe Price estimates that the slump in home construction alone will cost the nation 750,000 jobs more than the 250,000 that industry has already lost. High oil prices are beginning to hurt. The dollar's slump is becoming dangerous. So much could go wrong.
By the same token, widespread pessimism is a strong argument for you to be optimistic. Investor sentiment is a contrary indicator; extreme bullishness usually leads to a crash, and its opposite to the next bull market. Stocks' sharp correction in November could be the low point in the current cycle. Don't fight the Fed, warns an old market maxim. Read more...
William McChesney Martin, who ran the Federal Reserve throughout the 1950s and '60s, was the central bank's longest-serving chairman, but he's chiefly remembered for his pithy definition of the Fed's central purpose: 'The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting.'
Martin was referring to the Fed reining in economic exuberance by raising interest rates. Right now it's doing the opposite: It's spiking the punch with easy credit to, it hopes, forstall a recession. It poured in pure grain alcohol on Sept. 18, a rate cut of 50 basis points. On Oct. 31, it went back to its usual stimulant, a 25-basis-point reduction.
Not surprisingly, the party on Wall Street has gotten very interesting. Diamonds Trust ETF (DIA), the investable version of the Dow Jones industrial average, ended October just below its all-time high, and for ETFs as a whole the month was the second-best of the year, after September. Read more...
September is over, but the market forces it unleashed will march on. To protect the U.S. economy from the widening subprime mortgage mess, the Federal Reserve was forced to slash short-term interest rates half a percentage point–the first 50-basis-point move since November 2002, when the Fed was nursing the economy out of recession. September's move was pre-emptive, and markets rallied for the strongest month so far this year.
But—and this is a very big 'but'—the central bank acted despite immediate damage to the value of the dollar and the likely exacerbation of inflation. Prices for food and fuel are already spiking higher. Also, the Fed's action implied that the risk of recession has increased significantly, and the world's stock markets recognized this: Stocks of small U.S. companies, which are most sensitive to the pace of domestic business, fluttered like wounded birds when the rest of the flock took wing. iShares Russell 2000 Index (IWM) eked out a 1.5% gain at a time the big-cap SPDR S&P 500 (SPY) advanced 3.4% and the foreign-stock ETF, iShares MSCI EAFE Index (EFA), spurted 5.3%. Read more...
You think the last few months have been bumpy? It isn't over. You can blame a bout of queasiness among Wall Street lenders for the rough ride.
More than $1 trillion of commercial credit must be renegotiated by the middle of October. Buyouts, mergers and reorganizations worth more than $300 billion are stalled. Most ominously, two million homeowners face default, even if the Federal Reserve begins cutting interest rates. Some pundits are predicting home prices will tumble an average of 10% in coming months. Last time that happened, it was called the Great Depression. Years-long weakness in the U.S. dollar could become a rout.
By comparison, what's happening in the stock market is downright gentle. At one point this summer, SPDR S&P 500 (SPY) fell 9% in the space of a few weeks, but it quickly rebounded and is solidly positive for the year. That's nothing compared with the meltdown of leveraged hedge funds—and that is nothing compared with the prospect of losing your home. So far, investors have been spectators at a Demolition Derby. The problem is, it looks like the debris is about to start flying into the stands. Read more...
The market had a panic attack in July, as megamergers came grinding to a halt amid a sudden credit crunch. But while it might have felt like being dunked in a Wisconsin lake, the jolt sobered up a lot of bankers who had been giving money away like it was free. What you and I need to do is remember that a dash of cold water doesn't mean we're drowning.
The S&P 500 Index slumped 2.7% in the month, but the tumble felt worse because the benchmark had been ahead more than 3% at one point. And that was nothing compared with small-company stocks. Vanguard Small Cap ETF (VB) skidded down 6.2%, and Vanguard Small-Cap Value (VBR) did even worse, plunging 7.7%. Read more...
ETF Insider has a simple premise: You can make more money investing in exchange-traded funds than in any alternative. All you need are the tools to choose intelligently among them, and that's what I plan to provide.
Let me introduce myself. My name is Tim Middleton. I began my career as a financial journalist 25 years ago, and quickly concluded that mutual funds were the best investment solution for most people, because they diversify their holdings as a protection against company risk. I became the mutual funds columnist for The New York Times and then for MSN Money.
The mutual fund scandals of 2003 were an eye-opener for me. I was shocked to learn how brazenly many reputable companies were fleecing their customers of literally billions of dollars. Although ETFs were then still relatively new, I realized they were a nearly scandal-proof alternative. They offer the same diversification benefit as mutual funds, but they cost less. No loads, no redemption fees, no 12b-1 fees—no pot of gold for crooked fund companies to loot.
I developed a model portfolio of ETFs at the end of 2003, and since then it has marched ahead at a market-beating annualized clip of 13.1%, as of the end of the second quarter, even though it is 25% or more in cash and other income investments. Obviously, this is no get-rich-quick scheme—but it works.
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