December 9, 2008
The News Continues Dismal: Why Doesn't the Stock Market Decline Further?
Real GDP for the third quarter 2008 has been revised downward. Job loss numbers for November are attention-getting to say the least. The home price index is off 17% year-over-year. Existing home sales fell again. New house sales continue to lag, and the inventory of unsold homes is today at a level of 11 months' sales (vs. an historical average of 3-4 months). Congress is now managing the "Big 3" auto companies. And yet Friday, U.S. equity markets responded to all this by going up 3.5%--on Monday another 3.8%.
Media pundits, flogging the obvious, continue their dirge. Investors, and those managing other people's money, look for indications amongst the statistical debris that equity prices are stabilizing. A ratcheting down in the intensity of bad news might signal a bottoming. In the words of some in our shop, "flat is the new up." What could go right to turn the emotional tide?
The signals indicating a course change toward normalcy will be faint and not easily read. The whole world seems to have bought into the idea that a deep recession is upon us. Many even believe that asset price deflation, not just disinflation, will inexorably follow. However, rather than paying too much attention to those who write and pontificate for a living, it might be more rewarding in the long run to abide by the well-worn traders' adage, "don't fight the Fed." During the past 18 months, our central bank or Federal Reserve has released an unprecedented amount of liquidity into the U.S. banking system, and unveiled a series of unconventional monetary policy innovations and instruments, all aimed at reducing official interest rates, as well as bringing down the cost of mortgage financing. It takes time for these moves to work their way through the banking system to the consumer, but the first observable impact could be a pick-up in mortgage refinancing activity, a sign that a loosening in the household credit sector was underway. Such a turn could lead to a rebound in consumer confidence and spending which would be further bolstered by continued declining energy costs. A mere whiff of this reversal could be enough to improve investor psychology.
The Other Side of the Alternative Investment Coin
In some of our past commentary, we have suggested there could be a darker side awaiting revelation for those who extolled and committed an inordinate amount of their investment portfolios to illiquid alternative investments (e.g., hedge funds and private equity participation). The headlines last week featured the $8 billion write-down from July to October of Harvard University's endowment of some of its exotic unmarketable holdings and warned that until appraisal results (presumably for its 8% allocation to leveraged real estate) were in and, the full extent of the carnage would not be quantifiable.
Down 22% since the beginning of the current academic year (i.e., fiscal year ending 6/30/09), Harvard's loss may be relatively manageable when compared to what could be Yale's result. With roughly 60% in alternatives, Yale's portfolio performance, as will be the case for many other endowment, pension, and non-profit funds, will put unprecedented cash flow pressure on many of these already under-funded institutions.
The only faint positive in Harvard's press release was the announcement that the University was in the process of selling $2.5 billion of its own bonds to raise capital for the massive Allston campus expansion. If this underwriting is successful (Harvard is currently a AAA-rated credit), it will be further evidence the credit markets are no longer gridlocked.
SSFIP (Systemically Significant Failing Institutions Program): The TARP Family Continues to Grow
If one ever doubted the creative instincts of our public servants to involve themselves in the private sector, attention is drawn to the proliferation of new "remedial" programs announced almost weekly by the Treasury Department. Beyond SSFIP, unveiled last week was the Capital Purchase Program (CCP) which funnels funds to healthy banks and thrifts. For all practical purposes, the U.S. banking system has been nationalized, a development which in more normal times would have been strongly resisted.
The irony remains that those in charge in Washington, regardless of political party affiliation, if held to the same accounting standards as the private sector, would be seen to be presiding over a bankrupt enterprise. The ultimate incongruity would seem to have been last week's dedication of the DC Capital's Federal Visitors' Center, a $620 million edifice ($200 million over budget; close enough, one supposes, for government work).
As always, your thoughts, comments and questions are most welcome. Please contact us via email at tfc@tfcfinancial.com or call us at 617-210-6700.
Regards,
James L. Joslin
Chairman & CEO