A Point Isn’t A Point Anymore

Not all that long ago, back when your pundit was a pup, 100 Dow points was a big deal. 100 Dow points would be more than 10% on the market value of the Dow.

Today, 100 points is 1% of the Dow, almost. 600 points or 500 points aren’t as big as they used to be. In October of 1987, Monday the 19th to be exact, the Dow lost 508 points in one day. Back then, it was 22% of the Dow’s value the previous day. Don’t even think about what that would take today. Keeping in mind that the Dow at 11000 is a lot different than the Dow at 1000, the trouble a lot of people have is relating to daily changes that are frightening by their size, but really aren’t that unusual. Today’s 300 point change is the same as a 30 point change on one tenth the market price.

When your children are little, even a small weight loss like a couple of pounds can be frightening. Having a forty-pound child lose three pounds probably means something serious. But, losing five pounds to fit into a prom dress or make a wrestling weight is generally not all that traumatic.

Daily volatility in the stock market runs around 0.7% to 0.8% one way or the other. That averages in the 2% days with the 0.2% days. So, the volatility we’ve seen lately is well above normal. In the month of August so far, daily volatility has averaged 2.8%, including the three days that didn’t see a 1% change along with the seven that did. That is roughly four times the normal volatility. No wonder people are nervous.

But, we’ve seen this sort of thing before and doubtless we’ll see it again. But, it doesn’t really have to lead to anything except less volatility in the future. It is hard to keep up this level of whipping around for very long.

Issue of the Week

Are we going to have a recession? Probably not. You see, growth is the normal phase of economic activity. Recessions are unusual and usually the reaction of the economy to excesses built up during the growth phases. The last couple of recessions were that way. The 2001 recession was a reaction to excessive investment in technology and telecom in the US. We had multiple fiber-optic cable systems vying for our phone usage plus all the investment around Y2K. Then in 2008 we had the collapsing housing sector and the implications that had for the mortgage finance sector and thus for the financial system more broadly.

Do we have too many workers today? Is there too much home building? Too many cars being built? Too much investment in factories, mills and mines? No, the only thing we may have too much of is government as that is the biggest area of growth in the last couple of years. Maybe reining in the government will cause growth to slow enough to cause a recession, but we don’t think so. Reining in the government ought to unleash the private sector to do what it usually does, grow.

The risk we face these days is that our ‘normal’ growth rate isn’t what it used to be. As we tried to explain last week, the new normal is a far cry from the old normal. Back when our economy was growing at an average of 4% or more a year over entire economic cycles, we could have a period of slow growth and it would still be 2.5%. When the new normal kicked in, the growth potential of the economy slowed to about 2.75% give or take and so when we slow down now we get some pretty scary numbers. This does raise the risk of recessions pretty much all the time, but it doesn’t change the economy’s predilection to grow.

Besides, this ought to be the strongest year both economically and in the market of President Obama’s term. As the theory on the election year cycle goes, presidents try to goose the economy going into an election year by unleashing all the fiscal and monetary policy tools at their disposal. The strong policy response leads to heightened economic performance in the election year, helping the president get re-elected. But, if this is the best Obama can do in this regard, he had better hope he can blame this on Dubya.

Economic News

Productivity declined in the second quarter and was revised to a decline in the first quarter. We have gotten used to productivity being something akin to 2% across the broad sweep of US economic history. It is rare for productivity to decline, especially during times of slow economic growth. We’d look for this number to get revised later to show some modicum of productivity rather than its opposite.

Unit labor costs rose by 2.2% due largely to the decline in productivity.

The Federal Budget Deficit came in at $129 billion in July, actually better than expected and better than last year. But, it was never the deficit that would have caused a default on US Treasury securities. So long as we have revenues, and there are lots of revenues ($159 billion in July alone), we will pay our debts, but a lot of other stuff may not get paid for.

Our Trade Deficit grew in June to over $53 billion. The larger deficit was caused by a decline in our exports, even with a decline in imports, the gap widened.

Retail sales grew by 0.5% in July. The gain may help alleviate fears that a recession is bound to overtake us. The gain was widespread with most areas enjoying increases. Auto sales rose 0.4% so that wasn’t the only area that showed a solid increase.

Consumer Sentiment from the University of Michigan and Reuters was awful. All the default talk and venom spent on the debt ceiling talks didn’t help the average American feel better about things. The current level of 54.9 is the lowest point in the recent past. You have to go back to 1980 to see a lower reading. For those of you not even alive in 1980, that time was horrible – high inflation, higher mortgage rates, really high prime rate, high unemployment, Jimmy Carter, Iran hostages, the whole sad episode.

Weekly Stuff

We had another wild week in the markets with most risk assets down and some bonds up. It could easily have been a lot worse but for a couple of decent up days for risk assets toward the end of the week. The low for US stocks was last Tuesday when traders read what the Fed announcement said and decided that more economic weakness lay directly ahead. This wiggle was quickly and forcefully reversed in no time at all and stocks rocketed up about 600 points in about half an hour to close at the day’s highs. Still, a bad Monday, wild Tuesday, bad Wednesday, strong Thursday and wimpy Friday added up to a down week. But, nowhere near as bad as the two prior weeks.

We don’t want to jinx this but with the huge decline in investor sentiment, the decline in prices and the modest improvement in the news flow, the bottom may be in on this panic attack. We are starting to see some of the proven indicators of market value – insiders are buying stock and the public has been selling stock.

The earnings picture has been largely ignored by the press and the investing public, but it has been remarkably resilient. With 90%-plus of S&P 500 stocks having reported, it looks like the year over year gain in earnings will be roughly 18%. That is both better than expected and absolutely great. We will probably hit an all-time high in earnings per share for the S&P 500 next quarter.

Selling has been focused on financials and some leading tech companies. Has anyone noticed that Bank of America has fallen by half this year and Citi isn’t far behind? The financials have the problem of owning a lot of Treasury debt but also we are still feeling the aftermath of the housing finance debacle. Law suits blaming lenders/originators for bad faith in selling mortgage-backed bonds are all the rage.

Treasury bonds set new, all-time low yields on 2-year and 3-year notes this past week. We saw Treasury bills once again hit zero yields. 10-year notes yielded 2.1% briefly and 30-year bonds saw a yield of 3.5%. This is madness, but we’ve seen madness before and likely will see it again. To quote Lord Keynes – the market can stay irrational longer than you can stay solvent.

Other parts of the bond world weren’t so lucky. Most high grade sectors saw their prices either stand around, if they were lucky, of fall. Any area with credit risk fell in the indiscriminant selling. Our convertibles, high yield, and floating rate commitments saw prices falling. Foreign bonds were mixed along the same lines as the US market, corporate unchanged, sovereigns up, anything with less than sterling credit was hit.

Alternatives were not all that different than stocks last week. Real estate was shellacked. With the growth story falling apart, lots of sellers of REITs came forward. We have largely given-up gains for the year in real estate.

Commodities weren’t a lot better with losses in crude, some grains, some livestock and some industrial metals, but gains in other energy, some grains, some livestock and some industrial metals. The only sure bet last week seemed to be gold, but that started coming apart as the risk-off trade started to unwind on Thursday and Friday. But, even with big losses those days, gold was ahead 5% on the week.

Have a great week.

Karl Schroeder, RFC, CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.