Economic Review and Market Perspective
First Quarter 2009
Economic Review Despite the U.S. Government taking extraordinary measures to stabilize and revive the financial system, the economy continued to show considerable signs of weakness in the first quarter, after contracting at an annualized rate of 6.3% in the final quarter of 2008. The Federal Reserve’s Beige Book reported that national economic conditions deteriorated further from January through late February. The deterioration was broad based. The Beige Book also indicated that near-term economic prospects are poor, with a significant pickup not expected before late 2009 or early 2010. The financial turmoil that began a year and a half ago has produced the longest economic recession since 1982. Similar to last quarter, the deteriorating economy contin¬ued to take its toll on the U.S. job market with 598,000 (later revised to 655,000) and 651,000 non-farm payroll jobs lost during the months of January and February, respectively. The initial report indicates the decline was well above 600,000 jobs in March. Since the beginning of the recession in December 2007, a total of over 5.0 million jobs have been lost, with the unemployment rate rising to 8.7% and approach¬ing levels not seen in 25 years. The U.S. housing market, which is where many say the problems started, continued to show considerable weak¬ness during the first two months of the quarter, with hous¬ing starts reported at a seasonally adjusted annualized rate of 477,000 in January followed by 583,000 in Febru¬ary. While the February data represents approximately a 47% year-over-year decline, the numbers do indicate a substantial improvement over January’s data. At the same time, the economic downtown continued to weigh heavily on the auto industry, which has experienced dramatic declines in sales unit volume. In February, U.S. auto sales plunged 41% from levels one year ago accord¬ing to Autodata Corp. In addition, February’s dismal num¬bers marked the fifth straight month that U.S. auto sales fell 35% or more from a year earlier. In February, General Motors posted a loss of almost $31 billion dollars for calendar year 2008. In the meantime, the problems the automakers are facing have the potential to spill over to their suppliers, which could create further problems for the automakers. Economies outside the U.S. continued to show signs of further deterioration during the quarter. In February, Eurostat, which is the statistical arm of the European Commission, reported that the Euro-zone contracted by 1.5%. The quarterly decline, which was generally higher than expected, was the 15-country Eurozone’s worst on record. The deterioration in economic activity was broad based, with Germany leading the way, as its GDP decreased by 2.1% over the previous quarter, the worst contraction since the country’s reunification in 1990. The United Kingdom economy was contracting similarly. In Japan, the evaporation of external demand and a yen rally have caused its recession to deepen at a rapid pace. Finally, preliminary Chinese first quarter 2009 GDP growth, though positive, was the lowest rate on record. While the international economic environment has been difficult, the outlook may not improve in the near term. The World Bank and the Organization for Economic Coop¬eration and Development predict the world economy will shrink by 1.7% and 2.75%, respectively, in 2009. The two international agencies expressed somewhat less alarming views about growth in the emerging economies but agree that the economic environment will be challenging. Market Perspective A U.S. bear market began about 18 months ago after market indices topped in mid-October 2007. Overall, the 18-month decline ranks as one of the worst bear markets in modern U.S. history. Despite a strong 20% plus rally to conclude March, domestic equities posted their sixth consecutive losing quarter, erasing a significant portion of the gains achieved toward the end of last year. By March 9, major equity indexes had substantially eclipsed their previ¬ous lows set on November 20, 2008 and reached levels not seen since the mid- to late-1990s. After March 9, however, equities rebounded amid news that some banks, such as Citigroup and JP Morgan Chase, may be returning to profitability. Further, the rebound was extended when the U.S. Government revealed details of its long-awaited plan to remove toxic assets from banks’ balance sheets, also known as the PPIP. It is useful to update market data to Friday, April 10, 2009 to include returns since the end of the first quarter (please note markets have zig-zagged since April 10, resulting in about net zero change as of this writing since then). The data are as follows:
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First Quarter 2009 |
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April 1-10 2009 |
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U.S. Big Companies (S&P 500) |
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-11.0% |
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7.5% |
U.S. Financial Firms (S&P sub-Index) |
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-29.5% |
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20.4% |
U.S. Small Companies (S&P 600) |
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-16.8% |
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11.6% |
U.S. Energy Firms (S&P sub-Index) |
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-12.1% |
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5.7% |
U.S. Government and High Quality |
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Foreign Big Companies (EAFE) |
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-13.9% |
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6.3% |
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Source: Standard and Poors, Vanguard, and MSCI Barra |
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Note that the biggest losers in the first quarter have been the biggest winners in the latest rally. Also, the surge in equities prices has coincided with market declines for quality bonds, as the increase in investor’s risk appetite has caused them to reduce low risk positions. Of even more interest, the March/April rebound pushed the S&P 500 Index up a rather dramatic 27% from 3/10/2009 – 4/10/2009.
It is important to note that over the year and one-half decline, there have been three rallies plus the fourth currently occurring, as just described. Of the four rallies, the fourth has been the strongest. However, the rally between November 21, 2008 and early January 2009 was fairly comparable; the period included a spurt when the S&P 500 Index was up 21% in just 17 days.
Key barometers of credit risk in the economy, such as the TED spread, which measures the willing¬ness of banks to lend to one another, improved modestly during the first quarter. However, other measures, such as spreads on high-grade corporate bonds, have not im¬proved. Accordingly, like in 2008, bonds continued to struggle and provided only marginal relief from equity losses.