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This Time It Really Is Different November 18, 2011
It’s hard to ignore the headlines of the latest crisis developing in the Euro zone and economic reports of a global economic slowdown that raise the specter of recession. Every morning and throughout the day we are bombarded with quotes from commentators who do their instant analysis and warn that the market is on a slippery slope that looks very much like the environment that led to the market crash in 2008.
While the market has continued to be volatile, it has been resilient, moving back and forth in a wide trading range around 1250 for the S&P 500 since early August. Those who choose to follow the daily trend of the market are bombarded by the chatter of those who peg the change in the Dow or the S&P to recently-released economic statistics, the latest news of the turmoil in Europe, or a worrisome statement by a Fed governor or the Administration. We have an overload of information, but little meaningful analysis in the public press.
But it’s not 2008 all over again. Remember that the recession began in December, 2007, followed soon thereafter by the credit crisis and the failure of financial firms including Bear Stearns, Fannie Mae, Freddie Mac, Merrill Lynch, Lehman, and Washington Mutual. The government injected billions into the U.S. banking system through the Emergency Economic Stabilization Act and the Troubled Assets Relief Program. The housing market was imploding; GDP slumped into negative territory with the loss of $685 billion of output and S&P 500 earnings collapsed to a loss from the peak of $24.06 in the 2nd quarter of 2007.
The European financial crisis intensifies as the European Central Bank searches for capital to stabilize the bond market, recapitalize its banks and avoid widespread sovereign default. Now contagion has spread to Italy with the spike above 7% for Italian 10-year bonds. We expect that Italy will still have access to capital markets, but at this high price, The slow-down in growth threatens a European recession, and if a full-blown banking and sovereign debt crisis is not avoided, the U.S. cannot expect to be unaffected because global financial markets are highly interconnected.
Since the Greek sovereign debt default erupted in May, 2010 the catalyst for financial market uncertainty has shifted from the U.S. to Europe with fears of default and banking crisis dominating markets. Despite the downgrading of U.S debt and the skepticism about the supercommittee, demand for U.S. Treasuries has pushed down yields to very low levels and the Federal Reserve keeps repeating its position that monetary policy will be directed toward keeping interest rates low until at least mid-2013.
The U.S. financial system is in much better shape than it was in 2008, corporate balance sheets are generally quite strong with cash at high levels, the recession is behind us and profit growth has been strong, consumer spending continues to improve and business investment is strengthening.
The global macro outlook is uncertain, and, if financial stress increases, that could lead to a freezing-up of credit. That would present a new volatility factor for the economy and markets, not just in Europe, but around the world. The consequences of failure to act are potentially so disruptive that global pressures are being brought on the ECB to come up with a plan to avert that risk.
We rate U.S. large-cap equities as one of the more attractive asset classes based on earnings prospects and valuations, especially at a time when bonds provide very low returns, and are vulnerable to higher interest rates and inflation at some point over the future.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.