Monthly Market Monitor - November 2008

Another Rough October

Historically October has been one of the worst months for the stock market --- think 1929 and 1987. Double-digit losses for most of the major indexes caused this October to be the worst in a decade.1 The impact of the deepening credit crisis and the attempts to avert permanent damage to the global financial system produced wild swings. Twice the major indices reached lows not seen in over five years only to rebound 800-900+ points quickly thereafter. As the month ended, global stock and bond markets remained very unsettled despite repeated programs to stabilize the world’s financial institutions. However, early signs of freer lending between banks are encouraging. This provides some confidence that, after several piecemeal attempts, the latest governmental efforts will finally get to the root of the primary problem: lack of trust among financial institutions. The fact that there is now a more holistic global program being undertaken by most of the major countries of the world has helped significantly.

The markets remain reluctant believers. However, regaining investor confidence after past major financial crises has not occurred immediately and the depth of the current banking problems suggests this could take some time. Many of the fixes have never been tried in our financial system or have not been used for over seventy years. Several US governmental departments, including the Federal Reserve, the US Treasury, and the Federal Deposit Insurance Corporation (FDIC), are involved. Details of the many moving parts of the new programs are still being worked on and require the coordination of many of these participants. For example, a program introduced several weeks ago for the Fed to support money market funds was only up and running this past week. Overlooked in the $700 billion “bailout” for Wall Street was plenty of flexibility to attack the many aspects of the problem, including direct aid for home owners. There are now signs of a new program for more direct relief to mortgage holders being put together. Other unforeseen offshoots of the credit crunch may show up over the next few months. Markets will likely continue to be nervous, but it is clear that global authorities are better anticipating new problems and will continue to use whatever resources are needed to solve them. The threats of a global financial meltdown have faded significantly.

“Deleveraging” the Markets

One major offshoot of the frozen credit markets has been the forced selling by aggressive investors that had borrowed money to invest in an effort to boost their returns. In an era when money was plentiful and all markets were going up, most outsize “hedge” fund gains were created by this borrowing or leveraging. With the value of their holdings now going down, leverage users have been forced by their lenders to put up more collateral or sell (deleverage) those holdings to pay down their balances. With a quickly declining market, the hedge fund managers have chosen to sell holdings to pay back the debt. Particularly in this environment, the assets that are easiest to sell (or can be sold) and have declined the least are the largest or safest. This explains why many of the traditionally safest asset classes, including municipal bonds and even gold, and the strongest companies have been subject to unusually large price declines. The huge increase in the number of hedge fund managers in the past few years has aggravated the problem because there are many more assets that need to be sold at the same time. Moreover, because of the particular lack of transparency of hedge funds, the inability to predict the size of the leverage that needs to be “unwound” continues to weigh on the markets. That has added another important layer of daily volatility to the markets. Traditional buyers wanting to take advantage of good fundamental values have run into these waves of forced selling, accounting for many of these huge market swings this past month. This again is not unexpected given the disruptions the financial system has undergone and the size of the borrowing built on the upside. Many analysts believe these violent swings are actually encouraging signposts in the normal process of markets wringing out excess speculation and beginning to stabilize.

1. Wall Street Journal, 11/1/08

The views are those of Martin Cosgrove CFA, Director of Investment Research, Research Department/ING Advisors Network, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

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