Running Out of Ammo?

The economic news throughout the final quarter of 2008 was unremittingly bleak.

• The National Bureau of Economic Research declared in December that not only was a recession under way, it had begun in December 2007, a year earlier.
• The Commerce Department reported that the Gross Domestic Product fell 0.5% in the third quarter.
• Corporate profits fell 1.2% in the third quarter, the fifth straight quarterly decline.
• Auto sales, which had been hit hard by high gas prices in the summer, simply collapsed in the fall, leading to the necessity of a federal bailout. Even Toyota suffered badly, recording its first quarterly loss in 70 years.
• The housing sector continued to struggle, as sales of existing homes dropped 8.6% in November. The inventory of unsold homes grew to 4.2 million, an 11.2-month supply at current sales rates. The median home-selling price fell 13% in November alone, to $181,300, the lowest since February 2004. However, some observers believe that by historical standards home prices remain high.
• State and local governments found their budgets extremely stressed. Public pension plans, which are not subject to ERISA funding requirements, suffered significant losses as the stock market fell. Taxpayers may be asked to make up the shortfall.
• Unemployment reached a 15-year high of 6.7%, with some experts forecasting unemployment as high as 9% by the end of 2009.

Almost no interest
To counter the grim economic news, the Federal Reserve Board cut the federal funds rate to the lowest level in history, a range of zero to 0.25%. What’s more, the Fed announced that new steps would be taken to pro-mote economic growth, including printing more money and buying up mortgage-related bonds and corporate bonds. But will that be enough? President-elect Obama declared: “We are running out of the traditional am-munition that’s used in a recession, which is to lower interest rates.”

The new Congress is expected to enact new spending on infrastructure, with a price tag of $600 billion to $1 trillion over the next two years. If there is a possible bright spot, it is that the tax increases promised dur-ing the presidential campaign appear likely to be postponed. Everyone seems to understand that tax increases can only make a bad recession much, much worse.

Stock market outlook
The Dow Jones Industrial Average had its worst year since 1931, down 33.8%. The S&P 500 did even worse, down 38.5% in 2008, its worst performance since 1937. All told, U.S. stocks lost an estimated $10.4 trillion from their high in October 2007 to the low in November 2008. Public announcements of confidence in the economy and in the stock market as an engine of growth, made by such investment notables as Warren Buffett and John Bogle, were not persuasive to the investing public at large.

Still, the overall market has been depressed by exceptionally poor performance in a few sectors. There are some bright spots. By traditional measures, such as price to earnings, price to sales, price to book value and dividend yield, many stocks are at bargain prices, values not seen in years. They are poised to take off when the economic recovery begins.

The unanswerable question is: When will the recovery begin? Almost no one expects recovery before the fourth quarter of 2009. However, in the past the stock market has bottomed about six months before the economy turns up, because the market is always looking forward. The strongest gains for stock prices have happened as the economy emerges from a recession (though past performance does not predict future results).

© 2009 M.A. Co. All rights reserved.