"The stock market remains an exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient."
-- Warren Buffett
By any measure, the second quarter was dismal for investment markets worldwide. The debt ceiling debate, constant dithering in Europe over whether or not Eurozone members should be allowed to default on their sovereign debt, partisan bickering regarding the downgrade of U.S. government debt, a continuingly high unemployment rate and a generally unsettled feeling about the global economic recovery have all combined to put investors in a sour mood. When investors are pessimistic (or uncertain) about the future, they typically sell - as they did, steadily and persistently, throughout the summer of 2011. It is hard to now remember that in the first quarter of this year, just a few months ago, global markets were flirting with a full recovery to their 2007 all-time highs, or that before this quarter started, markets were in positive territory overall for 2011.
With that said, and in an attempt at some brevity, here are a few short bullet points with data and some perspective.
The Market Numbers
- The Wilshire 5000 index, which most closely reflects the total U.S. stock market, dropped a remarkable 13% of its total value for the quarter. This wiped out the gains of the previous two quarters, and the index is now down about 6% year-to-date (as I write this on October 11th), but up marginally for the last 12 months.
- Internationally, the results were much the same - only more so. Broadly, world markets were down 19% last quarter, with Europe leading the way, itself down 23%, as were broad emerging market indexes.
- Just when you thought that yields on government bonds couldn't go any lower, they did. One-year US Treasuries are essentially paying zero interest, while five-year Treasuries are paying 1% a year, and a 10-year Treasury issue would lock you in at 2.1% per year for the next 10 years.
The Actual Underlying Economics
So, how much of the market's downward trend is justified, and how much is based on fear and/or speculation? Consider the following economic data:
- U.S. GDP (the broadest measure of economic activity) actually grew 2.3% for the third quarter, up from the anemic first quarter (0.4%) and slightly-more-promising second quarter (1.3%).
- Jobless claims in the last two weeks have been in the 395,000 to 401,000 level, better than expected, and in line with slight - emphasis on slight - improvement in the labor market.
- The late September high frequency (daily-to-weekly) economic data, ranging from industrial and trade indicators like steel production and rail car traffic, to measures of consumer activity like weekly chain store sales and hotel occupancy, all have improved from last year and remain stable from week to week.
The bottom line is that this level of weekly jobless claims and the most recent high frequency economic data is not currently pointing towards another recession, as it stands now, although the market seems to have largely priced in a near certain recession.
. . . And Then There's Europe (which is going to take more than just bullet points)
Of course, another fear weighing heavily on the markets is that the Eurozone will collapse under the weight of Greek (and other European) debt. Greece, by the way, has been in sovereign default for 105 of the past 200 years, so to some degree you can file this under, "nothing new under the sun"; however, what is new is that much of Europe is bound to Greece's problems by way of the single Euro currency they share and all that that entails.
While the fear is that the European debt crisis has the potential to be another Lehman Brothers type situation, just one ocean removed, there are reasons to believe that that won't likely be the case. The single biggest reason for this, in my mind, is the widespread recognition that everyone loses if the members of the Eurozone let the entire house burn to the ground. Although there has, and will continue to be, much arguing over who's toaster caught the house on fire and how much water each country should/will contribute to the effort, I think the likelihood is that the European Central Bank (ECB), and it's member states, will do what is necessary to prevent the worst case scenario, just as the U.S. did in the fall of 2008 and spring of 2009. Additionally, the Lehman Brothers situation occurred concurrent with the crash of the U.S. housing market, one of the largest, if not THE largest, drivers of worldwide economic activity. That market has not begun to recover, and we are not likely to see that particular scenario repeated regardless of what happens in Europe.
None of that is to say that markets won't do what they always do in the meantime - which is to prognosticate, react, and possibly over-react, to those prognostications. What that is to say, however, is this: assuming the ECB does (eventually) take the necessary steps to shore up and recapitalize their largest Eurozone banks so as to be able to withstand the probable sovereign defaults, I suspect it likely that any market reaction would be reversed in relatively short order. U.S. and world markets in the post-Lehman period are a good example of this: having fallen nearly 50% in the six months following the Lehman bankruptcy, they subsequently recovered back to their pre-Lehman values within 13 months of their March 2009 lows (and are just at or above the pre-Lehman values as I write this on October 11th). To state that another way, despite all that ensued, global equity markets have produced positive returns, dividends included, since September 12th, the day before Lehman filed for bankruptcy. We are still below our October 2007 all-time highs, but the market damage from Lehman on has been reversed.
Meanwhile, supply shortages of oil have eased from the start of the year, causing prices to drop; consumers have paid down enormous amounts of debt over the past three years, bringing them in line with where the consumer debt burden has been for the past 30 years; and corporate profits and cash levels remain at record high levels . . . and there are signs that the unemployment problem is starting to ease - although it will undoubtedly be years before we see unemployment fall to levels seen in the early part of the 2000s.
Even with all this good news hiding behind headlines about U.S. and European sovereign debt levels, it is hard to predict when the markets will rally decisively . . . but it is equally difficult to bet against a sudden shift in sentiment, especially since there have been so many such shifts in the past few years.
Finally, I'll close with one quick statistical item: During this August's market meltdown on the heels of the U.S. debt debate and concerns about Europe, U.S. corporate insiders - company officers and directors - spent even more of their own money buying company stock than they did at the bottom in March 2009. The dollar volume of insider purchases in August was $681 million, 15% greater than the insider purchase volume from March 2009, the market's post-crisis low point, and arguably the greatest equity buying opportunity in a generation. On this point, at least, Warren Buffett is right: the stock market does remain an exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient, or in other words, from those focused on the short term to those focused on the longer term.
As always, please let me know if you would like to discuss or if there is anything I can do for you.