Dear Clients:
As 2008 draws to a close, the US economy has been in a recession for over a year, making it one of the longest recessions we’ve had in 25 years. It is important to note that capital markets tend to lead the economy by approximately 6-9 months as a barometric indicator. As capital markets remain in a negative mode, the economy should continue in that manner also for at least that same amount of time. It may take until the first half of 2009 for the capital markets to recover, and then hopefully the economy will follow at some point in the second half of next year.
The triple witching hour of the housing bubble contributed to the financial bubble, which in turn helped usher in the current recession that started back in 2007. These forces have contributed to a comprehensive decline in most of the major markets from real estate to large cap US domestics, small caps, and pretty much across the board in overseas investments. In fact, overseas markets show declines more severe than domestic declines. However, this recession has yet to equal the depths or lengths of the recessions of 1980-81 or 1973-74, which was the greatest recession since the Great Depression.
With 2008 coming to a conclusion, the capital markets, represented most commonly by the S&P 500 and the Dow Jones 30 Industrials, will more than likely set a record of financial ineptitude. The worst decade in American history has traditionally been the 1929-1939 period in which returns were anemic, but nonetheless positive. Surprisingly, that period showed a positive return of 10% cumulatively, or 1% per year. The current period from 1998 to 2008 appears poised to set a standard for lowest economic returns for the major indices, which currently range from -20% to -30% as a cumulative 10-year return.
In 1998 we had a similar but far less severe recession that started with the collapse of Asian currencies. The US government injected significant amounts of liquidity into the system, propped up Lehman Bros., and a sharp but short recession was ended; the economy recovered within 7-8 months.
The year 2000 brought in the tech bubble and many overvaluations in the capital markets. Then in 2001 we had 9/11, with the subsequent recession in 2002. These factors contributed to a longer than normal period of recovery for the capital markets.
This current recession has created a series of events that may set new standards – the lowest, the worst, and the first negative returns for major market indices over a 10-year rolling period in eight decades.
Declines of major magnitude have usually been followed by periods of higher than average rewards. The 1980s and 1990s were a period of very high returns, which followed the decade of the ‘70s during which returns were far below average. Many market mavens suggest that current valuations portend dramatically higher-than-average rewards, not only contributing to a recovery but also establishing a new era of prosperity. We shall see.
From an economic standpoint, we will be thankful for 2008 to end and look forward to 2009 with a degree of concern but also a bit of optimism. As investors, we tend to be overly optimistic in good times and overly pessimistic in bad times. As Warren Buffett commented, “Be fearful when others are greedy, and be greedy when others are fearful.”
We wish you a happy holiday season, with hope for a more positive outlook in the coming year.
Sincerely,
David W. Demming, CFP®