After a two month delinquency in updates we’re back. And, wow - what a market to start writing about again. Since our last post in April, the S&P 500 lost 9% of its value while the Dow surrendered a hefty 11%. In fact, we are knee deep in recession as far as textbooks go - with the Dow crossing the 20% drop mark in early July. So, what now? To steal a line from the late great Douglas Adams - don’t panic. The slow market days of summer are the perfect time to step back and reassess the situation.
Credit Market? What Credit Market?
I know, I know - I’m sick of hearing about it too. One year after it began, the infamous “credit crunch” has continued to wreak havoc in the US. Mortgage lenders who made loans to individuals with no down payment and no documentation of income created a dangerous and unsustainable situation. The big banks, chasing higher yields via exotic debt instruments (e.g., CDOs) were scuttled when the consequences of this were brought to bear. The unwinding was so bad that the federal government had to intervene to prevent the entire system from sinking overnight (ever heard of a little firm by the name of Bear Stearns?). The result: credit available to borrowers dissappeared in the blink of an eye. The good news is that access to capital has no impact on economic growth (wait a minute…).
Housing, Unemployment & Inflation = Stagnation
With lending standards tightening and home prices inflated - yet another bubble burst. Home prices across the nation have fallen, with some areas (i.e., California & Las Vegas) losing almost 40% of their value as foreclosures continue to hit the market. To further grind salt into the wound, inflation has reared its ugly head via rising food and oil prices (the Consumer Price Index grew 5% in June ‘08 vs. June ‘07). Even more bad news: inflation decided that his good buddy unemployment should join the party too (the jobless rate hit 5.5% in June). The result: one heck of a “stag” party. “Stagflation” that is - that lovely phenomenon that manifests itself in the form of slow economic growth, rising prices, and increasing unemployment. And I thought we’d only read about that phenomenon in textbooks.
So Now What?
Sound bad? It is. In fact, according to Barron’s the average recession lasts around 400 days - and stocks tend to lose over 30% of their value. But don’t despair - history tells us that opportunity rises out of the ashes of ruin. After the great depression, the Dow Jones Industrial Average soared over 300% in the following 5 years! So, chin up - let’s stick to facts and look for opportunity in this market with a critical eye. And don’t forget to ask yourself that one all important question - what would Warren Buffett do?