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Randall Financial Group News

15-Oct-08

2008 Q3 Market Summary

Markets continued to deteriorate in the third quarter along with economic fundamentals. But the overriding concern was a worsening financial crisis as global financial institutions lost faith in each other and credit markets ground to a virtual halt. Equity markets across the globe finished the quarter lower as the U.S. economic slowdown and credit crisis spread around the world. The S&P finished the quarter down 20.68% and the Dow Jones Industrial Average posted its worst one day point decline in history with a drop of 777 points on the second to last day of the quarter. International markets also headed substantially lower. The MSCI EAFA index of developed international markets was down 31.07% for the year with more than 21% of the decline coming in the 3rd quarter alone. There were no safe havens as stocks in the mid and small cap ranges were also hit hard. Bonds didnt fair much better with the Lehman Bros. Aggregate bond index down 0.49% for the quarter while clinging to a gain of 0.63% for the year. Even commodity prices saw a significant pullback. Crude oil led the way finishing down 28% for the quarter while still posting a gain of 8.0% for the year. Prices for oil have continued to fall in October as concerns about a global economic slowdown have reduced forecasts for crude oil demand.

The most significant events of the third quarter surrounded a rapidly worsening credit crisis and continued concern about home prices putting further pressure on financial institutions. After having bailed out Bear Sterns in March, the government chose to let Lehman Brothers, the fourth largest investment bank in the country fail. Their bankruptcy, the largest in U.S. corporate history dwarfed other recent high profile failures like Enron and WorldCom. It had broad ranging, and what many would call unforeseen consequences. These included a large money market fund in New York breaking the buck as its share price fell below a dollar, only the second time this has happened in U.S. history. This also called into question the credit of other short-term borrowers. The U.S. Government became the only safe place for cash as short-term treasuries soared and yields plunged. At one point investors saw negative yields on short-term treasuries, effectively paying the government to keep their money safe.

The Lehman bankruptcy also raised doubts about other large Financial Institutions. Regulators in Great Britain engineered the takeover of HBOS, a large European home lender and nationalized others. Here in the States, attention focused on American International Group or AIG. As well as being a large insurance conglomerate, AIG was a massive issuer of exotic derivatives known as credit default swaps. As the inherent liability of these positions multiplied with the worsening credit markets, AIG was forced into a death spiral, having to raise billions of dollars of new capital to secure its balance sheet. As credit markets continued to deteriorate, the Treasury and Federal Reserve decided to step in with an $85 billion rescue package to prevent AIG from going under, having made the determination that this firm was too big to fail. Shortly after the rescue, Merrill Lynch was forced into selling itself to Bank of America in order to prevent a similar fate. The two remaining U.S. investment banks, Morgan Stanley and Goldman Sachs have seen their shares battered and whipsawed as traders speculate on their future. Both firms have filed with the Federal Reserve to become bank holding companies, giving up their long history of being independent investment banks in order to seek some of the protections afforded federally chartered commercial banks.

Changing course from their previous pattern of reacting to crisis in a piece meal fashion, Treasury Secretary Paulson and Fed Chairman Bernanke proposed a massive $700 billion dollar bailout rescure to congress. After days of political drama and one aborted attempt to pass a bill that sent the Dow down 777 points, congress passed what turned out to be a $850 billion dollar plan. It is designed to re-capitalize U.S. banks, secure bank deposits and buy toxic mortgage assets off of bank balance sheets. Further details of the rescue plan are being released as this is written. In the mean time, credit markets are still under distress and stock market volatility has reached historic proportions.

Its impossible to say when a recovery might start. The first thing to look for will be stabilization of credit markets and increased lending among banks. One key indicator will be residential housing inventories. These inventories reached record levels in 2007. Until inventories return to historic averages, home prices and their associated mortgages will not stabilize. Once they do, well still have to deal with the more mundane aspects of a slowing economy and likely recession into 2009. Until that time, the best defense is a well-diversified portfolio appropriate to your risk tolerance, a cash cushion for near term emergencies, and a significant amount of patience as we wait for markets to recover.

Information presented here is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.

© 2008, Randall Financial Group, LLC All rights reserved. Please Visit www.Rfinancialgroup.com

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