January 2008 Newsletter
Out of the Box in 2008 - Compiled by Guy Baker
The stock market’s performance during the early weeks of January has certainly not warmed investors’ hearts. Volatility and losses marked many of the trading days. What’s more, January has not been without remarkable events, nothing more striking than the Federal Reserve’s 75 basis point drop in the benchmark interest rate on January 22, 2008, 25 points more than anticipated. An old wives tale is that “as the first five days of January go, so goes the year.” That’s one of many “trading rules” popular among technical investors, who believe profitable trades can be made by interpreting correctly the patterns in various market indicators. But another trading rule is markets rise in presidential election years. The conflict between these signals about potential stock performance in 2008 demonstrates only that when it comes to technical analysis, it is probably better to pick your position first and then find a rule to support it.
U.S. Stocks 15% Off Their Peak
It might be helpful to put the early January decline into a longer-term context. Since the market’s peak on October 9, 2007, as measured by the S&P 500 Index at 1,565, stock prices have declined about 15% to 1,325 on January 18, 2008. In market parlance this is considered a “severe correction.” Investors are now asking themselves whether it will turn into a bear market (– 20%). While we don’t know which way the market will turn, when we add up the pluses and minuses, the pluses still seem to be ahead.
Economic Growth, Though Very Weak, Continues
While some observers believe we may be staring recession right in the face (and recent data seems to support that thinking), the economy is still growing. The production of goods and services probably expanded at a real (inflation-adjusted) annualized rate of about 1% during the fourth quarter. (The first of three government estimates of fourth-quarter growth is due to be released January 30.) Economic growth has been supported by moderate consumer spending and the stimulus a weak dollar gives to exports. The pace of growth is likely to slow further during the first quarter of 2008. So far it seems that activity during the first half of this year will avoid meeting one “rule of thumb” definition of a recession: two consecutive quarters of contraction in the gross domestic product.
Light in the Housing Tunnel
Housing remains the most fundamental problem, as new construction continues to fall, sales are sliding, and inventories remain excessive. But here there might be a sliver of light. Many regions have experienced significant declines and prices have become more affordable as mortgage rates have dropped below 6%, typically a point where activity begins to pick up. Subprime rate adjustments will likely peak in the next several months and while they will remain high throughout 2008, the pressure is declining. Plus, the Fed’s January action to drive rates down provides another glimmer of optimism for the housing market.
Fed Intervention Offers a Lift
So what does all of this mean to investors? It appears that while the U.S. economy will continue to be mired in gloomy news, it will muddle through for the next couple of quarters, rather than falling into a recession. The Federal Reserve will likely make additional rate cuts which—in tandem with the cuts already made—should begin to provide some lift to the economy by the end of the second quarter. Some investors extrapolate all of the bad news and seek the haven of cash.
So in general, while it is uncomfortable to watch a turbulent market flounder, a long term perspective to investing still makes sense. Once the Subprime problem works through the economy, things should stabilize, unless there are major tax hikes, or other disruptive events. Long term buy and hold has always been the best strategy and once again, it is very likely it will work during the coming months.
Adapted from various news articles and thoughts.