Fears Grow Over Deepening Recession

Significant Losses Amidst Extreme Volatility!

A second tough week with growing losses as the S&P and NASDAQ both experienced sharp weekly declines of 6.2% and 7.9% respectively. Volatility was at extreme levels as the market swung back in forth throughout the week. However, intraday volatility was even more surprising and extreme. In Thursday trading, the market average swung an incredible 11% in just one day. Volatility is so high that market moves over 5% in just one hour of trading are becoming commonplace. We just have not seen market swings like this in a very long time, if ever! The extreme levels of volatility are very disconcerting, and really testing the patience of investors. It is not surprising that many investors are sitting on the sidelines. The volatility was tied to growing concerns that the recession would be more severe and longer lasting that previously thought.

Fears of Deeper Recession

Reports continue to build providing more evidence of a deepening economic recession. Retail sales dropped a record 2.8 percent in October as consumers slammed the brakes on spending out of recession fears. Many retailers lowered their next year outlooks yet again and this time even more severely. Best Buy went so far as to say that “rapid, seismic shifts in consumer behavior have created the most difficult climate ever seen”, and then subsequently slashed earnings guidance for their fiscal year. Unfortunately, it is not just retailers as Intel also slashed earnings guidance due to slowing business demand and investment. The reluctance to spend is contagious and exasperating the fear that this recession will be long and deep, much worse than previously feared. To add more fuel to the fire, jobless claims hit another high, and more companies announce major layoffs with each passing week. The big automakers are teetering on bankruptcy and may fail unless there is government intervention. Oil prices dropped again this week, clearly a sign that demand is decreasing as businesses cut production needs. We all know that the economy is not doing well, but this week marked a growing sentiment that the recession could be longer and more severe than first perceived.

Future Outlook is Challenged

Next week will bring further pressure as more quarterly earnings reports are released reflecting poor economic conditions. In addition, the PPI and CPI measures will be released and most certainly will provide further evidence of the economic slowdown. There is also growing concern and a lack of confidence in the ability of the government to provide support and solutions to the crisis. The government plans put forth to date to address financial and economic concerns keeps changing as priorities shift. Concern is growing with the suggestion that the government does not have a good handle on the problem and the solutions that are needed. Agreeing to spend money is good, but throwing good money after ineffective solutions will not be helpful. The first priority from the Treasury is now to strengthen the capital base of our financial system. The second priority is to provide support for the credit securitization market outside of the banking system, which encompasses items like credit card receivables, auto loans, student loans and similar products. The third priority is to continue to explore ways to reduce the risk of foreclosure. Our main concern is that these measures may not be direct enough to address the housing concerns and related problems, which in our view is the largest component of the problem. Consumers have to feel secure in their jobs and the value of their homes before they will get back on that spending bandwagon. The government has to encourage business and consumer spending with all tools available in order to provide the necessary stimulus. Our economy is driven more by consumption, and until consumers begin to spend, the economic struggles will continue. We expect that corporate outlooks will continue to be challenged well into 2009, and this will weigh on any potential moves in the stock market.

Volatility Remains Extreme

We reported last week that volatility will likely remain high and that turned out to be an understatement! The market has had extreme movements throughout the week and has moved more than 5% in just one hour of trading with growing regularity. Last week marked the Nov 15 deadline for hedge fund redemptions and surely that had an impact on volatility. However, fears of a deepening recession continue to grow and that is weighing heavily on the market, and some would argue a level not yet fully factored into current stock prices. The volatility will likely continue as concerns over the economy and skepticism over government interventions continue to grow. The change in administration will also bring uncertainty as Obama appointments are announced and evaluated, and as more information on future administration plans are announced. With year-end approaching, there is also the looming tax sale deadline for dumping losers which will further pressure stocks. As we have said before, investors need to be patient, and perhaps even opportunistic in light of the current volatility. If the market moves strongly in one direction, there may be opportunities to play a bounce, as the market has intraday swings of 5% or more quite frequently. A good way to play these short term movements is by trading the market indexes or even options based on those indexes. Volatility can be very trying for buy and hold strategies, but it does offer opportunities for short term trading. Last week we set new market lows as we broke through previous lows set in October, before settling back at higher levels. We may test those lows again next week or in coming months as the volatility and selling pressure continues. However, while the economy has a long way to go before it gets better, we still think the market already reflects most of the bad news, with many stocks sitting at very compelling price levels. We are planning to invest some of our cash into stocks over the next few weeks as we find good opportunities, and would suggest that investors sitting on cash do the same. We are also going to look for more short term trading opportunities with the market indexes to take advantage of the high volatility in the market. Patience will reward the long term investor as positive momentum and confidence will eventually return. Despite the terrible market, all of our portfolios show positive returns since their inception, which is truly exceptional given that the corresponding market returns all show significant losses. Remember, the ultimate goal is to beat the market, even if that means losing less than the market over a short time periods!