|Oct-08||Y-T-D||1 Year||3 Year||5 Year|
|MSCI Emerging Markets||-27.37%||-53.18%||-56.35%||-0.37%||9.51%|
|Lehman Muni Bond 1-10 Yr||-0.18%||1.00%||2.41%||3.49%||3.06%|
|Lehman High Yield||-15.91%||-24.38%||-25.81%||-4.40%||0.43%|
|Lehman Global Aggregate||-3.69%||-4.11%||-2.57%||3.94%||4.11%|
|CSFB Bank Loan||-13.03%||-19.61%||-20.33%||-3.94%||-0.11%|
|DJ-Wilshire US REIT||-32.38%||-31.54%||-41.48%||-7.05%||4.59%|
|S&P-Citi World Property||-27.40%||-44.70%||-51.48%||-8.23%||4.00%|
|Red Rocks Domestic LPE||-31.93%||-46.91%||-53.39%||-16.19%||-4.22%|
|Red Rocks Global LPE||-33.07%||-52.63%||-57.59%||-9.85%||5.08%|
It seems much longer than just one short month ago that the financial markets watched closely as Congress voted for the second time on the $700 billion Troubled Asset Relief Program. It had been only a few days since the initial rejection of bailout plan had sent the markets tumbling, and everyone seemed to be holding their breath as Congress attempted again to get the program passed.
Since that October 3 vote, the financial landscape of the world has changed with unprecedented speed. The Federal Reserve soon extended its balance sheet further by setting up two separate facilities to purchase commercial paper; the consolidation of the banking industry continued as Wachovia was acquired by Wells Fargo after a short battle with Citigroup; various governments across Europe —- including those of Greece, Sweden, Germany, Denmark, Austria and Britain —- beefed up their domestic bank deposit guarantee programs; the Icelandic government took control of the country’s second largest bank, while loaning 500 million Euro to its largest; and, in an extraordinary coordinated effort, a number of major central banks —- including the U.S. Federal Reserve, European Central Bank and Bank of England —- cut rates simultaneously by 50 basis points each.
These efforts only seemed to flame the concern of a global banking meltdown, as during the first seven trading days of October the S&P 500 fell more than 22%. The credit markets seemed to be close to a standstill, fear of failures among banks and financial firms increased, and reports circulated that companies were having difficulty acquiring capital for their day-to-day operations. Additional affirmative steps were soon taken by the fiscal and monetary authorities. Following the U.K.’s lead, governments across the European Union pledged a total of roughly 1.5 billion Euros to shore up their banking systems via loan guarantees and capital injections. The U.S. government also responded, dedicating $250 billion of the Troubled Asset Relief Program to recapitalizing domestic banks, extending FDIC insurance, creating a program to support money market fund redemptions, and establishing swap lines with the central banks of Brazil, Korea and Mexico (the first time that lines were offered to emerging market economies).
Despite the efforts of the Central Banks to inject liquidity in the markets, October proved to be a devastating month for investors, who became increasingly concerned about a protracted global recession.
In most times, there is a non-correlated asset class or region in the world that provides a positive return. October proved to be an exception. Fixed income provided some protection, as the Lehman Brothers Aggregate Bond Index returned -2.36%, a mild loss compared to most other asset classes. U.S. large-cap equity markets performed only slightly better than the U.S. small-cap equity markets or international equity markets. The S&P 500 lost 16.80%, compared to a 20.15% loss for the S&P 600 Small Cap Index and the 20.18% loss of the MSCI EAFE Index. Emerging markets, represented by MSCI Emerging Markets Index, suffered most heavily —- down 27.37% during the month —- as investors fled to the safety of developed countries. The fear of a global recession also sent commodity prices tumbling. The Dow Jones-AIG Commodity Index fell 21.28%, as oil fell below the $75 mark for the first time in 14 months. The price declines over the course of the month have no doubt reserved October 2008 a place in the history books alongside the October crashes of 1929 and 1987.
The month was an unsettling ride for investors as the world’s stock markets exhibited tremendous volatility. Headlines trumpeted not only the largest one-day percentage drops in the Dow and S&P 500 since October of 1987, but also the largest one-day percentage gains in the Dow and the S&P 500 since the Great Depression. The Chicago Board Options Exchange Volatility Index (VIX), a measure of the implied volatility of S&P 500 index, reached an all-time high during October. This volatility represented the huge daily swings in the value of equity markets, sometimes creating a daily change of more the $500 billion in market capitalization.
The impact of the Central Banks’ actions has been encouraging. Spreads on interbank loans and high quality commercial paper have come off their peaks of mid-October. The TED spread, the difference between the yields on three-month T-bills and three-month LIBOR (and a general measure of perceived credit risk in the economy), reached all-time highs at mid-month as LIBOR spiked to nearly 7%, but eased significantly by the end of October back under 3%. Investment grade and high yield corporate bond spreads closed the quarter at multi-decade highs.
Although the panic has lessened, there are still areas of concern. Economic conditions are likely to continue to deteriorate further, due to reduced consumer and corporate spending and tight lending standards. While Central Banks have become creative and aggressive in an all-out effort to restart growth, the financial crisis appears to be imposing a longer than usual lag between the policy actions and their effects. However, some experts believe that the conditions are conducive for equity markets to finally make a bottom: equities are very attractively valued relative to Treasurys; stock prices appear to more than adequately discount the extreme pessimism of consumers, businesses and investors; Central Banks have cut rates aggressively; and, additional fiscal stimulus on the way. Maintaining a long-term perspective becomes even more essential during these volatile times. While no one is able to predict the future with precision, eventually panic will ease, stability will reappear and patient investors should be rewarded.
Gordon Tewell, CFA