March 2008 Market Commentary
|Y-T-D||1 Year||3 Year||5 Year|
|MSCI Emerging Markets||-5.29%||-10.99%||-10.99%||21.33%||29.24%||35.53%|
|Lehman Muni Bond||2.86%||-0.61%||-0.61%||1.91%||3.71%||3.93%|
|ML High Yield||-0.52%||-3.04%||-3.04%||-3.53%||4.91%||8.57%|
|SSB Global Bonds||3.22%||9.66%||9.66%||20.29%||7.27%||8.14%|
Fire Sale? In hopes of attracting new buyers, the gloomy merchants of Wall Street kept marking down the prices of riskier assets during the month of March. The dearth of willing buyers led to stocks’ decline for the fifth straight month. Few buyers seemed interested in the financial merchandise that appeared to be so attractive just a few months or a year ago.
Prime contributing factors in this pessimism included the ongoing negative reports about the credit crunch, housing prices and the slowing U.S. economy. Perhaps the low point of the credit debacle may one day be judged to be the collapse of Bear Stearns, one of the largest U.S. investment banks. The Federal Reserve decided not only to facilitate the sale of Bear Stearns to JP Morgan Chase, but to open its discount window to broker/dealers. In the face of a financial crisis and a weakening U.S. economy, the Fed temporarily discharged its main duty of containing inflation and made cheap money available to financiers. The Fed Funds rate ended the month at 2.25%, less than the Core CPI of 2.27%. Just 12 months prior, the Fed Funds rate was 5.25%. Nonetheless, the Fed’s actions have been ineffective at lowering the cost of financing residential real estate. The national average for a 30-year fixed-rate mortgage near the end of March was 5.8%, only slightly below the 6.0% average of a year ago.
With the exception of small cap U.S. stocks, equity investors around the globe had their merchandise discounted again in March. At its lowest point during the month, the S&P 500 had fallen 19% from its high in October 2007, and small cap stocks were off 25%. Among the hardest hit investors were those allocated to the fashionable emerging markets; declines were in excess of 5% for the month. The slowing U.S. economy might mean fewer buyers of the goods produced in the developing economies with relatively low labor costs. Nonetheless, the compounded annualized return of the emerging markets over the past five years through March 31 was in excess of 35%.
Even though commodity prices were cut by 6.34% for the month, the asking prices for energy, food and other raw materials were nonetheless dramatically higher than a few years ago. At the end of the quarter, gold was $930 per ounce, and crude oil was $105.56 per barrel, levels 40% and 65% higher, respectively, versus a year ago. REIT prices, which had declined more than 30% from their lofty 2007 peak, rebounded by over 3.5% for the month.
The near-term outlook for lower inflation and weaker economic growth brought some cheer to the investment-grade bond market. Investors continued to avoid issues with unclear risks, sending the prices of high-quality bonds higher and their yields lower. With a high average credit quality of AA, the Lehman Aggregate Bond Index provided a total return of 0.34% for March. The 13-week Treasury-bill hit a 50-year low on March 20 at less than a 0.5% annualized yield. Bonds appeared to have priced-in a U.S. recession. Continued weakness in the U.S. dollar gave a boost to holdings in non-U.S. bonds.
Low-quality fixed-income securities continued to suffer. Fears of higher defaults among highly leveraged companies sliced more than 0.50% off the value of the Merrill Lynch High Yield Bond Index.
After a liquidity-induced sale in February, municipal bonds rebounded by 2.86% during March, as measured by the Lehman Muni Bond Index. Nominal municipal yields higher than those of U.S. Treasurys attracted buyers to the tax-free bond market. However, concerns persisted regarding the value of any insurance protection underwritten by Ambac or MBIA.
In a few years investors may look back and realize that the rampant pessimism in the financial markets over last several months led to some “fire sale” prices. In particular the risk/reward ratio has become more favorable for large cap U.S. equities, REITs, and certain low-quality corporate bonds. On the other hand, some assets appear to be overpriced, such as U.S. Treasury securities. At Innovest, we believe that successful long-term investing comes not from timing the markets or economic cycles, but from having a disciplined, long-term investment process. We will be discussing these important items with our clients in the coming weeks.