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By Howard Aschwald The stock market is amazingly resilient. The sky is not falling, despite what the pessimists would have you believe. Yes, the Dow Jones Industrial Average entered bear market territory in early July. Yes, oil prices are incredibly high. Yes, June was a really lousy month for stocks. But you might be surprised at how fast the stock market can change...for the better. Looking back, the market has recovered remarkably — and quickly — from some notable downturns. 2001-2002. After the four-day closure of the stock market following 9/11, the Dow fell 685 points (the biggest single-day drop ever) to 8920 on September 17. It kept falling, losing 14.26% in a week to close at 8,235 on September 21. But what happened next? A huge gain. The Dow closed 2001 at 10,021 — a 21% rebound in less than three months. There were more challenges ahead. On October 9, 2002, the Dow had fallen to 7,286. But on Halloween, the Dow sat at 8,397 — a 10.6% gain in 22 days. As for the people who panicked and bailed out of the stock market, they ended up kicking themselves: in 2003, the DJIA gained 25.3%, the S&P 500 26.4%, and the NASDAQ 50%. 1987. October 19 was Black Monday: in a contagion of selling exacerbated by unchecked computer technology, the Dow lost 22.6% in one day, falling to 1,738, a 508-point loss. (That would be akin to a 2,300-point one-day drop today.) The S&P 500 lost 20.4%. By comparison, the initial "Black Monday", the stock market crash of 1929, represented a 12.8% market loss. Then the recovery kicked in. During the next two trading days, the Dow gained nearly 300 points — and it closed 1987 at 1,939, gaining back all of the loss and ending up 2% for the year. By January 1990, the DJIA was at 2,800. If you were fortunate enough to invest $1,000 in the S&P 500 index at the close of Black Monday and reinvested your dividends, you would have wound up with about $10,800 twenty years later. If you had invested in the Dow stocks a week before Black Monday, you would have lost 30% on your investment in the crash...but if you held on, your investment would have gained 462% over the next 20 years. This is what the market is capable of achieving. There are periodic descents, but history is definitely on an investor's side. When it comes to investing, it's OK to listen to your feelings, but even better to ignore them. Back to TopQuarterly Update and Outlook By Howard Aschwald Quote for the quarter: "Nothing is said that hasn't been said before." — Terence (Publius Terentius Afer) The quarter in brief. It was an odd and volatile quarter for the investor, and a trying one for the American economy. The economic troubles from the first quarter continued: record-shattering oil and gasoline prices, falling real estate prices, and a credit crisis that wouldn't cease. Were we seeing the depths of a recession? Would we see an upturn from here? The Dow entered bear market territory as the quarter drew to a close; however, in May and June, some economic indicators began to subtly improve. Domestic economic health. In April, the markets performed extraordinarily well. The S&P 500 had its best month in nearly 4½ years, and the S&P 500, NASDAQ and Dow Jones Industrial Average gained between 4.5-6% for the month. On April 30, the Federal Reserve made its seventh interest rate cut since September, bringing the federal funds rate down to 2.0%. Stock markets in Europe and Asia posted great gains (the Nikkei 225 shot up 11%, India's Sensex 30 11%, and the Hang Seng 13%) as oil and gas prices set or flirted with records. But the consumer was feeling squeezed: oil prices rose 12% for the month, retail gas prices began to spike, and mortgage rates climbed back over 6%. In May, the Dow lost 1.4% worth the NASDAQ respectively gained 1% and 4.5%. The dollar began to recover from its fall and winter depths, and the Fed hinted that its rate-cutting measures were coming to a halt. On the commodities front, oil futures peaked on May 22 at a new record of $135.09 a barrel on the NYMEX; oil prices gained 13% during May. Precious metals had a down month, and many agricultural futures fell sharply. Bits of good news began to emerge in the housing sector: new home construction and housing starts increased. The first wave of economic stimulus checks sent disposable incomes up by 5.7% in May (the biggest one-month increase since 1975) and overall income up 1.9%. Overseas, Asia's stock markets fell 0.3% and Europe's stock markets 2.8%, in a month in which most of the world's central banks considered how to battle rising inflation. You've probably heard that this June was the worst June for the Dow since 1930. Oil prices ended June at precisely $140 per barrel, having already flirted with the $143 mark. America's housing market showed signs of increased sales activity, if not quite recovery. The Fed left interest rates unchanged at 2% and released the final 1Q GDP calculation: 1.0%. Fed chairman Ben Bernanke said interest rates were "well positioned" and spoke of the Fed's commitment to a "strong and stable" dollar. In fact, during the second quarter, the dollar gained 0.3% against the Euro and 6.5% against the yen. Major indexes. The bull run of April gave way to the swoon of June — as the quarter ended, investors hoped for pleasant surprises in the upcoming earnings season and a 3Q rebound. Energy stocks performed extraordinarily well in the second quarter; financial stocks didn't. Note the small gain for the NASDAQ.
Source: CNBC.com, 6/30/08 Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends. Global economic health. Policymakers worldwide had one eye on the U.S. markets, the other on the inflationary pressures within their own economies. The European Central Bank has long had a 2% target for inflation, so May's 3.7% reading and June's 4.0% reading were cause for worry. In Asia, inflation pressure remained much greater: by June, the latest figures had inflation running at 7.7% in China and 1.5% in Japan (the highest inflation rate in a decade). The inflation rate was 8.9% in Thailand (nearly quadruple what it had been at the start of the year), 11% in Indonesia, 6.5% in Vietnam and 5.5% in South Korea. The European Commission reduced its growth forecast for the EU to 2.0% in 2008 and 1.8% for 2009 (compared to 2.8% in 2007). The EC also projected 6.8% unemployment and 3.6% inflation for 2008 (a 50% rise over 2007's 2.4% inflation.) Also, the Bank of Japan cut its growth forecast for the next 12 months from 2.1% to 1.5%. World financial markets. In Europe, the quarterly losses were mild; in Asia, they were more significant. If you think what American investors went through in this quarter was rough, you can always look at China: the Shanghai Composite index fell 21% in 2Q 2008. The Hang Seng (Hong Kong) was down 3.3% for the quarter, and India's Sensex posted a 14% decline. The bright lights here were Japan's Nikkei 225 (up 7.6% in the second quarter after an 18% loss in the first quarter), Canada's TSX (up 8.4% in 2Q), and the MSCI Latin American Emerging Markets index (up 10% for the quarter). As for Europe, the DAX fell 1.8% for the quarter, the FTSE 100 dropped 1.3%, and the CAC 40 in France declined 5.8%. Commodities markets. Oil prices gained 39.9% in the second quarter. As the quarter ended, oil prices were up 45.9% for the year. The amazement doesn't stop there. Look at the rest of these quarterly gains: heating oil, 37%; gasoline futures, 33.9%; diesel, 31.4%; corn, 24.5%; oats, 27.4%; soybean oil, 26.5%; soybeans and soybean meal, 32.1% and 33.6%; cocoa, 36%. Coal topped them all, with a 69.6% gain for the quarter (at the end of 2Q 2008, Central Appalachian Coal futures were up 143.4% for the year). Precious metals eked out gains, even with the dollar showing renewed strength in May and June. Gold prices had gained 9.7% on the New York Mercantile Exchange for the first quarter; for the second quarter, they rose 0.3%. The rise in commodity prices is starting to look very much like the bubbles seen in tech stocks and real estate over the past ten years. Housing & interest rates. There were some positive signs here. New home construction rose 8.2% in April (the biggest jump in two years), with building permits up 4.9%. The pace of new home sales also rose by 3.3% in April. Existing home sales rose 2% in May, with the inventory of unsold homes shrinking by 1.4% (although the median resale price 6.3% lower than in May 2007). The National Association of Realtors' Pending Home Sales Index (the number of home sale contracts signed) rose by 6.3% in April. However, May 2008 foreclosure filings were up 48% from May 2007 totals (according to RealtyTrac). Housing starts fell 3.3% in May; building permits also declined. While average interest rates on 30-year FRMs had finished the 1Q of 2008 at 5.85%, the downward trend was reversed by quarter's end. By the last week in June, 30-year FRMs were averaging 6.45%, with 15-year FRMs averaging 6.04%, 5-year ARMs averaging 5.99%, and 1-year ARMs averaging 5.27%. Quarterly outlook. Are things stabilizing, as certain manufacturing, retail and housing indicators have hinted? We think so. The pessimists are looking at the stock market, inflation and oil prices and seeing 1980 again. But it is not 1980, it is 2008, and the American economy really looks pretty good right now in comparison to those times. The economy is much healthier today than it was then: GDP is still in the plus column, we have 4% inflation instead of 14%, and 5.5% unemployment instead of 10%. In short, this is not time to panic. All markets go through cycles. The excesses in credit granting and financial liquidity are being wrung out of the global economic system. It's painful, but a necessary condition for the next inevitable upturn. Economists knew this year would pose some challenges for America and for the investor; the wisdom is in riding them out, and in taking advantage of the market rebound to come. While this has been said before, it's worth repeating. Back to TopGas: How High Can It Go? By Scott Whittemore Everybody is talking about the price of gas. Complaints about the price of gas have been a media favorite for a number of years, but this time there is real significance in the concern. The speed of the change is unprecedented. The rise is even more rapid than the oil crisis of 1979. The absolute price has never been higher. Inflation-adjusted numbers show all time highs. Even the IRS noticed. They raised the standard mileage deduction cents, to 58.5 cents per mile, from 50.5 cents effective July 1. With spot crude oil trading at over $140 per barrel and gas hitting almost $5 per gallon, it is difficult to remember that less than 10 years ago, in December, 1998, crude oil was under $11 per barrel and a gallon of regular was $1.15. We have yet to feel the full impact of the increase in crude oil at the gasoline pump. Four years ago, another Presidential Election year,crude oil was $38 per barrel vs. $134.52 today and gas $2.24 vs. $4.58 today. Over these four years, oil has increased 257% and gas has "only" increased 105%. If oil stays at the current prices, gasoline will continue to increase to reflect the higher proportional increase in oil. There is much discussion of the cause of the high oil prices. Over the past few years we have heard about growing global demand, short-term interruptions in supply (a strike in Venezuela, hurricanes in the US and attacks on oil producing infrastructure in Nigeria) and the weak dollar. Talking heads and politicians, ranging from Ralph Nader to John Barrasso, Republican of Wyoming, are now convinced there is a new cause: speculation! "It's a big gambling hall," The Washington Post quotes Fadel Gheit, an oil analyst at Oppenheimer. "This time it's just speculation," Peter C. Fusaro, chairman of Global Change Associates, told the Post, adding, "There's a large bet out there that prices will continue to trend higher. But it's detached from fundamentals because there's no shortage of oil." Who are the speculators? The money could come from a number of sources. Individuals, corporations, pension funds, and endowments may all be taking new positions in the oil market. They are moving their investments from real estate and stocks into commodities like oil. The Fed is adding fuel to the fire by lowering interest rates and flooding liquidity into the banking system. It is very cheap to speculate and leverage your positions right now. The speculation is done on the New York Mercantile Exchange and on a similar exchanges operating in London and Dubai. There, boisterous traders buy and sell futures contracts on the delivery of oil. The dollar amounts of these futures contracts are far larger than the actual oil deliveries they represent as they turn over and over at the Mercantile Exchange. How much has this abstract trading, fueled by rumors of storms in the Gulf of Mexico, or some possible political turmoil in a region of the world, separated the spot price from the real physical supply and demand for oil and its refined products? Energy analysts have stated they believe the real price of oil is closer to $75 per barrel, not the $140 we see traded in New York. However, speculation is not the only reason for high prices. There is a very fundamental difference in demand and supply right now. T. Boone Pickens, the eighty-year-old oil industry investor with 60 years in the oil business, summed up the current oil equation in a simple sentence. We (the world) consume 86 million barrels a day but only produce 85 million barrels a day. The June Oil Markets Report, produced by the International Energy Agency, supports these numbers. Supply is tight relative to demand, and in the short-term, there are few sources of new supply. When there is the need to dip into stocks of oil to meet demand, prices, which get set at the margins, must rise. Will these prices last? History suggests it will not. A dramatic change in price like the one we have had sets in motion self-correcting counter actions. The price rise is having impact beyond just attracting hot, speculative money. Just as in 1979, the price rise is changing behavior. Car-loving Americans drove 11 billion fewer miles in March than they did a year earlier, the U.S. Department of Transportation reported May 23. The 4.3 percent decline is the first year-on-year decline since the 1979 oil shock and the sharpest decline ever. SUV's are being traded in for much smaller cars. Public transit usage is surging. We are also actively installing alternative energy. Homeowners, businesses and government buildings are installing solar panels. Solar is not the only alternative energy source being pursued. According to the Nuclear Regulatory Commission there are 21 separate expected new nuclear power plant applications in the U.S. for 32 nuclear power units over the 2007-2009 period. The price increase is not just affecting the USA. This price rise is hitting the European economies full force since their rising Euro is not able to keep up with the surge in oil prices. In the UK, gasoline is nearing $10 per gallon. China is no longer subsidizing oil imports and letting the price rise in their domestic market. Back in 1979 and early 1980's surging prices caused similar changes in behavior and investments among consumers: better insulation in new homes, increased insulation in many older homes, more energy efficiency in industrial processes, and automobiles with higher efficiency. These factors along with a global recession caused a reduction in demand that led to falling crude prices. Only the global recession was temporary. Nobody rushed to remove insulation from their homes or to replace energy efficient plants and equipment — much of the reaction to the oil price increase of the end of the decade was permanent and would never respond to lower prices with increased consumption of oil. Higher prices also resulted in increased exploration and production outside of OPEC. From 1980 to 1986, non-OPEC production increased 10 million barrels. Remember 10 years ago, when oil was nearly $10 a barrel, no one was investing in oil exploration or infrastructure. Now at over $140, there is an investment boom in oil infrastructure on the scale of the late 1970's that helped produce the 10 million barrels a day increase from 1980 to 1986. Will the decrease in demand, switching to other energy sources and increases in oil supply lead to reduced oil prices like we saw in the 1980's and 1990's? If the oil market was a pure economic market, we could have absolute confidence that it would. Unfortunately, geopolitical factors can and do influence the price of oil. Most crude oil is owned and controlled by governments or government controlled oil companies. They do not always make decisions based on economics. These other dynamics of oil are not as easy to predict as economic behavior. As we look into this uncertain period of oil prices, how as investment managers do we take advantage of the situation? There will be winners and losers from these adjustments to the new prices. Fortunately, Quantum's investment discipline keeps us focused on what really matters and avoids most of the noise these abrupt changes create. Even within the energy sector, not all stocks are winners. Refiners of gasoline are actually having their margins squeezed by the higher price of oil because they cannot pass on the full amount of the increase of crude to the pump. Solar system installers are attracting capital as the new "hot" alternative energy (last year it was biofuels), but the real beneficiaries are the providers of the basic components of solar installations. Other likely winners are old-line manufactures of controls for building heating and cooling systems as building owners make simple upgrades that quickly pay for themselves. As always, we will be selective and measure the risk of any investment in conjunction with its apparent reward over the long term. Back to Top |
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