Another bad week for the global economy and global stock markets as fear of a longer and deeper recession continues. The poor economy coupled with the coming to a head of the 10 year old issues in the US auto industry has made even the most optimistic economists and investors scratch their heads. The S&P 500 is down 52% from its high in October 2007.

We did get some good news this week with the Consumer Price Index dropping significantly. The drop in oil prices caused by declining demand and strengthening US dollar has allowed consumers a break at the pump. Gas prices on average are below $2.00 per gallon and at $1.75 levels in some parts of the country. This price level has not been seen for quite a while.

Short term interest rates continue to improve which is good and may get better if the Fed cuts the discount and fed funds rates as expected. We do need longer term rates to decline in order for housing demand to pick up. Mortgage spreads continue to be at record levels to like treasury bonds which is not helping the leading cause of this mess, housing.

In yesterday’s WSJ, Andy Kessler wrote a good article titled “Ignore the Stock Market Until February.” In his article, he pointed out five reasons the market is dislocated which has lead to volatility and steep declines in the stock market:

1. Tax-Loss Selling – there are very large losses in investor’s stock portfolios and end of the year tax selling always happens and adds to volatility.
2. Mutual-Fund Redemptions – many mutual funds are sold for tax losses when the stock market is down. Much of the morning selling we have witnessed is because of mutual fund redemptions that force fund managers to sell shares in stocks to get cash for their clients.
3. Mutual-Fund Cap Gain Distributions – at this time of year, mutual funds distribute capital gains earned on investments sometimes purchased years ago. Despite a down market, the funds have gains. Investors then sell more shares to pay off the taxes associated with the gains.
4. Hedge-Fund Redemptions – most of these funds required a 45 day notice prior to redemption. Hedge fund investors have been sending in redemptions since September. These funds have been selling much of their holdings to pay for the cash requests of their investors driving stock prices down.
5. Margin Calls – investors who have been buying stock with debt have been greatly impacted. The margin investors have been required to increase the capital backing their margin requirements forcing them to sell large quantities of stock as the market has dropped. Much of the volatility in the last 30 minutes of trading is the result of this trading.

Andy’s article summarizes that the rest of the year will continue to be volatile from the above factors and we should not count on January to see much improvement. The above factors lead to negative sentiment and then once everyone thinks it can only go down, it actually might go up.

The rapid selloff in global equities is approaching the most pessimistic analysts “worst-case” scenarios which hopefully signals a bottom might be getting close. Once the fear and panic that has gripped much of the world ceases, we hope that the economy will focus on the large long-term growth opportunities that the world economy has in front of it.

We continue to value you as clients. Please let us know if we can help.

Colorado Financial Management