News & Insights
The Panic of 2008
Since last quarter conditions in the financial markets have deteriorated sharply. The 10% decline in the stock market since June captures headlines but chaos in the credit markets is at the core of the acute distress that drove Washington into the grand standing, self congratulatory, seamy huddle that passes for leadership these days. The rate that banks charge to lend among themselves on September 30 stood at 4.11%, 3 times the rate charged by the Fed. This rate is usually just slightly higher than the Fed rate. This reflects extreme mistrust among institutions. Our European friends are hoarding all their dollars to reserve against the collapse of mortgage backed securities purchased in the United States. Trust is at the center of how money moves around our economy, and right now it is not moving much at all.
This has begun to have an effect on even the soundest companies. General Electric one of the last Triple A credit companies in the world just borrowed money at usurious rates from Warren Buffet's Berkshire Hathaway, the corporate world's "rich uncle," to shore up its cash position and to prove to the world that it has the capacity to meet its obligations. This transaction will dilute current shareholders by about 6%; a price management believed it needed to pay to avoid a crippling "run" on its equity and its debt. Goldman Sachs, until last week the world's preeminent investment bank, sold a chunk of itself to Mr. Buffett under similar terms the week before. Certainly the extraordinary facts of the past two weeks ensure that there will be no more "whistling past the graveyard" by our policy makers, hoping that time will take care of the structural problems we face.
As this is being written, positive developments are being revealed. Congress has passed a bill providing up to $700 billion to purchase impaired securities from banks. In the middle of the panic, Wachovia Bank's shareholders were decimated by a fire sale to Citigroup arranged by the FDIC. Now Wachovia is reportedly being
merged with Wells Fargo, at a market price without substantial government assistance. When strong institutions buy weak institutions based on the fundamentals and not fear of imminent collapse, the market is beginning to function. The president of the European Central Bank is talking about lowering interest rates to stimulate growth, moving awayfrom the hawkish anti-inflation position of the past two years.
In our last update we indicated that stabilization of the housing market and a lowering of European interest rates would be a necessary predicate to "normal" financial conditions. With much drama and noise, halting progress on those fronts is being realized.
Stocks, Bonds & Cash
In our view, we are nearing the end of the financial crisis aspect of this bear market. This is just a waypoint along the way to a healthier stock market. As it has always been, earnings ultimately drive stock prices and earnings for the broad market will likely be weak for some time. Fortunately, the price of stocks reflects a sober outlook and values are good. While air pockets will continue to cause a turbulent ride for investors, the next few quarters will prove to be a fruitful time to build positions in good companies.
The poor outlook for growth in the developed world will bring a downward bias to interest rates making higher quality bonds more attractive than in the recent past. Money fund and deposit rates will stay low for the foreseeable future.
Commodity prices are dramatically lower. In our view, energy related investments will rebound over the next few quarters while the outlook for precious and industrial metals is unclear. A conservative allocation approach gives us the liquidity to take advantage of these lower prices in the stock and commodity markets as the economy recovers.
The Altavista Investment Team - Fall 2008