Calvert News & Commentary

November Market Commentary: Pushing on a String: Government’s Financial Infusions Have Yet to Stimulate Bank Lending

Severity of global recession not fully priced into financial markets


Untitled Document

By Natalie Trunow, Senior Vice President, Head of Equities
Calvert Asset Management Company, Inc.

The end of October market rally peaked on Election Day and markets have largely been down for most of the month of November. The Dow Jones Industrial and the S&P 500 Indices are down -4.85% and -7.17% for the month and -31.66% and -37.66% for the year to date periods, respectively.  There has been no material change in the fundamental economic picture this month. The release of new economic data and corporate earnings reports confirm a potentially prolonged and severe synchronized, global recession and the continuation of the de-leveraging process.

The Federal Reserve has committed $800 billion to unfreeze credit markets. The move targeted consumers, availability of credit and home mortgage rates. Corporations got additional relief when Citigroup became another “too big to fail” candidate, receiving an additional $306 billion of taxpayer funds, including a new $20 billion capital injection. Congress continued to debate whether the Big Three U.S. automakers will be next in line for a bailout. President-elect Obama, in addition to announcing his economic team, unveiled a preliminary economic stimulus plan which could cost as much as $700 million.

For their part, the European Union, China’s central bank and the Russian government announced  $259 billion, $586 billion and $200 billion stimulus proposals, respectively. Interest rates were cut worldwide. These significant regulatory efforts provided support to global equity markets at the end of the month. At the same time, regulation-induced declines in both the TED spread and Libor rates stalled in mid-November, but inched higher by month-end, indicating renewed uneasiness on the part of banks with respect to lending.

Economic data confirm recession

The severity of the economic situation has clearly not yet been fully priced in by the markets, as demonstrated by sharp sell offs during the month in reaction to a slew of weak economic data that appeared to confirm a recession. The gross domestic product (GDP) contracted -0.5% for the third quarter, more than the previously expected -0.3% decline. Growth in jobless claims indicates a large increase in unemployment, and reached its highest level since 1982. The unemployment rate in 2008 is heading toward the 7% level and is likely to reach or exceed 9% in 2009 and 2010, although most economists are not there yet. The latest surveys of home builder, consumer and manufacturer sentiment show declines to all-time lows, while manufacturing contracted by steepest rate in 26 years. The U.S. is well into a recession and without a catalyst to change the economic fundamentals, we will likely continue to see more of the same until consumers and corporations alike de-lever and improve their balance sheets.

Continued selling pressure in equities

This year, the hedge fund asset class is turning in one of its worst performances on record, with forced liquidations likely to continue. The processes of reducing leverage and risk, forced-selling, asset re-allocation and liquidations are likely to continue, as clients attempt to maintain their liquidity, transparency and asset allocation targets. Record numbers of hedge funds are closing, but the assets have only gone from ~$1.9T at the peak to ~$1.4T recently. There is a structural shift in how these assets are allocated, however, since hedge funds' average net long position went from close to 50% in 2007 to less than 20% more recently, bringing them more in line with their original mandate of being market-neutral or "hedged" investors. This move takes hundreds of billions of dollars out of the equity market, especially when adjusted for leverage.

Corporate pension sponsors are also making the case to government regulators that the rule requiring them to contribute assets into their under-funded pension funds be suspended. In the short term, if successful, this would be bad news for both equity and fixed income markets, since pension funds will not be investing hundreds of billions of dollars in equity and fixed income securities to meet their unfunded liabilities.

Corporate earnings across all sectors continue to disappoint, with companies from Wal-Mart to Intel revising down 2009 forecasts, or withholding forecasts altogether. Retail continues to be among the hardest hit sectors, but the pain has been widespread in the economy. Corporate defaults continue to be a worry, as confirmed by the highest CDS spreads on record, and could trigger a new wave of asset write downs at banks, further hurting financial shares.

Markets continued to be volatile during the month. The VIX Index, a widely recognized indicator of market volatility, spiked up to more than 80 mid-month and remained at historically high levels.

Market Outlook

In terms of fundamentals, we will need to see a catalyst for improvement in economic conditions on either the corporate or consumer side to signal market turn-around. Despite the hefty efforts by governments, regulatory actions alone are unlikely to do the trick, as demonstrated by the market price action in the past two months – arguably the two most active months in global market regulation and intervention.

The incoming Obama administration and strong Democratic majority in Congress brought some certainty  to financial markets, leading to a short-term stock market rally. The long-term impact of the new economic policy on the real economy remains to be seen. Its effectiveness will depend on the depth and severity of the ongoing economic and financial crisis in the months to come.

We are in the middle of serious capital market and economic contraction. The economic stimulus attempted so far may not be sufficient to counter-balance the severe private market contraction caused by what may turn out to be one of the worst recessions on record, as household spending, corporate capital expenditures, credit availability, the negative wealth effect and unemployment, as well as ongoing deterioration in business, consumer and investor confidence all continue to weaken.

From a technical standpoint, there was hope for improvement in short-term market sentiment when the market seemed to shrug off Intel’s reported negative numbers, but the move was short-lived. When the market does follow through with a sustained rally after absorbing negative developments we will have more confidence that all of the bad news has finally been priced in. An improvement in any of the fundamental economic drivers would also be a welcome sign. Until then, investors should expect more of the same.

#8517 (12/08)

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