Many years ago, in an economic environment that was very similar to what we are experiencing now, a conversation took place in a brokerage office. I was not there to hear it, but the story was retold to me by reliable sources, which I believe is a true account. One of the participants in the conversation was a very young and just-out-of -business school stock market analyst who had never seen a serious downturn in the market. The other person in the conversation was a seasoned, well respected and successful analyst who had been around for many years and had not only seen several bear markets in his career but also had developed the skills and foresight to survive them. During one of the severe down draft days in the market, the very somber and dejected young analyst walked over to the office of the older, experienced analyst and complained about all of the bad things that were happening in the economy and in the stock market. After the entire litany of negatives were aired by the young analyst, including the problems in the banking industry, the auto industry, along with weak employment numbers that were going on at the time, the young analyst finally got around to asking the question that he really wanted to ask. His question was “will this stock market ever come back?” “IT ALWAYS HAS” was all that the older and experienced analyst needed to say.
The president of the Federal Reserve Bank of Minneapolis said in an interview that the credit problems in the U.S. markets might get worse. One money manager said banks are only “one third through” their credit related write downs. There are some estimates that global write downs, due to losses in the credit markets, could be as high as $1.3 trillion. This is substantially more than the International Monetary Fund’s estimate of $945 billion. Our analysis suggests that there will be more subprime related problems to be revealed later.
Our research tells us that corporate earnings will remain weaker than analysts’ estimates for the rest of this year and at least through the second quarter of next year. There are an increasing number of analysts that are predicting that the U.S. economy will actually shrink in the fourth quarter of this year and in the first quarter of 2009. Two consecutive quarters of negative economic growth unfortunately meets the classic definition of a recession.
It is true that many of the bearish factors that are exerting downward pressure on stock index futures today have taken place during previous bear markets. A weakening employment picture always seems to be a common thread. Just last week the U.S. employment rate for October advanced to a 14 year high of 6.5%. In addition, the nonfarm payrolls portion of the report showed a 240,000 decline, when the analysts’ median guess called for a drop of 200,000. There was no help from the September and August figures, which were revised lower. So far, the total amounts of job losses for this year are now at 1.2 million. The increasing rate shrinking employment numbers is taking place across a wide range of sectors in the economy.
Consumers continue to have a difficult time getting credit lines and loans. This condition appears to be unlikely to be remedied anytime soon. Consumer spending could deteriorate even more as the problems on Wall Street move through the economy. There are concerns that this year’s holiday shopping season will not be robust. Consumer purchases in the most recent reporting period fell 1.2%, which was the third consecutive monthly decline. This most recent drop in retail sales was the largest decline since August 2005and it was the worst decline for any single month in the past three years.
Worries remain that any U.S. bank bailout plan will not jump start lending as potential homebuyers continue to remain on strike. Recent housing statistics suggest that the worst current housing recession since the 1930’s has a way to go. There is the growing feeling that there will be more problems related to the precarious housing industry within the next six to twelve months. According to RealtyTrac of Irvine, California 765,558 U.S. properties got a default notice, were warned of a pending auction or were in foreclosure during the third quarter. This is the most since records began in January 2005. Our studies suggest that the housing market will not bottom until the second quarter of 2009.
Problems within the auto manufacturing industry have been in the news lately as automakers continue to eat through cash reserves as sales fall. This situation is severe enough where the industry is moving closer to requiring a federally funded aid package in order to avoid a collapse. There is speculation that one of the major U.S. manufacturers may run out of cash reserves before the end of this year. Currently the industry is requesting $50 billion in loans with approximately half going into operations and the other half to be applied toward health care expenses. It is not all bad news, however. Currently it does appear that there will be an aid package for the auto industry. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid encouraged Treasury Secretary Paulson to make some of the bank bailout funds available to automakers. Senator Mel Martinez said “the United States must have an auto industry. We don’t want to see a loss of over a million jobs.”
Earlier this month equity index futures were able to advance after the Federal Reserve, along with the European Central Bank, the Bank of England, the Bank of Canada, the Swiss National Bank, the People’s Bank of China and Sweden’s central bank lowered interest rates in an emergency coordinated effort to alleviate the international financial crisis. Within this joint effort, the Federal Reserve cut the fed funds target by 50 basis points to 1.5%.There were sharp gains in futures as a result of this news. However, to the dismay of the bulls, there was no follow through to the upside and it did not take long for prices to head lower again. There is mounting pressure on the Federal Reserve to ease credit conditions again. According to the financial futures markets, there is currently a 90% chance that the Federal Open Market Committee will lower their fed funds target by 50 basis points on or before their next scheduled meeting on December16th to 50 basis points. While the additional accommodation from the Federal Reserve is well intended, it appears to be too little and too late. It is amazing that it was only a few short months ago that financial markets analysts were almost unanimously predicting tighter credit from the U.S. central bank, when inflation appeared to be the main concern.
We have seen a tendency for futures not to respond to bullish news for very long or even ignore it. The best and most recent example of this bearish signal took place when the $586 billion Chinese bailout plan was announced last weekend and futures could not hold the sharp gains that took place in the overnight trade. In fact, stock index futures actually closed lower on the day. This was a clear indication that the bear market was firmly in place.
Our research tells us that major bottoms for stock index futures have not been made and that the recent lows will be taken out later this year. Not all of the news is bad, however. It is likely that the simulative efforts undertaken by the Federal Reserve and the Treasury in these times of economic distress will cause the downturn in the economy to be of a shorter duration than it normally would have been. Be ready for massive buying opportunities to develop in the first or second quarter of 2009.
S&P 500 FUTURES – MONTHLY
Chart provided by APEX
If you would like more information on this article, please contact Alan Bush at 1.800.243.2649 or send an email to alan.bush@archerfinancials.com.
Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.
