Your Money Matters: Global markets

It is too early to assume that recent high market volatility is behind us?

September 20, 2007 08:15
3 minute read.
taking cash out of wallet 88

paying money wallet 88. (photo credit: )


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On Tuesday, the Federal Open Market Committee reduced the federal funds rates by 0.50 percentage points to 4.75%. It stated its reason for doing so as follows, "Today's action is intended to help forestall some of the ad-verse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time." The result was a US equities rally posting a 2.9% gain over the day and the gains continued into Wednesday. US government bonds rallied but mainly at the shorter maturities. The US dollar weakened against the euro. The rate cut provided a strong boost for equity markets because it indicated that the Fed is aware of mounting economic weakness in the US and wanted to provide assurance that it will do what it can to prevent the economy from sliding into a recession. This action makes the scenario for a hard landing for US corporate earnings unlikely and corporations are more likely to enjoy continued earnings growth. Evidence of this was further supported by better-than-expected profits reported by Lehman Brothers (which is one of the leading investment banks in the sub-prime mortgage-backed securities area) and positive earnings news out of consumer-related US companies. Stay the course with equities. Investors should maintain a preference for equities versus bonds on a global level. Currently, the US economy is in what I would call a quasi-recession. Pockets of the economy (i.e. housing, consumer spending, retail sales etc.) demonstrate characteristics of a recessionary environment. However, fundamentals show continued economic growth, albeit slowing down, and a continued low rate of unemployment. The US budget and trade deficits continue on their path of improvement as a weaker dollar contributes to increased exports and corporate America continues to make money and contribute to the coffers of the IRS. Regarding equities, periods of slowing earnings growth and monetary easing have historically been associated with improving fundamental valuations on companies and above-average equity market returns. The current situation strengthens the case for equities outperforming bonds over the next 12 months with an acceptable risk adjusted return. Interesting US S&P 500 statistics point to a high probability of investors being rewarded for staying with equities. Consider this, since 1950, the US stock market, as measured by the S&P 500, has declined more than 13% over a three-consecutive-calendar-month period on 10 different occasions. In eight of these 10 instances, the stock market rebounded by more than 20% over the following year. In seven of the 10 sell-offs, the subsequent rally was large enough to recover more than all of the market's previous losses. Some of the worst short-term losses were followed by substantial rebounds. These snap-back rallies were often as abrupt and difficult to time as the original sell-off. Beyond the US, the European Union economic forecasts point to continued growth. Japan continues to disappoint and confuse equity investors as economic growth fails to demonstrate a firm footing. Asian economies, led by China, are expected to maintain strong economic growth over the next 12 months. Other developing and emerging markets such as Vietnam, Kazakhstan and Ukraine are growing at double-digit rates. What's next? It is too early to assume that recent high market volatility is behind us? Investors are testing the waters but with reservations and much cash is still on the sidelines. The next few weeks will probably provide us with a clearer picture as to whether the markets have returned to terra firma or will continue in negative territory. On Wall Street there's a saying," Sell before Rosh Hashana and buy after Yom Kippur." This may sound like good advice, but our financial sages left out one little piece of information - how soon before and how soon after!? Shana tova and gmar hatima tova to all. The author is Global Investment Strategist at Tandem Capital.

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