Global Stock Markets: Surviving the Most Turbulent Week Since 1987

These are the quick market stats for the past week: the MSCI World Index up by 0.3%, the S&P 500 Index up by 0.3%, the Reuters/Jeffries CRB Index down by 0.1%, the U.S. Dollar Index down by 1.6% and the ten-year U.S. Treasury Note yield up by 4 basis points.

Was this an uneventful week? Well, not if you consider the monumental swings that characterized trading from hour to hour and resulted in the most turbulent week in financial markets since 1987.

Credit markets virtually seized up during the first three days of last week as a modern-day bank run occurred with investors withdrawing money from brokerage, money-market and bank accounts, sending the three-month U.S. Treasury Bill, a beacon of safety, to nearly 0% – its lowest level in more than 60 years. Actions by the U.S. government on Thursday and Friday, however, saved the day, resulting in the yield on short-term Treasuries spiking to just more than 1% by the end of the fateful week.

Thomas Meyer, chief economist of Deutsche Bank in London, summed up the situation most appropriately:

If a body dehydrates, it falls over and if it gets worse it can die. Likewise the financial system is starved of liquidity right now so the central banks will have to keep providing it.

Triggering a reversal in fortunes on Thursday and Friday was a tidal wave of announcements regarding U.S. government proposals to return stability to the financial system, including:

• The promise of a comprehensive solution, in Resolution Trust Corporation “dumpster” style, to fix the root of the financial problems by removing illiquid and toxic housing and mortgage-related assets from the balance sheets of financial companies (click here for text of proposal).
• A pledge to provide a guarantee program for troubled money-market funds was made.
• The SEC banned short selling of 799 financial stocks until October 2 (U.K. regulators also took action).

Lehman Brothers (LEH) also filed for Chapter 11 bankruptcy. A bank consortium, including three banks in the U.S and seven in the EU, revealed plans to create a $70 billion fund to provide emergency liquidity. The Fed announced several initiatives to provide additional support to financial markets, which include broader collateral eligibility at the Primary Dealer Credit Facility [PDCF] and Term Securities Lending Facility [TSLF], Bank of America (BAC) agreed to buy Merrill Lynch (MER) for $50 billion, and AIG (AIG) became nationalized by means of a $85 billion secured loan from the U.S. government. (Do you want to venture a guess as to who replaced AIG as Man United’s principal sponsor? Click here for the sad truth.)

According to Bespoke, one can tell that a story is really important when the The Wall Street Journal runs the lead headline across the entire front page. During the past week, the headline ran the entire front page on five occasions!

And for good measure, here is the front page of the Brooklyn Daily Eagle newspaper on the day of the initial Wall Street Crash in 1929 (Hat tip: Charlestone Voice).

Next, a tag cloud of the text of all the dozens of articles I have read during the past week. This is a way of visualizing word frequencies at a glance. Not too many surprises here, especially not seeing “banks” featuring prominently.

Commenting on the outlook for equities, David Fuller (Fullermoney) remarked as follows:

… central banks are now in a position to switch their policy emphasis from fighting inflation to stimulating GDP growth. They may remain crisis oriented, but at least we are beginning to see the coordinated intervention that I have been discussing and expecting.

I will certainly not be selling during what I expect is the beginning of the end of this bear market. However, as conditions improve I am likely to shift some of my ‘just in case’ cash holding into equities over the next few months.

Following an analysis of bear market troughs, Goldman Sachs concluded:

Using returns and valuation in prior bear markets as a template to assess the current situation implies the S&P 500 would bottom at 1070. … profit cycle … suggests the market bottoms four months before corporate profits trough, which we anticipate will occur in 1Q 2009. This pattern suggests the S&P 500 will trough in 4Q 2008.

Next week is likely to be pivotal to stock markets’ recovery, but I am still of the opinion that markets are bottoming out. I would not be surprised if a year-end rally has in fact already commenced.

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.

Economy
According to the Survey of Business Confidence of the World conducted by Moody’s Economy.com:

Sentiment among global businesses has not been materially affected by the renewed turmoil in global financial markets. Global businesses are worried, but this has been their mood for much of the past year since the financial shock hit. European businesses are the most nervous, followed closely by those in the U.S. and Japan. Asian businesses remain the most upbeat.

The Federal Open Market Committee held the Fed funds target rate steady at 2% on Wednesday for the third straight meeting. The accompanying statement cited the recent turmoil in financial markets and the ongoing slowing in economic growth, but said that growth should soon pick up. The statement noted recent high inflation, but said this should ease, although it did say that “the inflation outlook remains highly uncertain.” The FOMC cited both downside risks to growth and upside risks to inflation that were of “significant concern.” There was no indication of a bias towards lower rates. The decision to hold the Fed funds target rate steady was unanimous.

Putting the U.S. economic situation and the proposed Treasury action in perspective, Asha Bangalore (Northern Trust) said:

The optimism surrounding the Treasury plan is justified but it should be noted that economic recovery is several quarters ahead. The credit crunch and household balance sheet position will both play a critical role in how soon the economy gathers steam. Lest we forget, occupants are necessary for the huge number of unsold homes, which will occur only with significant gains in employment.

For the rest, economic fundamentals took a back seat as investors reflected on the effects of the bail-out mania.

Week’s economic reports

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Sep 15	8:30 AM	NY Empire State Index	Sep	-7.4	NA	1.4	2.8
Sep 15	9:15 AM	Capacity Utilization	Aug	78.7%	79.6%	79.6%	79.7%
Sep 15	9:15 AM	Industrial Production	Aug	-1.1%	-0.3%	-0.3%	0.1%
Sep 16	8:30 AM	Core CPI	Aug	0.2%	0.2%	0.2%	0.3%
Sep 16	8:30 AM	CPI	Aug	-0.1%	-0.2%	-0.1%	0.8%
Sep 16	9:00 AM	Net Foreign Purchases	Jul	$6.1B	NA	$55.0B	$53.4B
Sep 16	2:15 PM	FOMC Policy Statement	-	-	-	-	-
Sep 17	8:30 AM	Building Permits	Aug	854K	930K	925K	937K
Sep 17	8:30 AM	Housing Starts	Aug	895K	950K	950K	954K
Sep 17	10:35 AM	Crude Inventories	09/13	-6328K	NA	NA	-5828K
Sep 18	8:30 AM	Initial Claims	09/13	455K	440K	440K	445K
Sep 18	10:00 AM	Leading Indicators	Aug	-0.5%	-0.2%	-0.2%	-0.7%
Sep 18	10:00 AM	Philadelphia Fed	Sep	3.8	-10.0	-10.0	-12.7

Source: Yahoo Finance, September 19, 2008.

In addition to Fed Chairman Ben Bernanke testifying at Congress’s Joint Economic Committee on Wednesday, September 24, next week’s U.S. economic highlights, courtesy of Northern Trust, include the following:

1. Existing Sales (September 24): Sales of existing homes are predicted to have declined in August to an annual rate of 4.92 million from 5.00 million in July.
2. Durable Goods Orders (September 25): A 1.8% decline in orders of durable goods orders is the most likely forecast for August. Consensus: -1.6% versus 1.3 in July.
3. New Home Sales (September 25): The consensus forecast is a 510,000 annualized sales pace of new homes in August, down from 515,000 in July.
4. Real GDP (September 26): The 3.3% preliminary estimate of real GDP growth in the second quarter is expected to be unchanged. Consensus: 3.3%.
5. Other reports: Consumer Sentiment Index (September 26).

Click here for a summary of Wachovia’s weekly economic and financial commentary.

A summary of the release dates of economic reports in the U.K., Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues on, among others, the trend of the U.S. dollar.

Markets
The performance chart obtained from the Wall Street Journal Online Online shows how different global markets performed during the past week.

Source: Wall Street Journal Online, September 21, 2008.

Equities
Stock markets around the world suffered badly during the first three days of last week, but wiped out most of the losses on Thursday and Friday. The week’s movements – MSCI World Index +0.3% and MSCI Emerging Markets Index -1.2% – give little indication of the drama that transpired from hour to hour. The fact that these two indices surged by 5.7% and 10.1% respectively on Friday provides a clue as to the severity of the movements.

The table below, courtesy of Bespoke, highlights the percentage changes that global equity markets experienced from their Thursday lows until Friday’s close. Russia led the way with an increase of 20.2%, followed by Hong Kong (+18.7%), China (+15.1%), Singapore (+10.9%) and the U.K. (+10.0%). Forming the rear guard, Japan (+5.5%) and Australia (+6.1%) registered the most “muted” gains.

With the exception of the Dow Jones Industrial Index (-0.3%; YTD -14.1%), the U.S. stock markets all edged higher over the week as shown by the major index movements: S&P 500 Index -3.2% (YTD -15.4%), Nasdaq Composite Index (+0.6%; YTD -14.3%) and Russell 2000 Index +4.6% (YTD 1.6%). Friday’s session, which also happened to be a quarterly options expiration day, saw the highest volume (2.98 billion shares) ever traded on the NYSE, including significant short squeezes.

The outperformance of small caps is noteworthy as they have a history of often turning up before large caps at market bottoms. A breakout through the 760 level should be positive for the broader market.

The Russell 2000 Index has already managed to break through both its 50- and 200-day moving averages, whereas the Dow Jones Industrial Index and S&P 500 Index are still flirting with their 50-day lines. On the other hand, the Nasdaq Composite Index still has some work to do in order to catch up with its moving averages.

Click on the thumbnail below for a market map, courtesy of Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.

The table below, prepared by Bespoke, shows the performance of the ten S&P 500 sectors for the past week. Only two sectors, Energy and Financials, managed gains. Defensive sectors such as Utilities, Telecom, Consumer Staples and Health Care had the largest declines.

Bespoke also provided the best- and worst-performing stocks in the S&P 500 for the week. As shown, Merrill Lynch (MER) (+73.0%) was the best performer, while AIG (-68.3%) was down the most. Investor interest in financials stocks was sparked by governmental bail-out efforts, including a temporary ban by the SEC on short selling of 799 financial stocks and reports that the Treasury Department was working on a plan designed to help banks dispose of troubled assets. The extreme spread of the gains/falls summarizes the tumultuous nature of the trading.

Fixed-interest instruments
U.S. Treasury Notes saw yields falling during the first half of the week, but reversing strongly on Thursday and Friday with two-year Treasuries recording their largest one-day jump since 1981.

The ten-year U.S. Treasury Note rose by 4 basis points to 3.76%, the U.K. ten-year Gilt yield was unchanged at 4.60% and the German ten-year Bund increased by 5 basis points to 4.23%. Emerging-market bonds tumbled as investors shunned risky securities.

U.S. mortgage rates also increased, with the 15-year fixed rate rising by 13 basis points to 5.70% and the 5-year ARM 18 basis points higher at 5.97%.

Interbank lending markets were in crisis during the first part of last week as demand for cash sent yields on the three-month U.S. Treasury Bill, a beacon of safety, to nearly 0% – its lowest level since 1941. Actions by the U.S. government on Thursday and Friday thwarted the run on brokerage, money-market, savings, and even checking accounts, resulting in the yield on short-term Treasuries spiking higher to 1.01% by the end of the week.

The TED spread (i.e. 3-month dollar Libor less 3-month Treasury Bills), a measure of risk aversion and illiquid repo conditions, widened to 313 basis points on Thursday before easing back to 221 basis points by Friday afternoon.

Currencies
The U.S. dollar traded lower during the past week amidst the shenanigans of the credit crisis and the perception that the various bail-out actions could flood the world with dollars. Bud Conrad of Casey Research remarked:

As large institutions continue to tumble, and the Fed turns on the printing press in an attempt to limit the damage, the flight to safety will mean a flight from the dollar and further trouble for U.S. markets.

Over the week the U.S. dollar declined against the euro (-1.8%), the British pound (-2.2%), the Swiss franc (-2.3%), the Japanese yen (-0.5%), the Australian dollar (-1.4%), the New Zealand dollar (-3.3%) and the Canadian dollar (-1.3%).

Commodities
The Reuters/Jeffries CRB Index closed virtually unchanged during the past week as declines in agriculture, livestock and industrial metal commodities were counteracted by solid increases in precious metals and crude oil.

Gold bullion scored its biggest daily gain since 1980 on Wednesday, rising by 9.0% on the back of safe-haven buying and hitting an intraday high of $902.60. The entire precious metals complex – gold (+13.1%), platinum (+5.1%) and silver (+15.6%) – recorded strong gains for the week.

Legendary Peter Bernstein said:

In a total disaster, where there is a run from paper currency, you’ll get your biggest bang for your buck in gold. You don’t have to buy much gold to have an effective hedge. If everything hits the fan, gold should be worth several thousands dollars an ounce.

West Texas Intermediate recovered from a low of $91.02 a barrel on Tuesday to close the week at $102.75 on the back of violence in Nigeria, hurricane disruptions to oil production and refining activity in the Gulf of Mexico area, and U.S. gasoline stocks sinking to their lowest levels in 39 years.

Commenting on the outlook for oil prices, BCA Research said:

The growth slump has spread across the developed world and is threatening many emerging markets, causing investors to scale back expectations for energy demand and allowing prices to plunge lower. Implied option volatility has been high and rising for many commodities, which is typical capitulation selling. While these phases do not typically last long, we advise against buying into weakness at this time.

The following chart shows the past week’s movements for various commodities.

Comments

[poncawolf:]

Hurry hurry – Rush rush - Least we forget The Lessons of Iraq.

When Bush-Cheney and the neo-cons – rush through the Iraq bill – senators and congress fell in line – hurry-hurry – rush-rush.

Can anybody think of a bill – Bush-Cheney didn’t rush through congress and the senate – With-out there dire need for action now?

So why would anybody think this bail-out - bill - would be any different?

Just like all there other PREZ powers push – They don’t want anybody reading the bill – let alone deciding if it’s even really needed.

But - be rest assured – More then likely – and odds in favor – WE still have a IDIOTIC senate and congress.

2008 Sep 21 12:50 PM

[PeteK:]

That is government in Action, for the good of the country and the people. There's nothing wrong with that. If the politicians do that all the time, we will be in Great Shape.

2008 Sep 21 05:40 PM

[Same Old:]

It's only more debt. As if debt ever killed anyone. If all goes as planned, we can tap additional taxpayer dollars to recapitalize the banks, start a new housing boom, maybe even a bubble in the small caps (go russell 2000) and hire Greenspan to provide oversight for Frannie!

2008 Sep 21 07:37 PM

[Fighting Yoda:]

Bailout nation. Audacity of stupidity. This dynamic duo of Ben-Paulson have been wrong every step of the way. The bazooka misfired now they want a nuclear missile.

The wall street fat cats must be protected - that is the mantra of the country.

Get out and stay out these markets manipulated by the Govt.

2008 Sep 22 01:20 AM

[PeteK:]

sb-tiger, relax, don't get hypertension over this. The government has to come in to clean up the mess. No need to jump to conclusion. If nobody lends a hand, who do we depend on ? That's why this country is still number ONE on Earth. Just calm down.

2008 Sep 22 05:08 AM

[droopydro:]

We put them in and they blow the bank to get back in; it is worse than you think , or as good as it gets; ---that never changes. Yay!!--sentiment long --cause that is the way I feel and I feel Allright-- WHEN MY BRAIN IS DISENGAGED. As long as it my sentiment shared I can time anything.

2008 Sep 22 01:06 PM