Monthly Commentary

Glenn S. Davis, CFA
Senior Vice President & Chief Investment Strategist

The stock market has been in retreat since the highs last fall. The decline, ignited by the sub-prime induced credit crisis, which most recently claimed Bear Stearns, continues to weigh on the markets. The Federal Reserve has reacted in various creative ways to help mitigate the problems caused by the credit crunch. The Fed has used various tools to help non-bank financial institutions (investment banks) access liquidity via the Discount Window, as well as, cutting short-term interest rates. The buy out of Bear Stearns by J.P. Morgan was the work of the Fed. The Fed had to weigh the impact of a major brokerage firm collapsing versus backing JPM in taking over Bear Stearns. Ultimately the ripple affect was more dangerous than agreeing to the Fed absorbing the losses (and gains) on $30 billion worth of assets at Bear. The financials have declared write offs of approximately $200 billion worth of sub prime related securities. There are probably another $200 billion out there. The market has not missed this and approximately $400 billion of equity value has been taken out of the price of the financial sector. Clearly sub-prime has hurt. Are we near a bottom and the turn?

Calling a bottom is always tough or impossible to do. As the old timers say "they don't ring a bell"; the reason we do not advocate market timing. We are five to six months into this decline, and the economy has been slowing since last summer. The stock market during this cycle bottomed at around a 20% decline from the highs of last October. During the S&L Crisis in 1990-91 and the Long Term Credit Crisis in 1998-99, the recovery periods were six and four months, respectively. I will concede that this episode has cast a wider net and impacted far more of the economy, but I believe that it is fair to look backwards to give some context to the current market environment. Corporate earnings typically turn up six to nine months after a stock market low. So if March 10th was the low, corporate earnings may turn up in Q1 2009. It is highly unlikely that they rebound earlier. They won't ring a bell, but being invested will make sure that you don't miss the boat. Five months of negative returns is very unusual and the returns 12 months later are typically very good.

Source: Bianco Research

Source: Ned Davis Research, TDAM

The above chart illustrates that even when looking at one-year periods, an investor has a better-than 70% chance of positive equity returns. The odds improve significantly with longer holding periods. The message: Focus on the long-term. The market has always had rough spots and has emerged from the other side and moved up. The recent strength in the financial stocks may be the first step in a market recovery. There are still strong headwinds for markets: the residential real estate market is very weak, tighter credit markets, pessimistic consumers, and high energy prices. In spite of these obstacles we feel that the future will bring improvements, and the stock market and the economy will recover. We do not see a swift turn around, but we are feeling a bit more confident that the foundation for a recovery is being laid. Are we there yet? No, but we are closer than we were just a few weeks ago.

The fishing season is fast approaching, and I am looking forward to matching wits with my finned adversaries once again. I am not always sure it is a fair match, but the fish let me come back and try to outwit them each year.