Market Commentary, Third Quarter 2008
By Robert Stimpson, CFA
From Extraordinary to Extremely Extraordinary
The landscape of Wall Street changed significantly during the third quarter of 2008. Confidence in our financial institutions was shaken as the global credit crisis turned into an all out panic. The historic $100 billion-plus bail out of insurance giant AIG was shocking. As too were the bankruptcy of 146-year old Lehman Brothers; the sale of 94-year old brokerage firm Merrill Lynch; and the rescue of Freddie Mae and Fannie Mac due to their ambiguous “government sponsored” status. Major investment banks Goldman Sachs and JP Morgan were encouraged to reorganize into commercial banks in order to access Federal assistance if needed. Wachovia Bank was batted back and forth for acquisition between Wells Fargo and Citigroup, with the Fed playing a support part in a still undecided contest. Pillars of Wall Street vanished, restructured and reorganized, leaving chaos, fear and panic in their wake.
The global credit crisis exploded in the third quarter. Credit markets froze up, short-term Treasuries yields dropped to zero, yields on money market funds disappeared, and Wall Street was made to wait on the government to enact a $700 billion bailout of bad loans. With a deal needing to be reached just 6 weeks before a highly contested Presidential election, it wasn’t too surprising that confidence in the government’s ability to forestall the crisis faded quickly. Once signed, the bailout failed to provide any lasting support to a rapidly descending market.
The quarterly decline in US market indexes masked the true volatility of the stock market which essentially crashed, dropping over 20% in the first week of October. For the third quarter, the Dow Jones Industrial Average fell 3.7%, while the S&P 500 fell 8.37%. Crude Oil fell from $140 to $100 during the quarter as the reality of a slower global economy and the spreading credit crisis took its toll.
During these difficult times, it is hard to find reassuring words. Indeed actions speak louder than words and we continue to see unprecedented moves undertaken by the Federal Reserve. They have taken the unusual steps to pay interest on deposits at the Fed, to accept lower grade securities as collateral, to raise FDIC insurance levels, to pursue a 50 bps inter-meeting rate cut, to invest billions directly into the commercial paper market, and are now considering buying stakes in companies directly. They are doing everything within their power, and more, to lessen the impact of the global credit crunch.
However, fear and panic rule the day. They are also irrational by nature. The VIX Index, a measure of fear in the market, hit an all-time high this week and bullish sentiment readings are the lowest since the crash of 1987. Sentiment has been pushed to extreme levels and the Fed is responding accordingly to boost confidence in US financial institutions. Fortunately extreme negative sentiment levels often occur near market bottoms, which are also common in October. These may be small condolences in volatile markets, but successful long-term investing requires rational thinking while others panic. We have confidence in our companies and know that this too will pass with time.
This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.
The S&P 500 Index is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the stock market through changes in the aggregate market value of 500 stocks representing all major industries.
VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 Index options. Often referred to as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period.