Quote of the month. “I don’t know any other way to lead but by example.”– Don Shula
The month in brief. While economists gathered around the water cooler to discuss whether or not a recovery was really underway, stocks soared, consumer confidence grew, and home sales rose. The broad commodities market had a fantastic month; the dollar didn’t. Meanwhile, the government found that 10 out of 19 stress-tested banks needed more capital. One U.S. automaker went into Chapter 11 bankruptcy, and another prepared for it.
Optimistic Indicators.
Major indicators point to an improving economy. It will not be smooth sailing from this point forward, but there is noticeable improvement in fundamental market measures.
During the last quarter of 2008, the market, and market indicators were at traumatic levels. Those same indicators are moving in a more optimistic direction or back to typical levels. Three such indicators are the TED spread, the “fear” or volatility index, and the 10-year treasury yield.
TED Spread Percentage (Graph 1)
The TED spread, graph one, indicates how comfortable banks feel loaning money to other banks. Since the credit crunch was manifested by banks hording their cash this return to a historical half percent indicates banks are willing to lend once again.
Fear Index / Volatility (VIX) Index (Graph 2)
Market volatility scares people away from the market. The VIX moving away from its extreme highs of Q4 2008 and below 30 shows more market stability. Less volatility reduces fear, thus more people move into equities.
Treasury Yield Percentage (Graph 3)
The treasury yield dropped down as investors moved their money into treasuries due to stock market concerns. As confidence in the market is returning the unusually high demand for treasuries is attenuating, thus its yield is moving away from its extreme lows.
These three factors give optimism for the market.
S&P 500 Moving Average (Graph 4)
Technical analysis state that when the S&P 500 raises above the 200 day moving average, the market is flat to higher 80% of the time. This occurred in early June.
The above are all encouraging signs. Of course, there are areas of concern: high unemployment, low global economic growth predictions, new financial regulatory reform laws and practices, and any new surprise shocks to the financial system, e.g. terrorism, wars, excessive credit card defaults, etc.
The economy is improving, but the risks warrant caution. Confidence is returning and it is easier to analyze and value investments based upon their fundamentals and future assumptions. Longer-term, we will face slower economic growth as we pay for the excessive growth over the past decade and the cures being enacted today.
Domestic economic health. What would the government find out about the banks? Would GM and Chrysler go BK? Those were the media preoccupations for May, and while investors worried plenty about them as well, Wall Street as a whole rode through the attached fears and crises admirably.
The results of the stress tests administered by the Federal Reserve were publicized in the second week of May. Bank of America, Citigroup, Wells Fargo and GMAC were instructed to raise more capital; BofA was told to go get a whopping $34 billion. Some other banks (notably American Express, Capital One, Goldman Sachs, JPMorgan Chase and MetLife) were judged well capitalized to face the government’s worst-case scenario.1
Speaking of worst-case scenarios … as May ended, General Motors was poised to follow Chrysler into bankruptcy. (The official filing came June 1). There were indications that the bankruptcy process might be unusually swift. After only a month in bankruptcy proceedings, Chrysler got permission on May 31 to sell most of its assets to a group led by Fiat and emerge from court protection. Perhaps GM would do something similar. In the bankruptcy plan, the U.S. government will own 60% of GM, the UAW 17.5%, the Canadian government 12% and GM bondholders 10%.2
And now, the other notable news items. Consumer confidence rose: the Conference Board’s May survey recorded its best one-month gain in six years, and the Reuters/University of Michigan index climbed to 68.7, the highest mark since September. 3,4 Unemployment, of course, also climbed: the
Labor Department figure for April was 8.9%, although the pace of layoffs declined from March.5
Deflation fears were calmed a bit with the release of the April Consumer Price Index. Yes, consumer prices were flat for April, and yes, CPI fell by 0.7% over the 12 months ending in April - the first year-over-year drop since 1955. However, core CPI had gone up 1.9% across the same 12 months.6 Durable goods orders also increased in April by 1.9%.7
May consumer spending was down by just 0.1%, the Commerce Department reported, better than expected; personal income for May was flat rather than negative.8
The Obama administration got tough with credit card firms. It issued new rules forcing card issuers to notify cardholders of rate hikes 45 days in advance and curb retroactive rate increases. It also made collegians and teenagers less attractive targets for these companies by tightening credit
limits for them.9
