The stock market celebrated the twentieth anniversary of the crash of ’87 with a 2.5% decline on Friday. Unlike 1987, the market averages are still up 6 – 8% for the year. Not surprisingly, the financial sector is the exception, being down about 9% for the year, with many financial stocks trading at prices approaching their August lows. Last week, the market reacted to some old news and some new news.
The old news was financial institutions reporting poor third quarter results. No surprise here. This was expected because of the mortgage, securitization, and residential real estate market problems. And, when a company knows it’s going to have a bad quarter it writes-off/down as much as possible, takes as many reserves as possible, to better position itself foe the future. I suspect this went on with the financials. Caterpillar’s results showed weak domestic demand and strong foreign demand. No surprise here, either. We know the U.S. market for construction is weak, primarily in the residential sector, and foreign demand is strong. Some investors interpreted Caterpillar’s forecast of a weak U.S. economy in 2008 as evidence of a recession but that’s not what the company said. Slow GDP growth is not a recession. No new news here.
What about the price of oil hitting $90 a barrel? At what point does it take such a big bite out of consumers pocketbooks that it drives us into a recession? It appears rising gasoline prices won’t deter the consumer but what about rising heating prices? The fall has been mild so far. A harsh winter may show that $90 oil, and correspondingly high prices for other energy sources, may be the tipping point for the consumer.
The new news last week was the public emergence of the SIV (sounds like something out of Star Wars) problem. Structured Investment Vehicles are off balance sheet entities -- black boxes. Some SIVs hold subprime loans and other risky securitized debt. A SIV meltdown will paralyze the entire securitized debt market resulting in a full blown liquidity crisis. The SIV bailout pool announced with great fanfare by the banks and the Treasury Department won’t solve this problem. It’s going to buy the best performing SIVs. However, it’s the weak SIVs that need attention and banks have to come clean about the true extent of the problem before it will resolve itself.
The stock market reacted to the SIV and energy questions. Caterpillar’s forecast, layered on top of these issues, resulted in greater recessionary worries. Pending some clarity on these issues, the stock market will mark time. Keep in mind, even weak economic growth forecasted for 2008 includes an approximate 8% growth in earnings. (See Christmas in October and The Government was the Last to Know.) It this comes to past, the market will advance significantly from its current level.
