Economic Conditions Continue to Deteriorate

...makes the world go round

...makes the world go round

...makes the world go round

...makes the world go round

...makes the world go round

...makes the world go round

The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.

The Federal Reserve controls the three tools of monetary policy–open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee (FOMC) is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Today, the FOMC met and opted to keep overnight rates for banks unchanged.  While this is somewhat good news it certainly confirms what we had all feared: the US economy has slowed dramatically and requires rates to remain low if the country is to exit this period expeditiously with limited economic trauma.  The fact that oil rates have come off their highs allowed the Fed to avoid the immediate need for a rate hike to stave off inflation.  That said, economic conditions will likely remain challenging through the end of calendar 2008.  Banks and financial institutions will continue recapitalizing (and/or going private) as a result of the unprecedented decline of mortgage-backed securities and we will likely see corporate consolidation (as well as attrition, in some sectors) continuing throughout 2009. As we look forward into the Fall ’08, we anticipate the US will see continued demand destruction for petroleum-based products due to high prices.  The short-term impact of this market condition will be a significant correction in prices of crude oil and some “relational” commodities.  We anticipate that this will be short-lived, however, due to lingering inflationary pressures and production limitations.  Clearly, the emerging markets’ consumption of raw materials (or lack thereof) and food will play a defining role in commodity valuation. The US dollar’s value will also play a key role. For the year, our expectation for the US economy is rather lackluster.  While Armageddon is likely not forthcoming, the United States will likely see no more than a 1.75% increase in GDP for the year.  While economists differ on the exact definition of a recession, I suspect that reflections back on 08′ will see it as the inception for first recession of the millennium. These market conditions are nothing new for the multi-decade investor.  Many older investors have distinct memories of the high interest rates of the late 70s/early 80s, the market crash of ’87 (October, no less) and the dot-COM bomb of the early millennium.  What is important to keep in mind is that forward earnings define valuation for many of the leading companies in the world.  Many of these companies will not grow in a manner that behooves their lofty valautions.  This will crimp stock prices – many “juggernauts” often valued presently based on future growth and earnings prospects.  Growth companies have often taken a backseat to the more proven value companies in market periods like the one upon us now.  Investors need to use caution and consider risks and return before investing – even in instruments and entities traditionally perceived as “safe” (e.g. common stock in banks, auction rate certs, etc.) .  Growth for the next 18-24 months is a risky investment. A close friend sent me the chart below.  I think it speaks volumes.  It would be curious to see the see the aggregate performance of investors broken out by age and quantity of capital they possess.  I suspect that these numbers reflect the predisposition for many older wealthy investors to prefer fixed income. The graph below illustrates annualized returns for various investments over a 20 year horizon.  Note the “Average Investor Performance”.  It’s also worth noting that -on a twenty year horizon – real estate (via REITs) and the S&P performed comparably (70bp annually).

20 Year Annualized Returns for Various Investments


Current Yield


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