NBR Transcripts- July 4, 2008 - Markets at Midyear
Friday, July 04, 2008Stocks in the First Half
PAUL KANGAS: Just four days ago, we marked the end of the year's first half and as Suzanne Pratt reports, most stockholders were certainly happy to get past those six months.
SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: Shocking, event driven and very, very volatile. That's how market pros describe the stock market as it twisted and turned through the first half of this year. S&P investment strategist Sam Stovall says the volatility actually began in 2007, but just got more intense.
SAM STOVALL, CHIEF INVESTMENT STRATEGIST, STANDARD & POOR'S: Over the past 12 months, we have had more than 16 days of declines of 2 percent or more which is actually four times the average.
PRATT: The January to June period was a horrible stretch for the major averages, with the Dow, S&P 500 and NASDAQ all suffering double digit losses. Lehman Brothers strategist Simeon Hyman says serious concerns weighed on investor sentiment.
SIMEON HYMAN, EQUITY STRATEGIST, LEHMAN BROTHERS: The first half was driven by high commodity prices, difficult housing situation and a very difficult credit market. Those were the big drivers. Those are the headlines. Those are what people have been reacting to.
PRATT: The Dow began the year on January 2nd at what would be its highest point of 13,261. Its lowest point of just under 11,350 came six months later on June 22. In between, it was a rocky road for stock investors. Sub-prime mortgage-related write downs and losses at major financial firms like Citigroup, Merrill Lynch and Lehman Brothers punctuated trading throughout the winter months. But the biggest crisis of confidence came in March when the Dow stumbled again as Bear Stearns struggled to avoid bankruptcy. By mid-March, the Federal Reserve and JPMorgan had come to Bear's rescue. The central bank also restored some stability to financial markets when it agreed for the first time to provide liquidity to investment firms. UBS strategist Mike Ryan says it was important for investors to know that the Fed was on the job.
MIKE RYAN, CHIEF INVESTMENT STRATEGIST, UBS WEALTH MANAGEMENT: In essence, the Fed was drawing a line in the sand and saying, we're going to make sure that this liquidity crisis does not continue to cascade and they took very aggressive policy measures.
PRATT: Calm seemed to be restored in April and May as investors grew more upbeat about the outlook for the U.S. economy. But that optimism was short-lived due to surging oil prices which fueled worries about inflation. June was the worst month for U.S. stocks since the great depression. Investors seemed to realize the credit crisis was far from over and that high oil prices may be the new reality.
RYAN: Energy is continuing to move higher even as the economy was slowing. We saw the price of oil and other energy prices just kind of continue to defy most economists' forecasts.
PRATT: As a result of June's slide, the Dow at the mid-year mark was down nearly 20 percent from its 2007 highs. A decline of 20 percent is considered the start of a bear market, an unhappy milestone for investors. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.
What's Driving Commodities Higher?
SUSIE GHARIB: As Suzanne reported, the direction of the stock market in recent months was driven mostly by what was happening with oil prices. But oil was just one of many commodities whose prices headed sharply higher in the first half. Midwest bureau chief Diane Eastabrook reports on the reasons behind that trend.
DIANE EASTABROOK, NIGHTLY BUSINESS REPORT CORRESPONDENT: A weak dollar and strong demand led to a surge in the prices of most commodities in the year's first half. The Reuters/Jeffries CRB index which tracks commodity prices was up more than 20 percent through the end of June. The energy sector led the way and although oil and gasoline grabbed most of the headlines, price rises were across the board. For example, natural gas prices increased roughly 70 percent in the first half of the year after a full winter drew down supplies. The price of oil went up almost continuously, breaking $100 in January and then continuing to set new records ultimately breaking past $140 a barrel. Besides the role of increased worldwide demand and the lower value of the dollar, the currency in which oil trades, unrest in the Middle East, also played a role in driving the price rise. Sheraz Mian, energy analyst for Zack's Investment Research thinks oil could remain volatile in the months ahead.
SHERAZ MIAN, ENERGY ANALYST, ZACK'S INVESTMENT RESEARCH: There will always be occasional short-term spikes from current levels. I don't expect crude prices to move substantially higher from current levels. I would expect crude prices in a $15-$20 range up or down from current levels.
EASTABROOK: Oil strength also played a role in driving crop prices higher by promoting the increased use of American corn in ethanol. Corn headed towards $8 a bushel. Wheat prices soared early this year when bad weather threatened crops in Argentina and Australia. In the spring, corn and soybean prices soared when torrential rains flooded parts of the Midwest. Shawn McCabridge, senior grant analyst for Prudential Bache Commodities says tight inventories of corn could drive prices even higher.
SHAWN MCCAMBRIDGE, SR. GRAIN ANALYST, PRUDENTIAL BACHE COMMODITIES: (INAUDIBLE) going well this year. We still have good demand. So the function of the market becomes to ration that demand through the higher prices. These volatile price levels are going to be with us quite some time.
EASTABROOK: A sluggish U.S. economy and the weak dollar put the shine to gold since it's seen as a safe haven when the dollar tanks. It soared to a record of nearly $1,000 an ounce in March when brokerage firm Bear Stearns nearly collapsed from bad loans. Prices have since backed off from that level but Danny O'Neal, executive vice president of futures for Options Express says a new economic worry is keeping the floor under gold.
DANNY O'NEIL, EXECUTIVE V.P. OF FUTURES, OPTIONSXPRESS: The other big factor is, of course, inflation concerns. Gold is widely recognized as an inflationary hedge that stores its value when traditional paper currencies might be eroding in value.
EASTABROOK: The bull market for commodities has drawn attention from Washington where lawmakers are investigating whether speculators are helping to push some prices higher than they should be. Analysts admit there has been strong investor interest in commodities but many think the sector is mostly responding to a global supply imbalance. Dianne Eastabrook, NIGHTLY BUSINESS REPORT, Chicago.
Experts' Outlook
SUISE GHARIB: So what's the outlook for the economy and the stock market in the second half of 2008? I asked three market experts for their forecast. Hugh Johnson, chairman of Johnson Illington Advisors, David Katz, chief investment officer of Matrix Asset Advisors and Josh Feinman, chief economist at Deutsche Asset Management. I began by asking Josh if the economy is going to grow or stall in the second half.
JOSH FEINMAN, CHIEF ECONOMIST, DEUTSCHE ASSET MANAGEMENT: I think it grows but pretty sluggishly. The economy still faces some big challenges. It's being hit by three shocks here -- the housing slump, which is ongoing, the credit crunch, which is still with us and high energy prices, and all of those things are going to work as headwinds to sort of retard growth. I think it will still be positive. We saw the strong export sector. We've got some fiscal stimulus and easy monetary policy but it's going to be a struggle.
GHARIB: David, the stock market is now officially in a bear market. How do you see stocks doing in the second half of the year?
DAVID KATZ, CHIEF INVESTMENT OFFICER, MATRIX ASSET ADVISORS: Usually by the time you know it's a bear market you're closer to being out of it. We actually think stocks will do better in the back half of the year. We think that we're in a recession, but we think the recession ends sometime in December, January, February time frame and the stock market should precede that by six months in terms of going up. We're optimistic we actually can get into the plus column for the overall year.
GHARIB: Hugh, I know it's difficult to forecast when a bear market ends, but are you as optimistic as David?
HUGH JOHNSON, CHAIRMAN & CIO, JOHNSON ILLINGTON ADVISORS: If I look at history I can't be as optimistic because the average duration of a bear market is about 16 months and that goes back to 1890. So if David is right, this one is going to be short by comparison to postwar and prewar history. I think he could be right, though and I think the issue is the earnings recession and as soon as we see that we're not going to -- we're going to get out of this earnings recession which started in the third quarter of 2007, when investors believed that we're going to have year-over-year earnings that were positive, then I think that they're going to start to buy stocks and the stock market will do well. My guess, it can only be a guess, is that we'll see that sometime in the third quarter, early fourth quarter that they'll see the end of the earnings recession and the stock market will start to do better. That will be the end of this bear market.
GHARIB: Josh, another really big worry for investors are these record- high oil prices and the impact on consumers, on businesses and on the economy. The forecasts are for $150 a barrel oil, $200 a barrel oil. How do you see the Fed responding to this?
FEINMAN: High oil prices really put the Fed in a bit of a bind because they squeezed purchasing power. They depressed spending for households and businesses but they also push up headline inflation and have the risk of seeping into inflation expectations and into the wage and price structure. It hasn't happened yet, but it's a risk that the Fed is keenly aware of. It's a risk that's certainly going to keep them from cutting interest rates and get them thinking about raising rates. I don't think they're going to raise rates because the economy is still so soft, but it makes the Fed's choice that much tougher.
GHARIB: David, if the Fed does raise interest rates because of worries on inflation, what does that do to the stock market?
KATZ: It puts more of a headwind to the stock market but we actually don't think the Fed is going to raise rates. The economy is still struggling and we think oil prices are in a world of their own so the Fed really can't do too much to affect oil prices.
GHARIB: We've seen, Hugh, this connection between oil prices and stock prices. As oil prices keep going up, do you think the stock prices are going to keep going down?
JOHNSON: I think along with what David has said, if oil prices are going up and the rate of inflation is going up and the interest rates are going up, obviously that's going to be a real problem. That's a headwind for the market and the Federal Reserve responds by raising short-term interest rates. If they get the opportunity to do that, if the economy is strong enough, then absolutely, that's a headwind. It's going to make it difficult for David and I to be right. David says some important things about oil, though. He calls it a speculative bubble at times and I think that he's probably right on that. If I really crunch the numbers, if I look at global supply and demand conditions, oil should be around $83 per barrel, so at some point there will be an event and we're going to break this bubble and the price of oil is going to come down and if that happens, if oil comes down, the dollar stabilizes and attracts capital to our financial markets, David and I are going to look like pessimists, not optimists.
GHARIB: Let's talk about housing prices. Josh, you referred to that in the very beginning about the problems in the housing market. Do you see the housing situation turning around in 2008?
FEINMAN: Not really turning around but maybe bottoming out. Activity bottoms, starts have been cut very aggressively. I think maybe we're going to get some bottoming there later this year. And prices have fallen quite a bit. I think a little bit further fall is likely to bring them into alignment with fundamentals, but then maybe some bottoming, but I do not look for any sharp snapbacks.
GHARIB: David, Hugh was talking about an earnings recession. Do you see earnings in the second half giving any lift to stocks?
KATZ: We don't think earnings are going to pick up in the second half and we don't think that gives a lift to stocks. If you look at the last 50 or 60 years though, stocks generally can do well when you have a flat-to-down earnings environment. So we don't think that's going to be the key factor in determining stock prices. We think at some point before the year's out, people are going to start to look toward 2009. It's going to be a better economy, better earnings, stocks are going to go up before that.
GHARIB: All right. Talk about 2009, got to talk about the elections, who's going to be the next president. Which candidate do you think is going to be best for the stock market and the economy, John McCain or Barack Obama? Josh?
FEINMAN: First, I think Obama is most likely going to win, that's what the futures market suggests, anything could happen but I think he's the clear favorite and I think that he has some policies that might be not so friendly to Wall Street. Somewhat higher taxes almost surely, maybe some trade protectionist stuff. So it's a bit negative but I think we need to keep in mind, even if McCain wins, we're going to have a Democratic Congress and there is going to be some pressure for higher taxes.
GHARIB: David, what do you think?
KATZ: McCain's policies on taxes and on trade are both better for the economy and ultimately would be better for the stock market.
GHARIB: Hugh, where do you stand?
JOHNSON: Pretty clear to me that McCain would be better for investors, better for the stock market and Wall Street is going to embrace him and you can't underestimate how important the 15 percent tax rate on dividends, 15 percent tax rate on capital gains, how important that is, how getting rid of the alternative minimum tax which is a McCain policy is -- how important that is. The important thing, though, will be trade policy and McCain is obviously much more on the free-trade side. Obama's trying to get on the free-trade side but he has reservations, wants to renegotiate NAFTA. I think quite clearly McCain is better for investors, better for the market and Wall Street will embrace him.
GHARIB: Gentlemen, thank you so much, Hugh Johnson, Josh Feinman and David Katz and happy fourth of July.
Of Mutual Interest with Christine Benz of Morningstar
PAUL KANGAS: This year's carnage on Wall Street as well as the fall in the dollar and the rise in commodity prices all came across loudly and clearly in the prices of mutual funds, so in tonight's "Of Mutual Interest" segment, we take a look at the few bright spots in fund performance over the past three months and joining us to discuss that is Christine Benz, director of personal finance for Morningstar. Christine, welcome back to NIGHTLY BUSINESS REPORT.
CHRISTINE BENZ, DIR. OF PERSONAL FINANCE, MORINNGSTAR: Paul, it's nice to be here, thank you.
KANGAS: First let's look at which fund sectors did the best between April and June and not surprisingly at the top were the natural resource funds with 19.6 percent gain followed by Latin American stock funds up more than 12 percent. Is there a connection here?
BENZ: Absolutely. The Latin American economies and their markets tend to be very much driven by natural resources, not just oil but also basic materials like metals. When those commodities are up, so are the Latin American markets.
KANGAS: Interesting. Now let's turn to the top individual funds during the quarter and among the funds with more than $50 million in assets, heading the list Blackrock Global resources. How did it turn in a gain of better than 45 percent?
BENZ: Well, owning a lot in the energy sector and in particular, Paul, this fund made a very profitable bet on the coal industry and coal prices really surged during the quarter. So did this fund.
KANGAS: They sure did. And it's interesting that Fidelity and Rydex energy service funds also made it to the best performance list.
BENZ: These types of funds, Paul, will shoot to the top of the charts when oil stocks are performing particularly well. I would point out they also tend to be on the bottom of the heap when oil's fortunes turn down.
KANGAS: Now moving to the best performer over the last year, we see a repeater from the quarterly board -- Oppenheimer commodity strategy total return. What can you tell us about this fund?
BENZ: This is a commodity fund that tracks an index of various commodities, mainly oil and related products, but also metals and some agricultural products and as we have all seen, the prices of everything has been surging recently. These commodities have done well and this fund mirrors their gains.
KANGAS: Now taking a longer-term view, ING Russia continued as the top fund for the last three years with an annualized return of more than 49 percent.
BENZ: Right. A perennially strong performer over the past few years, really as go oil prices so goes Russia. This fund turns on both -- on the success of both areas.
KANGAS: Now finally, looking at the biggest funds in terms of assets, it's interesting that one fund actually ended the quarter in the black. That was Growth Fund of America. How did it manage to buck the trend?
BENZ: Well, one thing, Paul, it is what it avoided, which is the financial sector. As we all know, banks and a lot of other financial services companies have had a terrible time of it amid this mortgage crisis that we've had here in the U.S. This fund, Growth Fund of America tends to downplay those companies relative to some of the other biggies on this list like Vanguard's big 500 index, so it's been what it has avoided more than what it has owned.
KANGAS: OK, now, talking about growth funds, it's interesting to note that the midcap growth and small cap growth categories experienced solid gains after big drops in the first quarter. Are these groups that tend to lead the general market?
BENZ: They do. They tend to certainly lead the market when the economy is recovering. I think it's probably premature to say that we definitely are entering a recovery, but typically these groups will lead the way.
KANGAS: Very interesting, Christine and as always thank you for your analysis.
BENZ: Thanks so much, Paul.
KANGAS: My guest, Christine Benz, director of personal finance for Morningstar.
Uncle Sam to the Rescue
SUSIE GHARIB: Getting back to the economy, the half of the year may or may not be remembered as the time when a recession began, but what may prove far more significant are the quick actions the Federal government took to head off a collapse of the financial sector and a general economic meltdown. As Stephanie Dhue reports from Washington, even Capitol Hill did its part to rev up the economy.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: Usually, Congress leaves it to the Federal Reserve to manage the economy. But when the economy continued to weaken despite interest rate cuts, Fed Chairman Ben Bernanke suggested Congress step in.
BEN BERNANKE, CHAIRMAN, FEDERAL RESERVE: A fiscal stimulus package could be helpful in the current circumstances. It would provide a broader base of support to the economy than just that afforded by monetary policy.
DHUE: Lawmakers quickly delivered a $150 billion stimulus bill to the president's desk sending rebate checks to millions of Americans.
GEORGE W. BUSH, PRESIDENT OF THE UNITED STATES: The bill I'm signing today is large enough to have an impact amounting to more than $152 billion this year or about 1 percent of GDP.
DHUE: But soon another major crisis was brewing, this time involving Bear Stearns. In one day, on March 13th, the investment bank lost $10 billion in assets. Fearing a domino effect if Bear went under, the Fed stepped in. It arranged a fire sale of Bear to JPMorgan put up a $29 billion loan against losses on risky Bear Stearns assets. Later, Bear Stearns CEO Alan Schwartz claimed rumors the bank would run out of money were unfounded.
ALAN SCHWARTZ, PRESIDENT & CEO BEAR STEARNS: If the market couldn't see that we had someplace to go and borrow against that collateral, then the fears could start. I just never frankly understood or dreamed that it could happen as rapidly as it did.
DHUE: Still, there was no question that the real estate boom-gone- bust lead to Bear Stearns downfall. When home prices were soaring and the economy was sound, financial firms dove into the mortgage market. Lending standards were loosened to the point where people with poor credit had no trouble getting mortgages with no money down. Firms like Bear Stearns then packaged those loans as mortgage-backed securities which somehow received high ratings. George Washington University real estate Professor Richard Green said the rating service's mistake was assuming that home prices would never fall.
RICHARD GREEN, REAL ESTATE PROF., GEORGE WASHINGTON UNIVERSITY: It was as if we were in a brave new world sort of like the late '90's when people thought companies wouldn't have to make any money for the price of their stocks to go up.
DHUE: Lawmakers also crafted a bill to help homeowners avoid foreclosure. It would create a $300 billion fund for the Federal Housing Administration to buy troubled mortgages. Lenders would have to agree to take a loss on existing loans to participate in the program. Senate Banking Committee Chairman Chris Dodd played a lead role in writing the proposal.
CHRIS DODD, CHAIRMAN, SENATE BANKING COMMITTEE: We think we've recommended some specific ideas that can very well begin to treat the problem of growing foreclosures, declining values in our homes and the spread and contagion effect this is having.
DHUE: The bill's proponents say it will act to stabilize home prices, but analyst Andy Laperriere says by the time the legislation can take effect, home prices may already have reached bottom.
ANDY LAPERRIERE, MANAGING DIRECTOR, ISI GROUP: We're basically already through it by the end of the year. Only if things are going to get really rough and home prices are going to fall a lot in 2009 -- only under that scenario would the bill help.
DHUE: Congress left town for the July 4th recess without passing the bill, but is expected to take it up again next week. With an election looming and the economy struggling, neither party wants to be blamed for doing nothing. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
McCain vs. Obama
PAUL KANGAS: There is little doubt the year's second half will be dominated by the presidential campaign with the economy expected to be a key issue. Washington bureau chief Darren Gersh discussed that with Goldman Sachs political analyst Alec Phillips. He began by asking Phillips where Senators Barack Obama and John McCain are likely to differ when it comes to economic policy.
ALEC PHILLIPS, WASHINGTON ANALYST, GOLDMAN SACHS: We view the tax differences as probably one of the key differences in 2009 and going forward between the two candidates, McCain, for instance, would just extend the capital gains and dividend rates and for that matter all of the other tax cuts expiring in 2010. Obama would let some of those expire, potentially come up with a new system for capital gains and dividends.
DARREN GERSH, NIGHTLY BUSINESS REPORT CORRESPONDENT: So there has been a study out from the Center on Tax Policy which looked at both of these candidates' tax plans and said basically they're going to add trillions of dollars to the debt. Are these plans that the markets are going to welcome and say we can afford these? Or are these plans that the markets are going to look at and say they've got to change these because we can't afford them?
PHILLIPS: Under either scenario you're probably going to see tax policy add to deficits after 2010. Really, the question is on new tax cuts or on extending a certain amount of existing tax cuts -- for instance, capital gains, dividends, the upper-income brackets, that's where the differences are, but both have proposals that would actually cost a decent amount of money.
GERSH: Both men agree on the cap-and-trade system that they want to put in place a cap-and-trade system on carbon emissions to deal with greenhouse gas emissions. It seems to me that they agree on a very large change to the economy. Does that surprise you?
PHILLIPS: The cap-and-trade program, if it were implemented, for instance, if you look at the Lieberman-Warner bill that the Senate took up a few weeks ago would be interesting because at the same time that consumers are pressing for lower energy prices, this would essentially be a tax on energy, albeit a relatively small tax in the grand scheme things. So if you look at the annual revenue amounts, you're really talking about less than $100 billion a year. That sounds like a lot, but considering that the Federal government right now pulls in over $2 trillion a year in revenue, it still is actually a fairly small moving piece.
GERSH: Is health care fading as an issue because both of them are talking about big changes in health care but it's not getting much attention lately.
PHILLIPS: I think actually health care reform, despite the fact that it's not getting a lot of press right now, is going to be a pretty big issue in 2009 assuming that consumer confidence is still low and that the economic weakness is still a major concern. Ultimately, health reform is something that the government can do for people that will actually improve their financial situation as opposed to for instance climate-change legislation which, while it could potentially be neutral to their financial situation is unlikely to be seen as helping them significantly.
GERSH: Will the economy still be the number one issue when the next president is sworn in? And if we don't see a much stronger economy, are we going to get another stimulus plan?
PHILLIPS: It's hard to see how the economy is not going to be the number one issue by the time the next president is sworn in. If you look at where consumer sentiment is right now, if you look at where home prices are and our own economic forecast for that matter, we do expect to see weakness start to emerge again toward the end of the year as the current stimulus package fades away. That I think is going to increase interest in the market in figuring out what the next president is going to do to stimulate the economy, both in terms of consumer spending, potentially another round of checks, something like that, as well as potential further intervention in the credit and mortgage markets to the extent that housing continues to decline and the market weakens yet again.
GERSH: OK, Alec Phillips, Goldman Sachs, thanks for your time.
PHILLIPS: Thanks.
