The new year is supposed to bring hope of fresh starts. Instead, the new year so far has brought a ton of misery to the financial markets. Since the first of the year, the S&P 500 tracking ETF (SPY) is down about 4.3%, the NASDAQ tracking stock (QQQQ) is down about 8.2 % and the Russell 2000 tracking stock (IWM) is down about 7.9%. Here are the charts in the order just presented.
All of the charts indicated that sellers are clearly in control. Notice that volume increased as prices dropped, indicating sellers are getting more nervous about the market's prospects. So -- what is causing this sell-off?
The answer is simple: recession is a new buzzword on Wall Street:
Merrill, itself one of Wall Street's biggest casualties of the sub-prime crisis, is the first major bank to declare that a recession in the world's biggest economy is now underway.
David Rosenberg, the bank's chief North American economist, argues that a weakening employment picture and declining retail sales signal the economy has tipped into its first month of recession.Mr Rosenberg, who is well-respected on Wall Street, argues: "According to our analysis, this [recession] isn't even a forecast any more but is a present day reality."
Goldman Sachs yesterday joined a growing chorus of top Wall Street investment banks that are now forecasting the US downturn will turn into a recession.
Morgan Stanley was the first top investment house to forecast a recession, while long-time bears Merrill Lynch said following the latest jobs report that "recession is no longer a forecast but a present-day reality."
In a note to clients, Goldman said: "We expect economic activity to contract modestly through late 2008, followed by a gradual recovery in the course of 2009."
When the big investment banks start talking about recession, people listen.
And there is strong reason to be very concerned about the economic prospects going forward. Fed Chairman Bernake made the following comment in a speech:
Although economic growth slowed in the fourth quarter of last year from the third quarter's rapid clip, it seems nonetheless, as best we can tell, to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. Notably, the demand for housing seems to have weakened further, in part reflecting the ongoing problems in mortgage markets. In addition, a number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.
Financial conditions continue to pose a downside risk to the outlook for growth. Market participants still express considerable uncertainty about the appropriate valuation of complex financial assets and about the extent of additional losses that may be disclosed in the future. On the whole, despite improvements in some areas, the financial situation remains fragile, and many funding markets remain impaired. Adverse economic or financial news has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and businesses. I expect that financial-market participants--and, of course, the Committee--will be paying particular attention to developments in the housing market, in part because of the potential for spillovers from housing to other sectors of the economy.
One of the big problems is Retail sales over the Christmas season indicate the consumer is pulling back:
NEW YORK (Dow Jones)--National chain store sales fell 0.7% in the first five weeks of December versus the previous month, according to Redbook Research's latest indicator of U.S. national retail sales released Tuesday.
The drop in the index was compared to a targeted 0.8% drop.
The Johnson Redbook Index also showed seasonally adjusted sales in the period rose 1.3% compared with December 2006, relative to a target of a 1.2% gain.
Redbook said that on an unadjusted basis, sales in the week ended Jan. 5 were up 1% from the same week in 2006, following a 1.6% gain the prior week.
"Sales performance pulled back in the final week of December compared to the previous week," Redbook said. Heavy rain and flooding kept people at home on the west coast, though some discounters reported that consumption patterns had become more normal, with a focus on basic commodities.
And the Wall Street Journal Reported:
U.S. retail sales last month weakened, especially among clothing chains, but weren't the disaster some predicted.
The report capped a year that turned out to be retailers' worst in at least four years and a holiday season that hit a five-year low. Still, a sales gain for the industry as a whole in December -- albeit slight -- lent some reassurance that consumers continue to spend.
.....
The results confirmed pre-holiday worries that falling home prices and high gasoline prices would crimp consumer spending. Retail Metrics Inc.'s index of December same-store sales rose a scant 0.4%, compared to a 3.2% gain the previous year. Comparisons, in part, were skewed by December's reporting period having one less week of post-Thanksgiving sales than in 2006.
And the turmoil in the mortgage market continues to take its toll. On Friday, Bank of America announced it was buying Countrywide Financial. There is speculation this deal occurred for two reasons: First, Countrywide was either bankrupt or close to bankruptcy. Secondly, that Federal officials did a lot of back door negotiating to convince Bank of America to buy Countrywide to prevent a massive strain on the financial system. Bank of America initially invested in Countrywide at $18-$20 a share and is now purchasing the rest of the company when Countryside's share price is s bit over $6/share. This does not look like a winning bet unless there is something else going on. Herb Greenberg at marketwatch made the following observations:
1. The Fed is behind the deal. (Today's thought: It's as likely as yesterday.)
2. The Fed is behind the deal because the rumors yesterday of a near bankruptcy were probably true. (Based on the price, it would appear more evident than ever.)
3. As part of the deal, the government likely agrees to guarantee BofA against Countrywide-related losses. (There was nothing in the press release about that, so let's give them the benefit of the doubt and say BofA is shouldering all of the risk and at this price it believes the risk is worth the reward.)
Given that Treasury Secretary Hank Paulson use to be a big higher-up at Goldman Sachs, it is entirely likely he or someone of similar stature in the government helped to push this deal along.
So -- the markets are not happy and the general problems of the economy continue. There si no reason to think this won't continue for the foreseeable future. In other words, it sure looks like the first part of 2008 will be a very bumpy ride.