Most of today’s schedule was filled with a Mission board meeting, so this will be a brief summary of recent market and economic activity.
The most anticipated event of the week was Fed Chairman Bernanke’s talk from Jackson Hole, Wyoming this morning. Would he suggest another Federal Reserve rescue attempt? Bernanke offered no immediate stimulus but kept alive all possible options for the Fed’s upcoming September meeting. Fear of a disappointing announcement pushed the Dow down by 100 points on this morning’s opening, and initial concern that Bernanke had no new proposals pushed prices down by another quick 100 points. At that level the selling was exhausted, and prices rose in a modest volume rally from 200 down to about 200 up. A few more zigzags and the Dow closed up by 134 points. After strong declines over the prior four weeks, this week produced almost a 5% recovery rally. That leaves the S&P 500 down by 10.6% for the third quarter and down by 5.1% for the year-to-date.
Similar frenetic activity took place in stock markets around the world. To those who do not pay detailed attention to markets outside the United States, it may come as a surprise that we are doing far better than most. Despite collapsing prices in recent months, the U.S. and Canada are the only two of the world’s largest markets not to have fallen by more than 20% from their 2011 highs. Bad as it has been here recently, it has been far worse elsewhere. There is worldwide concern about declining business conditions around the globe.
The depth of the market decline so far could be a helpful forecaster of whether there is more decline ahead. There have been only three instances in modern U.S. history in which stocks have fallen as far as the S&P has this year that have not been followed by a recession (1966, 1987 and 1998). In each of those instances the market fell hard despite strong economic growth. Unfortunately, the current decline is taking place in an environment in which growth is almost non-existent. Whether a recession follows is extremely important from a stock market perspective. On average almost three-quarters of a bear market’s decline takes place after a recession begins. If we’re headed into a recession, traditionally allocated stock/bond portfolios will probably endure significant losses. Over the decades, our Controlled-Risk Flexible Allocation process has protected capital extremely well from major market declines and has left us able to take advantage of many of the market’s bounces, even in bear markets.
Further confirming the risk of a new recession is an ISI report that since 1970, in six of the seven times that real year-over-year GDP has slipped below 2%, a recession has been signaled. Virtually all economists expect that the economy will drop below that level when this quarter’s GDP is announced.
We again remind all readers that we are in an environment in which the financial system itself remains in great danger. The problems in Europe are not merely those of liquidity, but of solvency. If the current rescue efforts are unsuccessful, the fallout could be huge worldwide. We continue to maintain great flexibility and remain alert to both dangers and opportunities wherever they may arise.