As everyone knows, the markets got killed today. Each of the primary market indices were down over four percent, with financials leading the way on news that Lehman Brothers declared bankruptcy and Merrill Lynch would be acquired by Bank of America. Today’s decline in the S&P 500 was the worst in apparently six years according to some and since 9/11 according to others. Take your pick; it was pretty bad.
This morning, I was driving to an advisory board meeting at Miami University. Before leaving early in the morning, my wife noted that Miami’s campus was closed due to power outages associated with the remnant winds of Hurricane Ike. While I called the head of the board before leaving home, his cell phone wasn’t working and I didn’t hear back from him until around 10am when I was a tad more than halfway there. He said his commute to Oxford from Cincy was twice as long as normal, that his power was out, and that it had taken him a couple of hours to get out of his driveway this morning.
I decided to turn around and head back home, well aware of the hurricane that was working its way through the financial markets. We broke a number of key longer term support levels in the markets today, including the prior low in mid July, so it’s anyone’s guess what could happen in the short run.
It may not help much that Goldman Sachs reports its quarterly results tomorrow morning. Goldman has been affected by the current environment but unlike the carnage for most investment banks, its injuries pale in comparison. While the Fed does meet tomorrow and further cuts may be forthcoming, the point feels silly as it rolls off my tongue. I keep thinking of the novel Flyboys and the helplessness that the Navy Medics likely felt in tending to injured Marines on Iwo Jima. At this stage, any moves by the Fed will be much less about physical comfort and much more about emotional and psychological comfort. Just being there may help the most.
In spite of all the pessimism, I still come back to the same argument we’ve been making for awhile. The housing and financial stocks have experienced a bubble. The most relevant precedent, therefore, may not be a garden variety recession, but what happened when the tech bubble burst earlier in the decade. The hurricane gusts are certainly being felt in other sectors many states away, but the bulk of the damage will likely still remain centralized.
If you look at some of the peak market caps of companies like AIG and FNMA, you will see declines that have been every bit as severe as those for many individual tech stocks earlier in the decade. Who would have guessed that this could happen to an industry once viewed as the bastion of stodginess and conservatism, at least relative to the far more romantic technology space? But that may be just the point. When bubbles are involved, you have to get out of the way. Stick with quality, like Goldman if you must, but know that the ride still won’t be much fun.
So then, what might the future hold? Let’s look at some more comparisons. The valuations of financial stocks may not be stretched nearly as high as those of technology stocks earlier in the decade, but most technology companies also had huge cash balances unlike the debt laden financials of today. This may mean far more bankruptcies for the financial bubble than the tech bubble. If there is good news in this scenario, it would be that the removal of excess industry capacity - if the government allows it - will occur much more quickly than it did for the technology industry, where most stocks are still far below levels reached at NASDAQ 5000 and price deflation has generally run rampant.
These are unusual times, for sure, but also not without precedent. Ironically, I worry far less about financials at this stage of the game and far more about the recent pullback in prices of energy and other commodities and what it could mean. I want to believe that the retracement in these prices is a natural reaction to an interim period slowdown in global economic growth and nothing more. At this point, I believe that’s the case. But I’m also very focused on the issue, mindful that we can ill afford the bursting of a third bubble so soon.
I hate it that I even think of such things and yet think, I know I must.
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