Some in the media are proclaiming the worst in the credit crisis induced market sell-off is behind us, but with only $250 billion of an expected $1 trillion (courtesy of the IMF) in sub-prime write-offs behind us, more bad news form the credit market is likely. We may never hear about many of the write-downs held at pension funds and sovereign wealth funds but more debt downgrades from the rating agencies are likely to hit the banking sector. More telling, there is little evidence banks have started lending to each other again as LIBOR rates jumped up around 20 basis points in the last week moving the TED SPREAD further into negative territory.
On top of credit market issues, a deflating residential real estate market and higher energy and food prices have the U.S. consumer in a foul mood. Confidenced readings are very very low.
It is hard to imagine stocks advancing much from this level but there may be a few pockets of opportunity.
Ongoing globalization may be able to help deliver some positive returns in 2008. Raw material demands from emerging markets have put pressure on commodity prices and some of the industries closely associated with commodities (agriculture, mining, energy) are experiencing a favorable business climate as a result. But the commodity price link between these investments can introduce an additional element of risk and a global economic slowdown would likely reduce demand for raw materials. Also, the pricing pressure for food and energy cost are likely to send inflation numbers higher globally, eroding real returns.
One commodity that is under pressure is gold. It continues to decline from its March sell-off, on a strengthening dollar and increased risk appetites by investors.
When comparing international stocks with U.S. stocks in the short term, the Vanguard Total Market Index (VTI) for the U.S. has declined 10.19% from the October 2007 highs while the Vanguard All World Ex-US (VEU) is down only 8.18% during the same period. Interestingly, since the March ’08 bottom the VTI is up 9.52% while the VEU is up 11.41%. Below is a one year chart of the two indexes.
With emerging countries strengthening their economies and instituting improved financial systems, it is possible a U.S. slowdown will have a smaller effect on other parts of the world.
As is usually the case, there is conflicting data to contend with in terms of investment opportunities. Given uncertainty in credit markets, the real estate and economic slowdown in the U.S., and the grumpy U.S. consumer, I believe a defensive bias in portfolios has merit.
