JULY 3, 2008
JULY 2008 COMMENTS - THE DIFFERENCE A MONTH MAKES
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May flowers brought June showers, on the equity markets that is. The spring rally has given way to a test of the March lows that are occurring as of this writing. Tax rebates are making their way through the economy helping to keep consumers treading above water. They are facing higher energy costs and lower liquidity due to deflating asset values. More financial institutions have been downgraded by ratings agencies and investment houses as the real estate meltdown continues to dominate investors' mindset.
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We continue to believe economic weakness will persist through 2008. Rebate checks and lower rates will likely forestall negative growth comparisons in the second quarter, although may not be sufficient to overcome the continued asset deflation. Rhetorical political statements regarding future tax policy are not helping the equity markets either. One party has underlined a policy of higher income tax rates, higher dividend and capital gains tax rates, and a social security tax increase of sorts that will support an aggressive social agenda and reduce the budget gap. The timing could not be worse. Tax increases retard economic growth and a weak economy can only become weaker under such a scenario. Despite the rhetoric, if the presidential race changes the party in control, economic sloppiness will more than likely prevent any major tax policy changes in 2009. Beyond that, changes are a distinct possibility.
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Liquidity for borrowers continues to be constrained and this makes stabilization in housing futuristic at best. We still believe that the economy will begin to show some stabilization in 2009 as lower rates and the reduced number of upward adjustable mortgage resets helps to take the pressure off of the economy. While the recent pullback in equity prices has been uncomfortable, the discounting mechanism of the stock market should soon begin to reflect an improved environment later in 2009.
THIS MONTH'S FIXED INCOME FOCUS
- Is the Fed about to tighten rates?
The Fed's recent 325 basis point cycle of rate cuts included 225 basis points of cuts initiated this year that ended just two months ago, on April 30 th . Many "market watchers" suggest that it takes up to 6 months for the Fed's rate changes to make their way through the system. As the fixed income market swings between the optimism (for bond prices) of recession and the pessimism of inflation, some suggest the Fed may soon begin to tighten because of these inflation fears. We believe the Fed Funds rate will remain at its 2.25% level at least through the time of the November Presidential Elections. The Fed's prior history of rate moves, credit market conditions and the employment situation all suggest this will be the case.
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Municipal Bond "Insurers"
On June 19 th , the inevitable occurred when Moody's downgraded the Insurance Financial Strength ratings of two of the former major insurers, AMBAC and MBIA, from Aaa to A2 and Aa3, respectively. Since the business of the insurers was to lend their Aaa cachet to lesser-rated bonds, it appears their business will be severely impaired by this move on the part of the rating agencies. Beacon Trust's policy on municipal bond insurers continues to stress the importance of fundamental credit research on each bond, and to consider credit insurance a bonus, but not a reason to buy a lesser-rated bond.
- Comments of Interest
-Arthur Levitt Jr., Former Chairman of the SEC: "Lenders [today] are not exposed to risk from borrowers-they have no 'skin in the game'" (as a result of the securitization of pools of mortgages).
-Mark Zandi, Chief Economist, Moody's Economy.com: "Each 1 cent increase in the price of a gallon of gasoline over a 1 year period costs consumers $1 billion." Thus, the move from $3 to $4/gallon for the period of a year has cost consumers an estimated $100 billion, about the amount of the Federal stimulus package.
- Fed Senior Loan Officer Survey
The most recent results of this survey indicate the percentage of banks tightening standards for business loans, and increasing loan rates over the cost of funds were both at or near 20-year high levels. The good news is that, at least in the past, these extreme levels have set the stage for a return to more normal conditions.
We always welcome your thoughts and opinions on this Monthly Commentary, as well as any questions or comments you may have. Please do not hesitate to contact your Portfolio Manager or e-mail info@beacontrust.com.