Second Quarter 2009

Last Updated Monday, 06 December 2010

A quarter that brought a lot of pain to the Bears

At the end of the first quarter of 2009 our report posed the question on whether we are experiencing the end of business, finance and capitalism or one of the greatest buying opportunities. We now have an answer: The S & P recovered by about 50% since the March lows exhibiting one the greatest performances in history.

Short sellers experienced a lot of pain. Bearish commentators who became popular during the disaster of the previous year were forecasting additional disasters. Leftist political views were resurrected and with obvious pleasure were forecasting the demise of the free market system and of the USA.

In addition to short sellers, straight sellers were also penalised. In their effort to run for safety they did not participate in the remarkable stock rally. Moreover, by buying low yielding short-term fixed income government bonds they missed the very powerful rally and the high in yield spreads of the corporate bonds. Finally, short-term interest rates dropped below 0.5% and thus the exit from the stock market in order to invest in cash also proved to be a very unfortunate decision.

On the issue of macroeconomic policy, the real estate and the financial shocks that started in 2007 created an economic downturn that could not be corrected by market forces. As private Investment and Consumption collapsed, Government intervention was deemed necessary by the consensus in a huge effort to stabilize the economic system. Most economists were reminded that despite the progress in policy making, equilibrium in the economic system might not be stable. Shocks leading to destabilizations were not automatically corrected with the use only of monetary policy alone like in most cases since the 1930’s. Fiscal policy was required to be used aggressively as well. Thus, very expansionary Monetary and Fiscal Policies were adopted on both sides of the Atlantic to face the worst recession in the post War period. The challenge for economists and policy makers is clear: the extraordinary measures will hopefully become effective to reduce unemployment and restore economic recovery but they should be withdrawn in time to avoid future inflationary pressures

Will the Government be able to reduce the huge Budget Deficits and ‘exit effectively’ the expansionary policies before economic activity and money velocity improve? The timely reduction of the Budget Deficit will prove to be a very difficult task like parking a tanker vessel under extremely adverse weather conditions. In the 1930’s an untimely exit led the world economy in a new recession towards the end of the decade. Time lags in policy making are long variable and uncertain. Many analysts fear that the economy might have reached by the traditional business cycle forces the recovery stage when economic policy will become effective. Therefore, the joint outcome in the future might be very robust growth and inflation. However, we should constantly be reminded that at present rising unemployment and slowing economic activity are the major issues. Inflation might be a future problem. Signs of stabilisation in housing, the banking sector and on key economic statistics have been reported but are not yet conclusive.

For a three-week period, before the announcements of the second quarter earnings results, we experienced a market correction of about 10% that erased the gains of May and June. However, pessimistic expectations did not materialize in the earnings announcements. Thus we witnessed a very strong upward move in the stock markets (of more than 20%) leading to one of the strongest rallies in recent history and overcompensating for the correction of the previous period . We hope that pleasant surprises due to cost cuts will continue. However, we will eventually need sales growth (top line growth) in 2010 that will increase earnings in a healthy way since markets appear now fully priced.

N.Ritsonis August 6,2009

The above comments are not meant to deny that financial crimes were committed by homeowners, bankers, policy makers, rating agencies, government controlled enterprises, regulators, politicians, money mangers, investors…By EVERYBODY ! Greed, short-term personal considerations and excessive Leverage created enormous problems. A decrease in leveraging will mean an increase in the savings rate and lower economic growth for some quarters. The recovery might be anemic for some quarters.