December ended a very difficult 2008 for investors with, unfortunately, more dismal economic data and further signs of weakness in housing, manufacturing and consumer spending. Early in the month, the National Bureau of Economic Research (NBER) officially declared the U.S. entered into a recession in December 2007 — making it the longest recession since 1981. Economic data since then has consensus economic forecasts pointing to a continuing recession that may extend well into 2009 with more mounting job losses and economic pain. Still, continued government market intervention and steadfast commitment to boost economic growth provided a boost to financial and credit markets in December.
The housing market remains of huge economic concern, as rising foreclosures and tight credit conditions have placed additional downward pressure on home prices. The 20-city S&P Case-Shiller Index measuring home prices declined 18% in October 2008 from year-ago levels. The Index has now dropped for 27 consecutive months bringing prices back to March 2004 levels.
The manufacturing segment of the economy is deep into recessionary territory, with the ISM Manufacturing Index (an overall indicator of the market tied closely to GDP) dropping to 32.4 in December — its lowest reading since 1980. Auto manufacturers experienced their worst year in decades, as industry-wide U.S. auto sales plunged 36% in December from year-ago levels. The U.S. government decided to support the ailing auto industry in December with loans to GM and Chrysler as well as help to GM’s auto financing arm, GMAC.
Wearied consumers tightening their purse straps are proving problematic for the struggling economy, as U.S. consumers are finally deciding to save after decades of buying. In the third quarter, household debt shrank for the first time since 1952, and consumer spending growth contracted for the first time in 17 years. Weak December retail sales and a new all-time low in consumer confidence for December suggest further contraction in consumer spending which will hamper economic recovery. Furthermore, unemployment is on the rise after already reaching 6.7% in November.
The Federal Reserve has exhausted its conventional monetary policy measures, slashing its key fed funds rate to a range of 0% to 0.25% on Dec. 16 on weak economic conditions which warranted “exceptionally low levels of the federal funds rate for some time.” Still, the Fed has more up its sleeve as it continues a quantitative easing campaign, with the latest measures being purchasing debt from government agencies in a bid to drive down mortgage rates and providing insurance to investors who purchase debt backed by credit card and auto loans.
Fortunately, mortgage rates dropped dramatically as a result of Fed actions sparking a flurry of refinancing and hopefully providing some boost to the housing market. Additionally, key credit measures have improved as a result of Federal Reserve rate cuts, with three-month LIBOR ending the year at 1.43% and measures of credit market health at roughly their best since September. Still, credit remains tight going into 2009.
Investors seeking safe-haven from the economic uncertainties flocked to U.S. Treasury securities of all maturities in a remarkable rally (one could call it a bubble) that lasted nearly two months and pushed yields to historically low, or even negative, levels. While the U.S. stock market declined 37% for the year as measured by the S&P 500 Index, the 30-year Treasury returned more than 41% — with most of that return coming from the recent rally which pushed the yield as low as 2.52% on Dec. 18. Yields remain very low going into 2009.
December ended with a 5% rally in the U.S. equity markets the last week. That brought equities into positive territory with the S&P 500 Index up 1% for the month. Nonetheless, equity markets ended 2008 with their worst year since the 1930s — with the S&P 500 Index having lost 37% for the year. The broad bond market gained about 5% for the year, thanks to double-digit gains in longer-dated Treasury securities offsetting losses in credit securities. Credit spreads reached historic levels this year and remained at or near peaks in December.