The stock market trended progressively lower in the first quarter of the year.  In fact, March was the fifth consecutive month the stock market has declined.  The quarter was also punctuated by extreme volatility.  The Dow Jones Industrial Average has not had a daily 400-point move in almost six years, but recorded two such moves in the month of March alone.  For the quarter, the S&P 500 was down 9.4%, its worst quarterly decline in five years.  The stock market uncertainty is best explained by the recent Federal Reserve’s minutes regarding their economic outlook: “falling home prices and stresses in the financial markets could lead to a more severe and protracted downturn in activity than currently anticipated.”

Perhaps the defining moment of the first quarter was the collapse of Bear Stearns, Wall Street’s fifth largest brokerage firm.  Fearing a domino effect leading to the collapse of other brokerages and banks, the Federal Reserve facilitated a takeover of Bear Stearns by JP Morgan at $10 per share (Bear Stearns had recently traded as high as $170 per share).  While the market decline has been a painful experience for shareholders in general, we are comforted by the fact that coincident to the last four major Wall Street collapses (Continental-Illinois in 1984; Drexel Burnham Lambert in 1990; Kidder Peabody in 1994; and Long-term Capital Management in 1998) a stock market bottom was reached, and the S&P 500 was up a year later by an average of 10%.

Nevertheless, we do not expect a V-shaped recovery for the economy given what can be described as more than just a headwind for the consumer, rather a perfect storm. Remarkably, real consumer spending has increased for 64 quarters in a row!  In the meantime, home values are in a freefall with mortgage delinquencies and foreclosures at their highest levels on record.  Oil prices have soared past $100 per barrel, food prices are rising, and worst of all, the unemployment rate is climbing.  In fact, the economy has lost nearly 250,000 jobs since December.

After significant criticism that Federal Reserve Chairman Ben Bernanke was inadequately responding to the crisis, he has finally taken decisive action to restore confidence and avert a collapse in the financial system.  In addition to orchestrating the Bear Stearns deal, the Federal Reserve cut the Fed Funds rate by a whopping 200 basis points during the first quarter.  Combined with previous rate cuts, this has the potential to add three percentage points to economic growth according to a financial simulation model described in a recent Lehman Brothers report.

Currently, the stock market has a more optimistic tone and is on track to break its five-month losing streak.  While it is too early to declare that the worst is behind us, especially in the financial sector, recent earnings reports from companies like IBM and Intel support our view that strength in the global economy continues to offset weakness in the United States.  This global strength should help prevent a more severe and protracted downturn in the US economy going forward.  From a stock market perspective, we believe that the majority of downside risk has already been priced into the market.  We continue to see attractive investment opportunities, but realize we won’t be rewarded in earnest until there are more signs that the economy has stabilized.

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