The Federal Reserve and other central banks around the world cut interest rates this morning for reasons that are obvious to everyone. Normally, we’d criticize the cut, given the sea of liquidity already flowing from the world’s central banks. But these are not normal times, nor is it clear when normality, or something approximating it will return.
One indication of the abnormality is the rapidly fading threat of inflation, at least for the short term. With the credit crisis becoming materially worse over the past month, the idea of generally higher prices is on holiday until further notice. Disinflation if not deflation is the bigger risk for the time being, which gives the Fed and its counterparts around the world more room to drop rates. (The Fed’s cut was 50 basis points, which brings the Fed funds target down to 1.5%.) But while the evaporation of inflation risk provides some monetary breathing room, it’s also a sign of trouble in the global economy. There are several ways to mute inflationary pressures, but what we’re experiencing now is the worst of all possible ways to achieve that otherwise sound goal.
The immediate question is how much help will a rate cut bring to the frozen credit markets? The pressing goal is convincing financial institutions to lend. Today’s rate cut will help, as will the various efforts announced by the Fed in recent weeks. But the prospect of a quick turnaround in lending is dim, at least for the moment. Confidence has been shaken in the belief that loans will be repaid in a timely manner, if at all. Repairing that battered sentiment will take time, and a 1/2-point rate cut, while helpful and warranted, is only a small part of the solution.

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The rolling crisis that has become the daily routine of late has no obvious and immediate solution, but at least we can be clear about how we arrived in this thankless position. And maybe, just maybe, we can learn a thing or two about policymaking for the years ahead. It won’t be easy, but progress never is, especially in the dismal science.
Facing up to reality offers no silver bullet answers, but ignorance will only aggravate our troubles in the future. With that, let’s acknowledge that the current mess is the consequence of years, perhaps decades of mistakes and short-sighted policies. The list is long, and the details complex. Volumes will be written about how policy makers stumbled. For now, we’ll revisit one issue that this observer believes has been central, though hardly alone in the buildup to the problems that afflict us.
Arguably one of the bigger missteps flows from the idea that the economy can be reengineered and manipulated so that recessions are a thing of the past. For quite a while it’s been tempting to think that the Federal Reserve and its counterparts around the world figured out how to smooth out the rough bumps in the business cycle. Viewed through the perspective of history, the Great Moderation looked like the answer to every central banker’s prayers. The goal certainly was a populist winner: recessions that were less frequent, less painful and perhaps even a vestige of a bygone era. For a while, the impossible seemed possible. A look over the history of business cycles certainly gives that impression via fewer, less painful downturns. That appeared to be the new world order, and the assumption was that the retooled cycle rules could go on forever. The tech bubble burst early of 2000-2002 was a warning shot, but most chose to ignore it, in part because for all the pain of that episode, consumer spending never really suffered, thanks to Greenspan’s Fed.

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The finger pointing has only just begun, and there’s lots of targets to point at. Analzying what went wrong on Wall Street is clearly in everyone’s best interest if only to prevent trouble in the future. But the greatest danger is looking for scapegoats and missing the forest for the trees.
Let’s first recognize that a fair amount of the pain in the financial industry was self-inflicted. There simply wasn’t enough attention paid to risk management. Yes, there was a surplus of quantitative modeling, but at the end of the day too many relied on the math geeks, many of whom didn’t provide much value when it came to estimating the potential pitfalls of leverage, buying and holding mortgages of questionable risk, and diving headfirst into derivatives. Alas, the temptation to leave the analysis there is strong. It’s also a mistake, and probably dangerous if it influences the inevitable wave of policy changes that are coming.

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This morning’s employment report for September is the worst yet for this cycle, and we’ll probably see even deeper pain in the months to come. But for now, the last shred of hope that maybe, perhaps, somehow the U.S. could avoid recession has been definitively dashed, once and for all in today’s jobs update.
Nonfarm payrolls slumped by 159,000 last month, the biggest monthly loss for the labor market in five years and the ninth straight month of red ink for job destruction, the government reports. That’s a sharp drop down from the relatively moderate losses we’ve seen previously, as our chart below shows. Although unemployment was unchanged at 6.1%, the steady jobless rate for September should fool no one. The message from the labor market is clear: the one-year-old financial crisis is now taking a bigger toll on the broader economy, and the pain is still gathering steam and cutting deeper.

The mounting troubles for the economy have been bubbling for some time, of course, as CS has chronicled throughout this year. Back in March, we laid out the case for why a recession was virtually certain. Unfortunately, the corroborating evidence has continued to pile up since then. Earlier this week, for instance, we learned that car sales and factory orders suffered hefty declines last month, adding more signs that there’s still plenty of trouble ahead.

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The monthly numbers for all the asset classes suffered red ink in September (save for cash), as our table from yesterday details. Fortunately, that’s a rare episode.
For the 10 asset classes listed in that table, the last time the representative indices all posted monthly losses was October 2005. Overall, there have been three times in the last 10 years when losses infected all the major asset classes in one month: 9/08, 10/05, and 4/04. That translates to 2.5% failure rate, if we can call it that. It’s low, but it’s higher than zero, and so we can’t be blind to the possibility.
What’s different this time is that the crisis that came to a head in September 2008 makes the problems of the recent past look shallow by comparison. Indeed, the current troubles are deeper and threaten the economy. The main lesson today is that no asset class is immune from financial and economic crises. Nor is there any reason to think that all the major asset classes can’t suffer losses simultaneously.
The good news is that an across-the-board fall in the 10 major asset classes is abnormal. But it does happen, and a bit more often such events nearly happen.

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Thank goodness September’s gone. Although it’s passed into history, the legacy will long linger, in our minds and wallets.
Indeed, September 2008 was ugly. Really ugly. There was no place to hide other than cash. It was just one of those months and it didn’t really matter what you did or what you owned save for T-bills or the closest equivalent. Even our CS Global Market Portfolio Index (GMPI) was crushed last month, dropping a nerve-rattling 9.4% in September. As our table below shows, our index of the global market portfolio is down steeply for year-to-date and 12-month readings too.

That’s an extraordinary loss for GMPI, all the more so since the previous three months have witnessed hefty losses, although not nearly as deep as September’s tumble. But it’s not entirely surprising. Faith has faded in large swaths of the U.S. economy and investing strategies generally this past month, and GMPI wasn’t immune to the virus.
We’ll be analyzing why GMPI stumbled so horribly last month in the coming days, provide some historical perspective, and what it means for broad asset-class based strategies generally. For now, we’ll let the red ink above speak for itself.
One housekeeping note: the performance numbers for the individual asset classes above are based on indices rather than ETFs and mutual funds, which was the norm previously. That will be the standard going forward, in part because GMPI is based on indices rather than securities products and so the adjustment provides a more apples-to-apples comparison between the components and the global portfolio.

Yesterday’s huge tumble in the stock market has spread fear far and wide among investors, your editor included. But focusing on the here and now isn’t the answer. This too shall pass, but not anytime soon.
What’s a strategic-minded investor to do? Nothing at the moment. If you haven’t been trimming back on risk in your portfolio, now’s not the time to start. Easy to say, tough to do. But investing isn’t easy and panic selling is never the answer. Yes, those are just words and it’s slim comfort when you look at your investments and see only red. But keep in mind that people like Warren Buffett, and institutions like Citigroup and J.P. Morgan have been buying while everyone else is selling. Why? Because they’re looking forward, several years down the road.
We’ll go out on a limb here and predict that the global economy will survive, and in a year or two it’ll be thriving once more. One reason is that there are multiple mechanisms in place to prevent collapse. No, the risk of a deep, systemic failure isn’t zero. And, yes, an asteroid could hit the Earth next week. But for those with a medium/long time horizons, the key question you want to ask yourself: What will you think three years from now looking back?
For the 20 or so years your editor has been writing and investing for his personal account there’s a recurring theme that gnaws: we didn’t take advantage of the calamity. The mind tells us to run when there’s danger, and ride with the crowd when skies are sunny. There’s some logic to that, but left unchecked it leads to mediocrity or worse over time.

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There’s never a good time to release bad news about consumer spending and income, but it’s even worse on the day that’s likely to witness Congress vote in favor of the $700 billion bailout for the U.S. financial system.
Spending that mountain of cash to salve so much self-inflicted pain will inspire no one, least of all investors. Yes, it may provide a short-term bump in prices, maybe. And it may keep the apocalypse at bay, maybe. And the government may get the money back when it resells the assets down the road, maybe. But in the long run, it’s not a productive use of capital. Mopping up spillage never is.
For every argument in its favor, it’s easy to worry about the potential for negative blowback. Did we forget to mention that we’re in uncharted territory here?
Adding to the woes about the limits of Washington’s debt-financed restoration of financial order is news this morning that disposable personal income dropped 0.9% last month, the third in a row. No wonder, then, that personal consumption expenditures were unchanged in August from the previous month.
“With the labor market remaining very weak, slow to negative growth in disposable income will most likely plague the consumer for at least the next six months,” Adam York, an economist at Wachovia Economics Group, told CNNMoney.com.
It’s hard to see the outcome as anything other than recession. “It looks like we are poised to see a real-term decline in personal consumption and that will likely result in a negative GDP number in the third quarter,” James O’Sullivan, economist at UBS Securities opined to Reuters.
As we write, the S&P 500 is off by nearly 4%. Meanwhile, the flight-to-safety instinct is very much humming today. Demand for the 10-year Treasury pushed its yield down sharply to around 3.65% in early afternoon trading, New York time, down from 3.83% at Friday’s close.
The problem at the moment is the unknown. The haziness on the future—future earnings, future real estate prices, future this, future that—is weighing on just about everyone. It’s going to take time—several weeks, at least—to get a halfway decent guesstimate of what the government’s getting for its $700 billion. Add to that the question of how much patience the global markets have for yet another big borrowing binge by the U.S. And what will all this do to Joe Sixpack, and to corporate profitability, and real estate prices, and on and on.
No one really knows, and the depth of the ignorance and the magnitude of its implications have rarely been greater.
Yup, it’s a Monday alright.

As we prepare to enact the mother of all bailout packages, there are lots of questions about how it all happened. As The Big Picture’s ever-perspicacious Barry Ritholtz reminds in Barron’s, even Wall Street needed some help in blowing itself up. Alas, it’s too late for salvation in 2008, but Ritholtz’s brilliant analysis of what happened, and why, well, there’s always the next time. Too bad that enlightenment in the money game is still cyclical. But we can still dream, can’t we?

Surveying the financial and economic landscape looks increasingly like an exercise in watching the perfect storm unfold. Today’s sour updates on durable goods orders, new home sales weekly jobless claims only strengthen the sentiment.
Durable goods first: they’re down. Big time. The government reports that seasonally adjusted new orders for durable goods slumped 4.5% in August, the biggest percentage drop since January. As the chart below reminds, the trend looks equally troubling in actual dollar value as well.

It doesn’t help that on a rolling 12-month basis, new orders for durable goods have fallen for six months running. Ditto for the fact that the back-to-back losses of nearly 5% in July and August for the 12-month change in new orders is the deepest loss for two consecutive months in six years. Let’s not mince words: the trend is definitely not our friend here.

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