Investors thought September was a tough month for the markets. Then October rolled in. During October the U.S. stock market declined by an astounding 16.8%. For the trailing 12 months, the market lost 35.9%. But U.S. stocks weren’t alone in their declines. Foreign stocks (both from developed and emerging countries), commodities, real estate, municipal bonds, corporate bonds and other securities all posted notable declines. The pain that we, as investors, felt was intense.

We have been talking with our clients about staying the course and not letting emotions overrule their investment plans. To reinforce this, on October 30th, we hosted an event that provided participants an opportunity to talk about the current state of the economy and what to expect in the markets going forward. If you attended the event, a lot of what follows will be redundant. However, we think it is important enough to repeat. We think it is safe to say that we are entering into a recession. Preliminary 3rd Quarter GDP declined 0.3% on an annual basis. This is a relatively minor dip, but we expect that next quarter’s decline will be more profound. Recessions are normal and cleansing. In fact, going back to the 1800’s, recessions have occurred on average every four to five years. We expect that this recession will have two themes: the U.S. consumer and the dynamics of the global economy. Until now, we had not seen a pullback in consumer spending for roughly two decades. Given that consumer spending is a large piece of our economy, this could cause significant pressure in some areas. But consumers cannot delay purchases indefinitely. At some point spending will resume and the economy will likely get a boost from the release of this pent-up demand. The second theme is more complex. We are certainly tied into a global economy. The U.S. economy is pulling the world into a slowdown and will likely help pull the world out of the slowdown. The coordinated effort of the world’s central banks is an unprecedented dose of medicine that will soon be working through the economic system and restoring our economic health. Even though we are in a recession, this doesn’t mean that U.S. stocks are poised for additional declines. In fact, during many recessionary cycles, the market actually rallied and posted positive returns. This seemingly contradictory occurrence happens because the market is forward-pricing, meaning that the price is based upon expectations for the future, which are presently very pessimistic. When discussing what to expect from the markets for the remainder of this year and next, we can first assess the magnitude of the decline versus that of past bear markets. If history is any indication, we are most likely near a market bottom. In two significant bear markets (2000-2002 and 1973-1974), the S&P 500 hit bottom after dropping approximately 50 percent. In late October, the S&P 500 had dropped approximately 46 percent from its high. Thus far, we are in “normal bear market territory.” More importantly, when looking at the bear markets of the past 70 years, each was immediately followed by a significant bull market. As a result, investors who sold out near the bottom of the bear market would have also missed a sizeable part of the immediate rebound, thus being hurt twice. Conversely, investors who stayed the course and rebalanced or added to their stock positions actually benefited from the lower stock prices in the long-run. We have certainly been in unprecedented territory in terms of market volatility. Never have we seen the magnitude of the daily and even hourly swings in the market. This high level of volatility makes it very difficult to predict what will happen in the months ahead. But regardless of how 2008 finishes, the prospects for improving markets in 2009 and beyond, despite today’s pain, are actually good. Contact Bill, Charlotte or Ryan if you have questions or would like additional information regarding this topic.