The Capital Advisor

November 2008 - CEO's Monthly Letter

Controlling Risk in a New Environment

Since August 17, 2007 there have been more than 40 separate measures announced by the Fed and Treasury designed to stabilize the credit markets.  The most recent programs follow a similar remediation course to that of past credit bubbles that required direct government investment in banks and deposit guarantees by sovereign governments.  These recent measures, while unparalleled in size and global scope, have successfully contributed to nascent signs of stability. The three month Libor rate has dropped 196 basis points from its highs and the 90-day Treasury bill yield has climbed 37 basis points from its lows as some flight to quality pressures have begun to ease. 

Whether stability continues to emerge or not, everyone must adjust to a new reality in the credit markets and the likelihood that the long-term economic impact of the credit fallout is only just beginning to develop.  What were once considered safe havens or low risk options for cash investments must be reevaluated in this new environment.  Faith in everything from the safety of money market funds, to unwavering reliance in the rating agencies has been completely shaken (not just stirred).

Given that the inherent flaws in many short term investment options have been brought to light by the credit crisis, this month we wanted to explore the intricacies of evaluating risks in money market funds, likely the most common short term investment option available to treasurers. As specialists in separate account cash management for institutions, Capital Advisors Group is certainly prejudiced against many commingled solutions that, by design, cannot allow for the surgical control of credit and liquidity risk in cash portfolios. We prefer to focus on the risks we know, versus the unpredictability of cash flows associated with the pooled assets of money funds or commingled enhanced cash products. That being said, we also understand money funds can be a valuable portion of an overall cash investment portfolio strategy. As such, best practices in money fund selection, paired with the control offered by separate account management, can offer the best of both worlds.

This month we’ve prepared a review of best practices in the selection, use and monitoring of money market funds along with a candid look at the potential drawbacks of these popular investment vehicles. The full article can be downloaded in our Research Spotlight section to the left.

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November 2008

October Economic Recap

October proved to be one of the most erratic and volatile months in the history of equity markets, setting records for single day gains as well as losses. Throughout the month, the US Treasury, the Federal Reserve, the FDIC, the SEC and Congress all moved forward with unprecedented “bailout” programs in an attempt to unfreeze credit markets.  Congress passed a revised version of the $700 billion Emergency Economic Stabilization Act on October 3rd after rejecting the original bill a week earlier. Later in the month, the Commercial Paper Funding Facility, Temporary Liquidity Guarantee Program, and the Money Market Investor Funding Facility were all initiated.  In conjunction with other central banks throughout the world, the FOMC slashed its target rate by 50 basis points to 1.50% in an unscheduled meeting on October 8th and cut an additional 50 basis points at their scheduled meeting on October 28th and 29th.  The FOMC continued to say that market turmoil will cause additional restraint on spending because of the inability of households and businesses to obtain loans. In case you missed them, here’s a review of the economic highlights.  

Labor Market
Weekly jobless claims dipped off of their September highs throughout October, falling to 479,000, however, the less-volatile four-week moving average finished the month higher  at 475,500 (462,500 in September). The Labor Department’s September Employment Report continued its gloomy trend as the labor market lost jobs for the ninth consecutive month, bringing the year’s total job losses to 760,000. Payrolls dropped by 159,000, more than expected, surpassing August’s revised loss of 73,000. The job losses were broad in scope as factory, construction and service industries were all affected. 

Residential Housing
The bad news in the residential housing market continued according to the latest data. Building permits, a leading indicator, plunged by 8.3% in September to a 786,000 pace, a 27-year low. Housing starts fell by 6.3% while single-family starts fell to a 26-year low. Existing home sales jumped more than forecast in September, gaining 5.5%, while the median sale price dropped 9.0% over the last 12 months to $191,600.  New home sales unexpectedly increased in September, climbing 2.7% to a 464,000 annual pace following August’s downwardly revised reading of 452,000. Inventories dropped 7.3%, pushing the inventory to sales ratio down to 10.2 months worth.

Spending
The government’s advance reading of third quarter GDP growth contracted for the second time in the past four quarters, falling to 0.3%, which was above expectations of 0.5%. A massive slump in consumer spending cut GDP by 2.25% in the quarter while residential fixed investment subtracted 0.72%. GDP avoided greater contraction due to massive government spending, a surge in primary defense spending surging, and a sharp reduction of imports.  Spending by the business sector was positive this month as durable goods orders less transportation rose 0.8% in September, exceeding estimates of a 1.1% decline.  Manufacturing activity, as measured by the ISM Manufacturing index and the Philadelphia Fed index, showed that manufacturing has slumped to the lowest level in years. The ISM reading dropped to 43.5 – well below the 50 mark that separates growth from decline. The Philly Fed index plummeted at the fastest pace in twenty years in October, falling to -37.5, compared to 3.8 the previous month.  The Conference Board’s consumer confidence index rose in September, but the survey was completed before the most recent turmoil in the financial markets. Retail sales in September dropped by 1.2%, the most in three years, marking the third consecutive month of decline.  Overall, personal spending dropped 0.3% in September, more than the expected 0.2% decline.

Inflation
Falling global food and energy prices coupled with the Fed rate cut helped to curb inflation pressures last month.  At the wholesale level, the Producer Price Index sank for the second straight month in September, falling 0.4%, while core PPI rose 0.4%, doubling expectations.  Year-over-year, core PPI has increased 4.0%, marking the largest year-over-year jump since 1991. The Consumer Price Index was unchanged in September and the reading matched expectations. Consumer prices were 4.9% higher than a year earlier, and core consumer prices were higher by 2.5% in the same period.  Finally, the price gauge tied most closely to consumer spending and a rumored favorite of the Fed, the core personal consumption expenditures gauge, has risen 2.8% over the 12-month period.

Looking forward to the next FOMC meeting on December 16th, current fed futures contracts are pricing in 100% odds of additional rate cuts, which would bring the target rate below 1.00%.

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