AS the US stock market limps through the final days of a year so disastrous that it will perhaps reverberate for decades to come, investors, economists and fund managers are having many unanswered questions on their minds.
What, for example, happened to bring about the worst financial crisis since the Great Depression, and how could they have failed so badly to foresee it coming? Coupled with those are a set of more immediate questions: how much worse the economy will get next year and is there a chance for US corporations to slow the bleeding and keep their bottom lines from hitting rock bottom by the end of 2009?
The events of 2008 that have brought some of the world's largest corporations, most successful investors and even entire countries to their knees, loom large in those calculations. Last year at this time, Wall Street's market strategists were seeing storm clouds brewing for the stock market, and warning of a tumultuous year, but no one foresaw the crisis nor the historic crash in store.
While most of the top analysts The Business Times spoke with last year voiced concerns as 2008 dawned, single-digit gains for the major stock market indexes was the consensus forecast among Wall Street analysts.
'Going forward, it's vitally important to see what we missed this year and make sure we don't do so again in order to make intelligent assessments of the stock market and individual companies we advise our clients to invest in,' said Charles Crane, chief investment strategist at Scotsman Capital Management, who was expecting a mid-single-digit advance for the Dow Jones Industrial Average and the S&P 500 heading into 2008.
What he, and nearly everyone, missed was the extraordinary and pervasive impact the sub-prime mortgage fiasco, which had already cost banks upwards of US$40 billion by the end of 2007 and had sent the housing market into a year-long plunge, would have on nearly every sector of the financial world and the economy.
The crisis spread in fits and starts, building like incurable, air-borne contagion across every credit market even as government and corporate leaders declared that the worst of the crisis had passed as late as last August.
It wasn't until the full extent of the crisis finally erupted in mid-September that anyone seemed to truly comprehend the toxic effects of a disease whose first symptoms were manifested with the sub-prime mortgage-inspired downfall of two relatively small hedge funds run by Bear Stearns back in February of 2007.
By then it was too late to do more than apply emergency first aid to keep the entire global financial system from collapsing, as stock market investors raced out of the teetering banks and the entire market, first bringing down investment houses, banks and insurers before moving on to sow panic and destruction in industries from retail to car-making.
'We were wondering about the ripple effect from the housing and credit market problems and what we got instead was a tsunami,' said Ryan & Beck chief investment strategist Joe Battipaglia, who had forecast 2008 gains of 8 per cent despite his own warning last year that 'the extent to which the credit crunch will harm the rest of the economy beyond banks and housing' is uncertain.
Top market strategists such as Tobias Levkovich, Citigroup's chief investment strategist, went so far as to argue for double-digit stock price appreciation after what he termed a disappointing 2007, banking on the expectation that the economy would be able to avert a recession and banks would be able to bounce back during the second half of the year once the sector's problems were cleared out of the way and even lead the market.
Lead it did, of course, but in a crashing death-spiral that forever changed Wall Street. It left burning wreckage of the once-mighty Bear Stearns and Lehman Brothers, turning Fannie Mae, Freddie Mac and AIG into US$500 billion plus worth of de facto nationalisation efforts, severely wounding once-mighty Merrill Lynch so badly it was forced to sell itself to Bank of America, forcing investment banking titan Goldman Sachs to turn itself into a bank holding company in order to qualify for government aid, and nearly wiped out global banking behemoth Citigroup.
'It's a cliche to call it a perfect storm of disasters but that's what happened,' said Larry Adam, chief investment strategist at Deutsche Bank, who pointed out that despite the extreme turmoil besetting the housing and credit markets and financial sector throughout the year, the overall stock market was only down 13 per cent. 'We were having a tough year, but until the Lehman crisis, we were still talking about a rally in the last two quarters. Up to that point, corporate high yields were just down 2.3 per cent, and the Reits were actually up by one per cent.'
Indeed, before Sept 15, the CEOs of Lehman and Citi were competing with Treasury Secretary Henry Paulson for who could throw around the most assurances, Fed policymakers were fretting over inflation nearly as much as the slowing economy and the tight credit markets, and economists were still debating whether the US economy could stave off a recession.
Should Wall Street's highly paid analysts and money managers have been better able to interpret the long, steady stream of worrisome information and data flowing from financial companies since early in 2007?
'Yes, we should have,' answers Scotsman Capital's Mr Crane. 'Some of the essential clues were missing, because the banks and investment houses most closely tied to the credit crisis not only kept that information from us, but didn't understand it themselves until it was too late,' he said. Mr Crane, of course, was talking about the hugely leveraged exposure to toxic mortgage-back securities that many financial institutions kept squirrelled away in off-balance sheet accounting.
'But we had plenty of warning shots to let us know that something fishy was going on and big trouble was brewing, starting with the collapse of the Bear Stearns hedge funds in early 2007, and Bear Stearns itself last March. If I had to boil it down to one glaring mistake, it was the assumption that real estate prices couldn't go down by so much or for very long, and the failure to understand how dependent every other financial market had become on the real estate market,' he said.
As Mr Crane assembles his forecasts for 2009 and assesses the opportunities and risks of individual stocks investments, Wall Street pros like him say the disaster of 2008 has forever changed the way they look at stocks.
This article was first published in The Business Times on December 27, 2008.
