jp morgan Short Story

In a classic ghost story, some terrible event occurs in a house. Months or years later, long after all the physical evidence of the event is gone, a presence lingers in the house, frightening the inhabitants into behaving in ways which would normally be regarded as unbalanced.

In some ways, global financial markets today are akin to a haunted house. The terrifying event was the financial crisis, which reached its ferocious extreme in the weeks after the failure of Lehman Brothers in the fall of 2008, and triggered a very painful and deep global recession. In the past year, the financial and economic storms have eased, with the stock market seeing impressive gains and the U.S. and global economies gradually embarking on a path of recovery. However, central governments, central bankers, consumers, business people and investors are all still haunted by the memory of the financial crisis and their current actions are still very influenced by these fears. All of this can be seen in the environment facing U.S. investors today.

• The Federal Government took extraordinary measures both to combat the financial crisis and the recession which followed. While some of these measures were undoubtedly necessary to prevent the crisis from worsening, in its aftermath, U.S. government debt is ballooning. Moreover, the normal political push-back to expanding government has been muted by the shock of the financial crisis. Many in Washington appear scared that the private sector will be unable to recover on its own or to avoid another bubble. This may be a prejudice, but the net effect of this prejudice will likely be to raise Treasury interest rates in the short-run and increased taxes in the long-run.
• The Federal Reserve also remains haunted by the crisis. Even as the economy and markets recover, it is maintaining extraordinarily low short-term interest rates, and may do so for longer than would normally be the case because of its fear of an economic or financial relapse. One side effect of this policy is to squeeze investors who are holding their wealth in short-term accounts such as CDs or Money Market funds.
• Consumers are haunted by this crisis. Consumer confidence, while up slightly from its lows, remains extremely depressed for this stage of an economic recovery. One side effect of this may be a slower-than-normal unwinding of the pent-up demand for autos and housing which should have built up over the course of the recession. While this is impeding a very strong bounce-back in the economy in the first year of recovery, it may also, perversely, support the expansion for longer than would normally be the case.
• Businesses also seem extraordinarily nervous about the economic outlook. This has resulted in an inventory correction of historic proportions and only an anemic recovery in business equipment spending so far. However, as is the case on the consumer side, this slow recovery in demand suggests that above average growth in the cyclical components of business spending should provide mild support for an expanding economy for years into the future.
• And finally, investors remain haunted by a lost decade for stocks culminating in the huge losses of 2008 and early 2009. As a reflection of this, last year, despite a nice stock market recovery, investors withdrew $9 billion from equity mutual funds while plowing a record $375 billion into bond funds. In early 2010, this pattern appears to be continuing, despite very strong earnings growth and low bond yields that logically should be pushing money the other way.

All of this, to some extent, is the emotional legacy of the events of late 2008—fears which, borne of great stress, will take time to abate. However, for investors, it is important to realize that over

In a classic ghost story, some terrible event occurs in a house. Months or years later, long after all the physical evidence of the event is gone, a presence lingers in the house, frightening the inhabitants into behaving in ways which would normally be regarded as unbalanced.

In some ways, global financial markets today are akin to a haunted house. The terrifying event was the financial crisis, which reached its ferocious extreme in the weeks after the failure of Lehman Brothers in the fall of 2008, and triggered a very painful and deep global recession. In the past year, the financial and economic storms have eased, with the stock market seeing impressive gains and the U.S. and global economies gradually embarking on a path of recovery. However, central governments, central bankers, consumers, business people and investors are all still haunted by the memory of the financial crisis and their current actions are still very influenced by these fears. All of this can be seen in the environment facing U.S. investors today.

• The Federal Government took extraordinary measures both to combat the financial crisis and the recession which followed. While some of these measures were undoubtedly necessary to prevent the crisis from worsening, in its aftermath, U.S. government debt is ballooning. Moreover, the normal political push-back to expanding government has been muted by the shock of the financial crisis. Many in Washington appear scared that the private sector will be unable to recover on its own or to avoid another bubble. This may be a prejudice, but the net effect of this prejudice will likely be to raise Treasury interest rates in the short-run and increased taxes in the long-run.
• The Federal Reserve also remains haunted by the crisis. Even as the economy and markets recover, it is maintaining extraordinarily low short-term interest rates, and may do so for longer than would normally be the case because of its fear of an economic or financial relapse. One side effect of this policy is to squeeze investors who are holding their wealth in short-term accounts such as CDs or Money Market funds.
• Consumers are haunted by this crisis. Consumer confidence, while up slightly from its lows, remains extremely depressed for this stage of an economic recovery. One side effect of this may be a slower-than-normal unwinding of the pent-up demand for autos and housing which should have built up over the course of the recession. While this is impeding a very strong bounce-back in the economy in the first year of recovery, it may also, perversely, support the expansion for longer than would normally be the case.
• Businesses also seem extraordinarily nervous about the economic outlook. This has resulted in an inventory correction of historic proportions and only an anemic recovery in business equipment spending so far. However, as is the case on the consumer side, this slow recovery in demand suggests that above average growth in the cyclical components of business spending should provide mild support for an expanding economy for years into the future.
• And finally, investors remain haunted by a lost decade for stocks culminating in the huge losses of 2008 and early 2009. As a reflection of this, last year, despite a nice stock market recovery, investors withdrew $9 billion from equity mutual funds while plowing a record $375 billion into bond funds. In early 2010, this pattern appears to be continuing, despite very strong earnings growth and low bond yields that logically should be pushing money the other way.

All of this, to some extent, is the emotional legacy of the events of late 2008—fears which, borne of great stress, will take time to abate. However, for investors, it is important to realize that over time these fears will abate. The Federal Government and Federal Reserve will stop over-nursing the economy. Consumers and businesses will become more optimistic, spurring the demand for houses and cars and technology and workers. And financial market participants will see the risk in being too timid as clearly as the risk in being too bold. As always, though, the key for individual investors is to invest in a logical and balanced way today to take advantage of a gradual easing of the fears set in motion by the scary events at the end of the last, very difficult, decade.

time these fears will abate. The Federal Government and Federal Reserve will stop over-nursing the economy. Consumers and businesses will become more optimistic, spurring the demand for houses and cars and technology and workers. And financial market participants will see the risk in being too timid as clearly as the risk in being too bold. As always, though, the key for individual investors is to invest in a logical and balanced way today to take advantage of a gradual easing of the fears set in motion by the scary events at the end of the last, very difficult, decade.