Enduring Headwinds

Executive Summary

Our five core themes for the risk-averse, short-duration, and buy-and-hold corporate cash investor are:

1. Economy and Interest Rates: Looming Recession Risk and Lower Rates
2. Corporate Credit: Battered and Cheapened, but Not Down and Out
3. Market Technical Factors: A Wary Market Short on Liquidity
4. Asset-backed Securities (ABS): Show Me the Collateral
5. Return Expectations: A Steady Hand Wins the Game

As we read our tea leaves for 2008, a note of caution for the reader is in order as both the market and the economy are in a precarious situation fighting the housing and credit double corrections.

Enduring Headwinds

What a difference a year makes! A year ago, we titled the article of our 2007 outlook “Mostly Smooth Sailing with Occasional Choppy Water.”. However, what we experienced was more like a tsunami. As the subprime credit crisis played out longer and harder than most expectations, many corporate treasury investors were especially impacted. This is because many of the bruised asset types including money market funds, asset-backed commercial paper and auction rate securities were investments of choice in some cash portfolios.
Last year we properly forecasted the general direction of market developments but underestimated the great reversals of market liquidity and investor euphoria. While conservative investors were rewarded with respectable returns, they did not do so without some anxiety and restlessness. As we try our tea leaves again for 2008, a note of caution for the reader is in order as both the market and the economy are in a precarious situation fighting the housing and credit markets double corrections.
As with all of our publications, we are mindful of the relevancy of market outlooks for the risk-averse, short-duration, and buy-and-hold corporate cash investor. Here are our five core themes for the New Year.
1. Economy and Interest Rates: Looming Recession Risk and Lower Rates
The subprime crisis and an ensuing liquidity crunch forced the Federal Reserve’s hand in lowering the benchmark federal-funds rate by a full percentage point to 4.25%. The Fed did so without taking its eye off the inflation ball. We thought the GDP would be below the economy’s long-run potential, at just under 2% annualized. It turns out that the U.S. will have grown at a respectable pace of 2.5% (assuming 1% for the fourth-quarter). Even as the housing and credit markets sank deeper, the third and fourth quarters posted strong growth rates of 3.8% and 4.9%, respectively.
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