A Volatile Recovery: The Capital Markets for 2012
BY ROBERT C. SMITH, MANAGING DIRECTOR & TERESA C. KOHL,
DIRECTOR, SSG CAPITAL ADVISORS, LLC
The U.S. emerged from the longest recession since the 1930s fraught with an uncertainty that continues
to plague the capital markets. Concerns
over the faltering U.S. recovery; European
bank and sovereign debt issues; and U.S.
federal spending, policy changes, and
presidential election results, buffeted by
a series of self-inflicted, confidence-bashing episodes, have contributed
to anxiety throughout the system.
been in an expansion period for three
years. At this point in the cycle, historical
analysis would suggest that markets
will expand, employment data will
improve, housing prices will stabilize,
and consumer confidence will increase.
However, the latest recovery appears
more volatile and difficult to measure
than any previous post-recession period.
The barrage of negative headlines
might seem to imply that the capital
markets are frozen. However, certain
positive trends based on recent market
statistics could indicate a thaw, as
investors pursue safe, quality assets.
Crisis of Confidence
In the past 12 months, the capital markets
have dealt with one crisis after another,
punctuated by systemic institutional
lapses and global governmental and
regulatory uncertainty. The crisis
of confidence that spread from the
collateralized loan obligation (CLO)
market to the commercial paper
market and led to declines in corporate
lending during the recession has been
replaced by a crisis of confidence
in the capital market system.
Historically, recessions have had a
definitive beginning and substantive
decline in economic activity and
have ended in a trough that marks
the beginning of the next expansion.
An expansion does not necessarily
mean that favorable economic
conditions or normal operating
capacity has returned. Economic
activity can remain below expectations
well into an expansion cycle.
Taken independently, some metrics
do appear to reflect improvement. U.S.
housing prices have recently begun to
stabilize throughout most of the country.
The National Board of Realtors and
the latest Fiserv Case-Shiller Indexes
reported modest rebounds as housing
inventory levels shrank across the U.S.
With record low mortgage interest rate
environment, total existing home sales
in the second quarter of 2012 were 8. 6
percent above the second quarter of 2011.
The institutional lapses at JP Morgan
Chase & Co., weak money laundering
controls at HSBC, the LIBOR scandal at
Barclays, allegations of regulatory and
legal violations at Standard Chartered
Bank, and trading disruption at market-maker Knight Capital Group have done
little to minimize the volatility of the
economic recovery. Taken in isolation,
each of these events would cause only
ripples of concern, but the cumulative
effect casts doubt on the sustainability
of the “too big to fail” banking model
and further erodes confidence.
The National Bureau of Economic
Research, the official arbiter of U.S.
recessions, determined that the
last recession ended in June 2009.
Accordingly, the U.S. economy has
Conversely, there is little evidence
of the sustained growth expected
at this point in the recovery cycle.
The unemployment rate edged up
to 8. 3 percent in July, while gross
domestic product (GDP) for the
second quarter grew at a meager 1. 5
percent, well below the norm of 3. 3
percent. Economic activity appears
to be stagnant, and the explanation
can be found in the headlines, where
volatility has become the norm.
Adding to the turmoil is anxiety over
public finance, questions about the
safety and quality of government debt,
and shifting opinions of debt service
obligations, as reflected by ratings
agencies’ warnings and the uptick in
municipal bankruptcy filings. Municipal