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Stock Market Turmoil

- Looking Back to Look Forward

Wei (Victor) Huang

Shidler College of Business

University of Hawaii at Manoa

AmCham Vietnam

Ho Chi Minh City

April 2018

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Financial crisis – a review

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The Bear - WSJ March 3, 2009

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The Most Chaotic Week in Wall Street History9/12/2008 -9/19/2008• Treasury Secretary Henry Paulson, Fed Chairman

Ben Bernanke, and NY Fed chairman Timothy Geithner met and decided not to rescue Lehman Brothers Holdings Inc.

• On September 15, 2008, Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection

• Worst losses in Wall Street since 9-11• Dow Jones dropped by 504.48 (↓ 4.42%), • S&P 500 down by 59.00 (↓ 4.71%)

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Stock Industry Sept. 12 Sept. 15 Change %Change

Boeing Aerospace/Defense 63.3 62.25 -1.05 -1.66%

United Technologies Corporation Aerospace/Defense - Equipment 64.46 63.12 -1.34 -2.08%

Microsoft Applications Software 27.62 26.82 -0.8 -2.90%

General Motors Auto - Cars/Light Trucks 13.01 11.41 -1.6 -12.30%

Coca-Cola Beverages - Non-Alcoholic 54.5 54.75 0.25 0.46%

DuPont Chemicals - Diversified 46.39 44.74 -1.65 -3.56%

Hewlett-Packard Computers 46.97 45.33 -1.64 -3.49%

IBM Computers 118.97 115.19 -3.78 -3.18%

Procter & Gamble Cosmetics & Toiletries 73.15 72.14 -1.01 -1.38%

3M Diversified Industrials 70.15 68.88 -1.27 -1.81%

General Electric Diversified Industrials 26.75 24.6 -2.15 -8.04%

Intel Electronic - Semiconductors 20.16 19.36 -0.8 -3.97%

American Express Finance - Credit Card 38.95 35.48 -3.47 -8.91%

Citigroup Finance - Investment Banking/Banking17.96 15.24 -2.72 -15.14%

JPMorgan Chase Finance - Investment Banking/Banking41.17 37 -4.17 -10.13%

Caterpillar Machinery - Construction & Mining 65.46 63.21 -2.25 -3.44%

Merck Medical - Drugs 33.82 32.72 -1.1 -3.25%

Pfizer Medical - Drugs 18.62 18.05 -0.57 -3.06%

Johnson & Johnson Medical Products 70.59 69.61 -0.98 -1.39%

Alcoa Metal - Aluminum 28.67 26.93 -1.74 -6.07%

American International Group Multi-Line Insurance 12.14 4.76 -7.38 -60.79%

Walt Disney Multimedia 33.26 32.36 -0.9 -2.71%

Chevron Corporation Oil - Integrated 84.24 80.09 -4.15 -4.93%

ExxonMobil Oil - Integrated 77.5 73.25 -4.25 -5.48%

Home Depot Retail - Building Products 28.8 28.5 -0.3 -1.04%

Walmart Retail - Discount 62.41 61.63 -0.78 -1.25%

McDonald's Retail - Restaurants 64.06 63.72 -0.34 -0.53%

Bank of America Super-Regional Banks - US 33.74 26.55 -7.19 -21.31%

AT&T Telephone - Integrated 31.54 29.96 -1.58 -5.01%

Verizon Communications Telephone - Integrated 34.49 33.24 -1.25 -3.62%

Dow Jones Industrial Average 11,421.99 10,917.51 -504.48 -4.42%

Dow 30 Component Stocks

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Three months – Merrill Lynch -- freefall for financial stocks

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3 months -- AIG

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The Starting Point of the Crisis

• Fannie Mae Founded by the government in 1938– Became private in 1968

• Freddie Mac– Founded 1970– Created to compete with Fannie Mae

• Total mortgage related assets holdings: $740 billion in 1990, 5.3 trillion in 2006. Increased by 6 times, one-fifth is subprime mortgage. (Time Magazine)

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Sub-Prime Mortgage Crisis

• Excess liquidity on the loan market led to housing bubble

• Subprime mortgage crisis caused difficulty among mortgage banks

• Credit contraction

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Housing Bubble

• Real estate price increased 85% from 1996 to 2006

• Low interest rates

• Easy access to mortgages

• Banks were almost worry-free: make money from foreclosure in case of default.

• No regulation on loan broker: Mortgage brokers – the Case of Florida

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The Trigger

• In 2006, the rating companies downgraded banks that issued bonds linked to subprime mortgages.

• Investors avoid these banks’ stocks and bonds. These banks started to face liquidity crunch and were forced to reduce credit and raise interest rates.

• Borrowers of subprime mortgages start having difficulty in making payments. (especially for adjustable interest rates)

• Housing supply increased, price hike stopped.

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The Trigger

• Foreclosure increased, mortgage became greater than housing value, default shot up.

• Banks’ bad assets increased quickly.

• Several waves: 1) mortgage banks, 2) investment banks that sells mortgage-related derivatives 3) Insurer such as AIG

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Bank Loss

• In its survey, the American Bankers Association reported that 27% of the nation's 8500 banks held preferred shares in Fannie and Freddie in their investment portfolios. The shares are expected to be worthless.

• The survey found that 85% of the affected institutions were community banks -- those with less than $1 billion in assets.

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789 billion Stimulus plan

• part of the breakdown of the spending part of the New Stimulus.

- Health & Human Services, Labor & Education $91.3 Billion.- Medicaid Provisions $89.7 Billion.- State Fiscal Stabilization Fund $79 Billion.- Transportation and Housing Development $62.3 Billion.- Assistance for Unemployed Workers $45.7 Billion.- Health Insurance for Unemployed $40.8 Billion.- Agriculture, Nutrition, Rural Development $26.9 Billion.- Health Information Technology $20 Billion.

• The stimulus also will provide government grants in clean energy, Education, and other programs.

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Looking for Bargains: (Wall Street

Journal November 1, 2008)

The market has been in a long bull run (S&P 500) (about 34% -

second greatest since World War II)

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Dow 30

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Looking Forward

• Worries: – Inflation

– interest rates

– trade war

– over-correction

– Escalated regional conflict

• Offsets: – No recession likely

– EPS growth expectations for 2018 approach 20% (source: CFRA)

– Net-negative real-rate environment

– Tax cuts and infrastructure spending

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May see increasing volatilities

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History of declines

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Mid-term election-”Uncertainty” (source: CFRA)

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Recession?

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EPS

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P/E ratio of S&P 500 index

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Time to invest in international market?

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About forecast

• John Kenneth Galbraith once said: “the only function of economic forecasting is to make astrology look respectable”