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A Little Healthier, Psychologically
By: Dr. Charles Lieberman
Date: 4/13/2009
Five weeks of strong gains has investors asking if the turnaround is at home, while others dismiss the rally as a bear market rally. Better economic data, along with unexpected profits at Wells Fargo, suggests that the worst is over. There's little doubt more bad news is coming. The huge job losses will not suddenly turn into large hiring binges. GM and Chrysler are still likely headed for bankruptcy. Credit market conditions, while improving, are hardly normal. Still, the pace of decline is slowing, the economy appears to be bottoming and improvement increasingly likely lies ahead. That's a good foundation for the equity market to start improving.
Investors are still waiting for the results of the bank stress tests, even as the steep yield curve and the decline in mortgage rates is surely doing wonders for bank profits. While George Soros claims the banks are insolventwell, of course, they are, since no bank has sufficient capital to value all of its assets at stressed pricesnet interest income is providing a large earnings stream against which banks can write down questionable assets. In time, the write downs will cease, but the revenues will keep rolling in. That would end the credit crisis. Until then, signs of improvement in credit will be observable in the risk spreads, which continue to narrow. Capital flows into riskier assets have picked up. Demand is strong for new corporate bonds issues and cash is moving into junk bond funds. Rates on jumbo mortgages have also declined.
Estimates for second quarter economic growth have been revised upwards, although a large decline is still expected. Still, such a decline will not be taken badly, if it is half inventory liquidation at a massive rate, which is unsustainable. Firms must restock just to keep up with the current low level of demand. If demand picks up, as should happen in response to the fiscal stimulus, mortgage refinancing, and other factors, then GDP should experience a very positive jolt.
Equity investors have gotten the message. While some sort of setback would be entirely normal after a strong run, equities should move upward as long as credit market conditions continue to improve and economic growth remains on course to bottom and pick up. In this case, sell offs are opportunities to buy at lower prices. These trends are not locked into place quite yet, but the signs are becoming more promising by the day.
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