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Step by Step
By: Dr. Charles Lieberman
Date: 4/20/2009
Opinions on the sustainability of the rally in the stock market cover the waterfront, with some people thinking the new bull market has started, while others think it is just another bear market trap that will soon set new lows. Both the economy and credit markets must show clear signs of recovery to keep the rally going. Neither is sufficient by itself, since alone, either would falter, taking stocks down, too. The good news is that prospects continue to improve for the economy and the credit markets.
The progress of credit markets is easy to track by looking at risk spreads, new bond issuance, stock issuance, and trading activity. All are moving in the right direction. Last week, the first stock IPO of 2009 was launched successfully, while even junk bond issuance has picked up. It is becoming more difficult to find high grade bonds at attractive yields and it is no longer possible to be as choosy about our purchases as we were just two weeks ago. Asset backed bond activity has picked up and mortgage rates are comfortably below 5%. These are all good signs.
The economic data have moved from being uniformly dismal to quite mixed. The starkest contrast is between measures of sales and production. Production is still falling noticeably, but sales are flat or just declining slowly. This suggests that inventories must be plunging, which is confirmed by the inventory data. This disparity is unsustainable. Indeed, regional purchasing manager surveys and unemployment claims suggest that production is starting to stabilize. The housing market also seems to be plumbing bottom, as new construction is flattening out, while inventories are declining even with a range bound pace of sales. Thus, the momentum to the downside has been broken.
Circumstances are likely to continue improving, but significant risks remain. Investors will likely need to cope with formal bankruptcy filings for GM and Chrysler. The results of the stress tests of the banks may accompany new capital investments in the weakest of the large banks. Commercial real estate firms are still finding credit expensive or unavailable. None of these problems is a secret either to the Fed or investors and it is promising that the Fed is working on solutions. The damage caused by the credit crisis will not be relieved overnight, but that's also not necessary. What is necessary is that visible progress continues towards economic recovery and healthy credit market conditions. Ongoing progress is sufficient to keep the rally going.
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