The World Needs A Stronger Blog...

Many shell-shocked investors may be hesitant to look at their most recent mutual fund and brokerage account statements, and they probably tuned out CNBC weeks ago and that's understandable, given the market's manic mood and all the gloom and doom talk about recession, a bear market and whether we have reached a bottom in stocks. Thanks to the demolition of the housing market, the credit crisis and $100 a barrel crude oil, the U.S. economy is in recession – or so close that it would be quibbling to say otherwise. The stock market is bumping against bear market territory with the S&P 500 index down about 16% from its high. In short, the market is about as unstable as doing 90 in an '85 Toyota Tercel, and many investors are growing impatient. Investors have been burned several times in the last nine months by assuming the market bottom had come. So there is a whole lot of skepticism out there. Two issues will continue to weigh on stocks and the economy, and until they are resolved – or at least until investors get some clarity on these matters – the market melancholy will remain. Cue The Cure's "In Between Days"...

First, and most importantly, the collapse in housing continues to vex the market. The housing bubble was years in the making, and it won't be resolved next week. Secondly, the large investments banks – whats left of them anyway, brokerage firms and mortgage lenders need to regain their financial footing, regain the confidence of investors and start lending again. Investors are really panicked right now, and it doesn't help that the Fed and government officials have been denying that we are in recession when every indication is that we are. It makes everyone look very foolish- like they have a guilty conscience and can't be trusted. Which is not good.

The first quarter got off to a horrendous start in January with the DJI average giving up 10% – its worst start of a year ever. Stocks continued to decline even after the Fed cut short-term interest rates by 0.75% points at an emergency meeting on Jan. 22. In fact, the S&P 500 came close to bear market range – defined as a 20% decline – on the very day the Fed lowered rates. It fell to an intraday low of 1,274.29 – a 19.1% drop from its high of 1,576.09 on Oct. 11, 2007. But the central bank was just getting revved up. It cut interest rates again by one-half of a percentage point only a week later on Jan. 30, bringing the key rate to 3 %

That seemed to stabilise the market a bit, and stocks at least treaded water through February. But this was just a prelude to another round of volatility in March. With the economy and the stock market continuing to struggle, the Fed has taken an axe to interest rates and shoved money into the banking system by the truckloads. It is trying to stave off recession and prop up ailing banks by adding "liquidity" – that means money – to the system by slashing interest rates.

Yadda, yadda, yadda so now the question is this: Will the Fed's actions prop up the sagging economy, stabilise housing, ease the credit crunch, raise consumer confidence and give new life to the stock market? It's a tall order. Not unlike asking for ink-marbled stracchiotte with frutti di mare alla marinara at a Greek diner.

I believe at this point the only factor that will inject stability is time – time without the market hitting new lows; and time without more declines in the housing statistics. Everything needs to level the fuck out for a minute. Everyone needs to relax. The economy grew at just a 0.6% pace in the fourth quarter of 2007, meaning that it all but stalled. First-quarter numbers aren't available yet, but the consensus is that the economy probably turned negative to flat. This economic lethargy was reflected in corporate earnings growth, which declined by 21% in the fourth quarter. First-quarter earnings aren't expected to be much better. Many companies will release their earnings reports in about two weeks. Dun Dun Dunnnnnnnnn. So we may not know for sure if we are in an economic recession yet, but we are definitely in an earnings recession.

The collapse in the housing market continues unabated. It was bad enough when home prices dropped 8.9% in the fourth quarter of 2007. But home prices dropped almost 11% in January. Almost 3 million homeowners were behind in their monthly mortgage payments. By some estimates more than 2 million families will have their homes foreclosed on this year. The number of homeowners facing foreclosure climbed almost 60% in January compared to the same month a year ago. Many market experts said it's hard to say the stock market has bottomed with that kind of financial hardship lurking about. Many homeowners owe more on their homes than they are worth. And lenders have never before owned this high of a percentage of the average American's home. We have to start getting mortgage defaults behind us. If and when that happens banks can feel more comfortable increasing their mortgage portfolios. Then the banks, brokerage firms and mortgage companies will start packaging those mortgages again and selling them to institutions, which is how the system is supposed to work. K?

Institutional investors, pension funds, hedge funds and other large investors will only start buying them again when they see that there are fewer defaults. Unfortunately, falling home prices and rising defaults are only part of this story. The inventory of unsold homes has hit historically high levels. For years, the number of existing homes for sale has hovered around 1.5 million to 2 million. Currently, the number is more than 4 million.

What the fuck does this all mean you say? This means home prices are likely to keep falling for at least another couple of years as this inventory is worked off. The stock market is not likely to stabilise until the housing situation improves, and that could take some time. A lot of people don't realise that housing cycles take a long time to run their course. The average bear market in stocks is 15 months, but in real estate the cycles last for five years. So act like you know.

The meltdown in the subprime lending market has been well chronicled for months now. Too many people with poor credit bought homes they couldn't afford. For a long while there if you paid your credit cards on time, or at least one of them, and you had a pulse, you could get a $3M mortgage from someone. The question, though, since the fall of 2007 has been just how deep the problem extends into the nation's largest financial institutions, which packaged and sold these loans as high quality securities. And we all know what happened next on the weekend of March 14-16. Gulp.

Perhaps the first ray of hope that the banking system might be on the mend came March 18 when Goldman and Lehman Brothers, announced better than expected earnings. Shares of Goldman, the world's largest investment bank muhahaha, climbed 16% on the news, while Lehman stock rose 46 %. It is all about getting some clarity from the banks. It is not so important how much of their loan assets they write down, but rather it is what they say about the future. If the banks don't give us clarity, we will go down and hit that 20 % bear market level.

An improvement in the banking situation is an important first step to solving the economic puzzle. When banks start lending again it might be safe to conclude that stocks will move higher... and pay close attention when Citigroup Inc. reports earnings. It is premature to say the bear market is over and to write its obituary but certainly if we hear Citi say it is starting to lend again, then you can begin to conclude that the worst is over.

That is all. Carry on.