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Jewish World Review
January 29, 2008
22 Shevat 5768
Sorting out the stock market
By
Gail Marks Jarvis
http://www.JewishWorldReview.com | (MCT)
Wall Street loves slogans. One of the most popular is: Don't fight the Fed.
If the Federal Reserve is lowering rates, the saying goes, investors should go with the flow, buy stocks, and sooner or later benefit from the ability of consumers and businesses to borrow money at lower interest rates.
In theory, both consumers and businesses can't resist the urge to borrow at enticing rates. So with rates down, they spend money on everything from sweaters to vacations to computers and business equipment. Then companies benefit from rising sales and profits. And because stocks in theory rise based on company profits, the low interest rates the Fed sets in motion generally end up giving the stock market a boost.
But this time, the economy is weakened because consumers are in over their heads with mortgage debt, and financial institutions are stuck with billions of bad mortgage-related securities. That means investors aren't so sure they can count on the usual market elixir.
To Bob Rodriguez, manager of the FPA Capital and FPA New Income funds, the question hanging over the stock market is: Can you cure an excess of indiscriminate borrowing by giving incentives to borrow more?
Analysts are currently trying to decide if interest rate cuts and a stimulus packages will help or hurt.
Mark Zandi, of Moody's Economy.com, sees Fed cuts and Washington's proposed tax rebates as a step in the right direction. Consumers with mortgages about to reset to new rates might now be able to hold onto affordable rates rather than facing payments they cannot tolerate. That should keep people from losing homes and pouring more houses for sale into an already glutted market.
Meanwhile, consumers may have lower interest rates on everything from credit cards and car loans to home-equity lines of credit and college student loans. But lenders are monitoring credit histories closely, so those who have overindulged may not find relief.
And the housing mess that's been weighing on the economy and stock market is far from over. Homes are still priced twice as high as the ability of people to buy them in areas such as Miami, according to Zandi. And some analysts, including Merrill Lynch economist Sheryl King, continue to expect prices to drop a total of 25 percent over the next two years.
Fed rate cuts and the checks consumers will receive will be like starting to treat a serious infection, Zandi said. "It doesn't get rid of the infection, but it brings down the fever and buys time to treat the infection."
Zandi said the economy and, consequently, the stock market's problems won't be solved unless confidence is restored to the financial system. Despite $50 billion in writedowns, investors suspect that financial behemoths continue to have billions of dollars in mortgage-related security messes that will impair their ability to lend money to consumers and businesses.
Ultimately, money won't be freed up for loans until the market figures out how to put a value on mortgages and mortgage-related securities that were designed based on faulty models. And investors such as legendary money manager Jeremy Grantham say investors will be leery of the stock market as long as questions remain about the strength of the financial system.
Early last week, investors bought stocks in many of the large financial institutions, figuring that after 30 percent drops they weren't likely to sink further. Yet Friday they were declining again, indicating that predicting the bottom for these firms will be tough to do. In addition, Wall Street's bond alchemy involving mortgages is infecting other parts of the financial system.
A worldwide sell-off in stocks last Monday was set off in part by the fear that firms such as Ambac and MBIA, which insured some of the mortgage-related bonds, wouldn't be able to handle all the risk they have incurred. If those firms were to fail to provide insurance, "it would be the equivalent of the FDIC all of a sudden disappearing," said Jack Ablin, chief investment officer of Harris Private Bank.
A rumor that the government might try to shore up the insurance companies eased fears and prices rose in those companies. But the ups and downs indicate that worries about the financial system are intense, and for good reason, Rodriguez said.
"We are in the worst credit contraction in 37 years," he said. "This is a crisis with no precedent."
Despite the interest rate cuts and government stimulus measures, "I think we will have the credit crisis through all of 2008 and some of 2009. It's spreading from housing to credit cards, auto loans, lease obligations and commercial loans."
That makes it more difficult for many consumers to get loans and, even with Fed rate cuts, people without perfect credit could have to pay more to get them.
Merrill Lynch economist David Rosenberg notes that shopping center real estate investment trusts have declined sharply of late because of the fear that consumers won't be shopping as much. And Forrester Research, expecting a global slowdown in spending by businesses, has cut its forecast for an increase in technology spending for 2008 to 5.2 percent from its previous estimate of 6.4 percent.
"The consensus among economists is that it's too late for the Fed to stave off a recession," Rosenberg said.
Rodriguez blames the credit crisis and the resulting slowdown in business activity on a breakdown in risk analysis within the financial system. "You heard the term `covenant light loans?'" he said. "That was just a euphemism for, `We don't have any underwriting standards.'"
He said he would not buy any financial company stocks until he starts seeing clarity in balance sheets. "They must recognize losses, and companies must go out of business."
Rodriguez is cautious about his investments now. Although he said the rescue measures may allow the economy to avoid a serious recession now, unsound lending practices are simply "being kicked down to road to get larger."
In the bond fund he manages, he is investing in no high-yield bonds, he said. And 90 percent of his investments in corporate bonds are AAA or AA - the highest levels with the most insulation against defaults in a weakening economy.
He is also not buying long-term government bonds because he assumes that eventually the government will struggle with the deficit it has built up, including perhaps $140 billion from the new stimulus package.
Meanwhile, when Oakmark fund manager Bill Nygren looks into the future he is much less worried. He said he is bargain hunting now rather than focusing on a possible recession.
"No one knows when it will turn," he said. "I buy stocks (such as financial companies) based on strong fundamentals where the panic might be overdone. I'm investing for five to seven years out, and it's very unlikely then that the focus will still be the dollar's decline, the mortgage mess, or expensive commodities."
Every weekday JewishWorldReview.com publishes what many in the media and Washington consider "must-reading". Sign up for the daily JWR update. It's free. Just click here.
Gail Marks Jarvis is a personal finance columnist for the Chicago Tribune and author of "Saving for Retirement without Living Like a Pauper or Winning the Lottery." Comment by clicking here.
Previously:
01/03/08: One word for 2008 crystal-ball gazers: Caution
12/11/07: Buy and hold isn't necessarily tried and true
11/26/07: Translating the falling dollar's implications for investors
11/13/07: Gradual retirement may not be key to happiness
11/05/07: Rate cut won't offer immunity to investors
10/29/07: Employers set to help workers save in 401(k) accounts
10/22/07: Playing bounce may be costly to stock investors
10/10/07: Investors find boring often can be fruitful
10/01/07: Make up lost time with swift, smart action
09/24/07: Balance is key for investing by retirees
09/18/07: Homeowners who wait see options fade
09/04/07: Easy matter to rate fund's performance
08/27/07: Mortgage mess could be good for savers
08/17/07: Small stocks are coming with large caveats
© 2007, Chicago Tribune Distributed by McClatchy-Tribune Information Services
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