A 416-point stock market rally Tuesday seemed to rescue investors temporarily from the bear’s claws, but they have to wonder if the beast is truly gone.
Analysts aren’t confident that last week’s surge was anything more than one of the powerful rallies that often come during bear markets. Typically, they provide a short breather, but then are replaced by new worries. That was the case last week, as the Dow industrials ended the week with a loss of nearly 200 points.
Tuesday’s rally was set off by an innovative move by the Federal Reserve to relieve some of the tensions on lenders and get money flowing to borrowers by letting lenders use distressed mortgage-related bonds as collateral for loans from the Fed. But stocks remain well below their record highs; a common view is that a recession is now unavoidable and the bear market has not run its course.
“They still have not resolved the defaults and delinquencies in housing,” said Tom Atteberry, manager of the FPA New Income fund. “All of that is a full 2008 event, maybe into 2009.”
Atteberry said the Fed “took some of the near-term fear” out of the financial system, “but there will still be defaults.” Lenders will still wonder: “Do I get paid, and what loans will I have to forgive?”
More pain ahead
Despite more than $150 billion in write-downs that companies have taken on bad mortgages and mortgage-related securities, the expectation is that financial problems are far from over. Goldman Sachs economist Jan Hatzius is estimating that losses will ultimately total $400 billion.
For investors clinging to last week’s rally for a sign of hope, Atteberry delivers some bad news: The economy must go through the painful process of losses, after years of too much leverage — or spending and investing with tremendous levels of borrowed money.
Still, that doesn’t mean the stock market will “remain in the superdepressed land,” for years, notes market historian and strategist Steve Leuthold, founder of the Leuthold Group. “In a free economy, the cycles of expansions and contractions are as inevitable as greed and fear.”
As news of write-downs trickles out, investors are expected to remain nervous, unsure about the extent of unwelcome surprises in the banking system, or the effect they will have on banks’ willingness to lend money.
But by the time the economy looks the most bleak, Leuthold said, the market will start to come out of its funk, if history is a guide.
More signs of recession
Currently, economists are reading the signs that the economy is entering a recession.
The most recent job market data “leaves little doubt that the economy is in a recession,” Hatzius said. Also, he sees further weakness as consumer spending remains sluggish and job losses spread.
Last week, the retailer that seemed most resilient was Wal-Mart, as analysts speculated that financially stressed consumers are “trading down,” or shopping for cheaper merchandise that they normally do.
Consumers are hurting on two fronts, according to Merrill Lynch economist David Rosenberg. They are losing on their homes, as prices have dropped 10 percent on a national basis and more than 20 percent in some markets. On top of that, they see their portfolios shrink. Household net worth collapsed by $530 billion in the latest quarter, he said.
Those seeking a soothing message may have trouble finding it.
“Markets are still chaotic, and we have no confidence that the biggest upheavals are behind us,” said economist Ian Shepherdson of High Frequency Economics.
Still, market strategists are reminding investors that bear markets are a normal part of investing and that this one, too, will end.
Leuthold recently raised his exposure in stocks to 50 percent of his portfolio, from 30 percent, despite his belief that the bear market is only about half over.
He thinks the economy entered a recession in November, and typically the stock market hits bottom about six months into a recession, or roughly halfway through the average 11-month duration of a recession.
Even if the recession is worse than average because of the housing debacle and credit market freeze-up, Leuthold said, investors are probably on their way toward a recovery. The two longest recessions since World War II lasted no more than 16 months, he said. That means the stock market should bottom about nine months into the recession, or this July or August.
He estimates that the Standard & Poor’s 500 might dip to 1210, or a 23 percent decline from the Oct. 9 high. That would make the current bear market a mild one, compared to the average drop of 37 percent.
The rationale: Deep declines are often propelled by excessively expensive stocks. But in this cycle stocks have remained close to the long-term median price-earnings ratio of 17.3, Leuthold analyst Eric Bjorgen said.
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Contact her at gmarksjarvis@tribune.com.
