The Bulgarian Optimist

I recently heard a great joke that reminded me of the current economic and market conditions and the emotions surrounding every trading day. I should preface this by saying that if you are not familiar with Bulgarians you should know that they have endured a brutal history, which has earned their citizens a reputation as being some of the most untrustworthy and cynical folks from the former Eastern bloc. Here’s the joke: Two Bulgarians meet each other on the street. The pessimist says, “Things can’t get worse!” to which the optimist says, “I think they can get worse!”

I know that it would have been nice to think that Tuesday’s rally in stocks would be the much-anticipated bottom in the price of stocks. (If you were sleeping for a day, stocks shot up by 3.5-4% after the Fed announced that it was dropping short-term rates to 2.25% from 3%. The Dow enjoyed its biggest point gain since July, 2002 and financial companies reversed Monday’s losses after stronger-than-expected earnings from Lehman Brothers and Goldman Sachs. Even Bear Stearns added 23% to $5.91!) I heard a bunch of pundits quoting the Bulgarian pessimist, noting that the Bear Stearns deal was evidence that perhaps things can’t get worse.

I hate to insult the Bulgarian pessimist or American optimists, but the Federal Reserve’s two-tiered actions--providing financial institutions creative access to liquidity facilities and cutting short interest rates to help beleaguered consumers--can not stop the housing market from falling and the housing data has not yet indicated that the damage is done. In fact, this week it was announced that building permits fell to the lowest level in 16 years in February. From where I sit, the housing market continues to hold the key to providing confidence to investors and by extension, forming a true bottom in stocks.

We should not be surprised that it takes time for recovery. When a good idea (“I should use cheap money to buy assets that I think will rise in value!”) turns into a boom (I’ll only put down 10%) and then a bubble (I don’t have to put down anything!), the aftermath is not pretty. Perhaps that is why Joseph Stiglitz, the Nobel-prize winning economist and former chief economist at the World Bank, told Radio New Zealand “This is clearly the worst financial problem we've had since the Great Depression…More and more Americans are going to walk away from their mortgages, and that's going to undermine the foundations of these banking institutions.” In other words, the Bulgarian optimist may be right---things can get worse.