Is the Worst Over?

I find myself thinking “the worst is over.” To keep that feeling in check and hopefully prevent myself from getting snared in a bear market rally, I thought that it would be useful to ask the question: what if we’re not in the 8th or 9th inning---what if we are just in the dreaded 5th inning?

One of the main thorns in the side of the rosy outlook is housing. Considering that all of the problems that we are currently encountering stem from housing, the fact that it is still in the tank is problematic. We need to see home sales and prices stop falling and for buyers to come in and sop up the excess inventory. Until home prices find a bottom, delinquencies will continue to rise, keeping credit markets unsettled and relatively tight, and consumer confidence and spending anemic.

In addition to the housing/credit crunch, there is also the issue of soaring energy and food prices. Crude oil closed at $124 on Friday, up from $88 in early February and from $50 in January, 2007. The powerful move has come without a significant correction or even an extended sideways move. I had expected that the US/G-7 economic slowdown would dampen energy prices and in those areas, demand has certainly abated. However, in certain parts of the world (China, Russia and the Middle East), domestic oil is subsidized – obviously there is no incentive to reduce demand when you are not paying the full price to fill your tank.

The World Bank reported that over the past three years, food prices have increased by 80%. What is important to note is that farmers are producing record harvests, so the problem is not supply, it is an increase in demand, which has sent prices of rice, wheat and corn skyrocketing. The good news is that the global food crisis likely peaked in April-March and since then, agricultural commodities have pulled back.

As I continue to weigh the inning count, I think that the best news is that time that has elapsed from the March 17th lows without additional negative surprises. The “post-Bear Stearns” period has been healing in nature, allowing the US economy and financial system to absorb and recover from the myriad of body blows it has taken. Given all that has occurred, I am often struck that markets (and investors, for that matter) have been as resilient as they have been. The bears will note that there could be more problems ahead, but I come back to the fact that real negative rates exist; aggressive Fed policy/monetary easing should persist; and we are awash in liquidity. All of these factors should be bullish for the stock market and the economy over the long term.