The Stock Market: Less Bad, Not Yet "Good"

In the following article, we talk about hints of improvement in stocks and in the economy. These are important recent developments. At the same time, we also want to call your attention to an important article that appeared in Sunday's New York Times, titled "My Personal Credit Crisis", by Edmund Andrews. Andrews is the Times reporter who covers, of all beats, the Federal Reserve. He became trapped in the same mortgage and credit mess himself that he had been describing in his very own cautionary articles. It's a hard story to read, but you should – and so should any young people you know. See how easily this happened in Andrews's household, so maybe you can help keep it from happening in yours. http://www.nytimes.com/2009/05/17/magazine/17foreclosure-t.html?hpw.

More, today, the Senate passed a bill reforming credit card regulations, and the President announced new gas mileage standards that will be set by auto make and model. We'll give you a take on these in the next week or so – along with other recent government interventions.

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Ways of the World last discussed the stock market on March 9. We wondered then, along with two well-known business publications we cited, whether stocks would fall precipitously further or only a little further. The specific question was whether the Dow Jones Industrial Average, then at about 6450, would fall as low as 5000. As it turned out, that very day was the low in the various stock market indexes, which have since risen about 30% in a massive rally; the Dow is now just above 8500. How could this be?

The upturn in stocks suggests that investors believe the economy will turn around in the foreseeable future. It says nothing about exactly when, nor how strong any rebound might be. The evidence we have so far is sketchy, and some could accuse investors of grasping at straws. Actually the current metaphor, popularized by the Fed Chairman when he appeared on CBS 60 Minutes in March, is "green shoots": hints at favorable forces that may evolve into vigorous new plants or might instead fail to set down roots and so wither away.

Companies and Consumers Recuperate
The most significant determinant of stock prices is company profits. During several months at the end of last year, the companies making up the major Dow Jones and Standard & Poor's indexes suffered outright losses. This was the case for the Dow components in August, September and October, and for the S&P 500 group during the fourth quarter (Q4). These negative results, particularly for the S&P companies, were reported with the financial statements issued during the first quarter of this year (Q1), and stock prices came under severe downward pressure. It seemed that all the bad, panic-stricken news of last autumn might be repeated. But then, subsequent reports showed some improvement. Even if business didn't get much better, companies that had taken huge write-offs in Q4 didn't have to suffer those adjustments again, so their bottom lines were not so bad. Huge cost-cutting efforts also paid off, and businesses reduced their inventories, saving them further expenses.

There were hints of improved business, too, though. Consumer spending (that's the shopping you and I do) increased in Q1 after falling in both Q3 and Q4. Those declines had made the weakest consumer spending performance since the 1980 recession. And there is little assurance that the early 2009 rise will be sustained; indeed, it occurred in January and February, while March and April saw some backtracking. Even so, stock analysts seem more confident in recommending consumer goods and retailing industry stocks at present. In Monday's stock trading, for example, Lowe's, the home improvement centers, reported declining profits in Q1 from a year ago, but the decline was less severe than analysts had projected. So Lowe's stock rose smartly on the basis of this relatively positive development.

Hints of a Bottom in Housing
There are also signs that housing is reaching a bottom. Construction starts for single-family houses, though still historically low, have stopped falling, according to April data reported this morning. And the National Association of Home Builders reports that its members have shown a second month of modest gains in their survey of "sentiment" about the housing market. Low home prices and low interest rates are making for better market conditions for would-be buyers. However – there's always a "however" or an "on the other hand" – there remain huge inventories of unsold houses, which will likely limit much resurgence in construction activity. And construction of apartments, townhouses and other multifamily units was still down markedly in April. All of this building activity is at record lows in data that go back to 1959.

So the economic outlook is still murky. Companies are getting excesses worked out of the system, but renewed growth is another question altogether.

Stock Volatility Gauges Also Not as Bad – But Not Good
Finally, in assessing the stock market's condition, we have to lament that investors still have little confidence and that their valuations continue to move up and down widely and frequently. For instance, the Dow Jones average was up Monday, but it had alternated up and down moves every single day for the two prior weeks. It is true that last week the market absorbed a substantial amount of new supply; 30 companies raised $15.4 billion in new equity, following 20 companies the week before that raised $10.1 billion. It is no small matter that such a magnitude of equity investment funding is available, and in that light, the 5% decline in the price of an average share in the S&P 500 last week can be seen as quite modest. Still, prices remain unusually volatile. A standard gauge of volatility, the statistical measure called the "standard deviation" is running at about 8% of the S&P 500 price level, sharply higher than its average of 2.8% over last 37 years. So people seem still to have no firm conviction on the sustainable value of company shares.

In prior recessions, once stocks have moved ahead for more than about four months, the economy has tended to move into a recovery. Last week was the first such positive reading for the S&P 500 in this cycle. But we hesitate to call this a true signal because of the extreme volatility. As if trying to confound our analysis even more, another measure of volatility, the Chicago Board Options Exchange "VIX" index has improved of late, and today moved below 30 for the first time since last September 19, down from a peak of nearly 90 in late October. Its historical range has been 10 to 20. So this gauge is down, but not low. Is stability returning to markets – or not? Are we grasping at green shoots? Will they grow – or wither? Stay tuned.