Bulls bet they have weathered the worst
Wall Street surged Monday, lifting the Dow index to a record high, as big investors bet that the worst of the global credit crunch had passed -- and with it the threat of recession.
The Dow Jones industrial average jumped 191.92 points, or 1.4%, to 14,087.55, topping the previous record close of 14,000.41 set July 19.
After a summer of turmoil rooted in the housing market’s slump, stock prices have clawed their way back in recent weeks.
For many small investors, the rapid recouping of the market’s losses has put gains in retirement savings plans back into double digits. The average U.S. stock mutual fund, for example, is up more than 10% year to date, according to Morningstar Inc.
Banking giant Citigroup Inc. helped trigger the latest rally. Although the company said Monday that its third-quarter earnings would be slammed by losses on mortgage-backed bonds and other debt, Chief Executive Charles Prince predicted “a return to a normal earnings environment in the fourth quarter.”
That fueled new hope that the economy could avoid a serious downturn despite the dramatic upheaval in the financial system, analysts said.
“There’s an overriding feeling that we will keep the problems in the credit markets and the residential real estate sector from spilling over to the broader economy,” said Art Hogan, chief market analyst at brokerage Jefferies & Co. in Boston. “That has [investors] getting excited about stocks again.”
The market may have gotten a boost from the calendar on Monday: The fourth quarter historically has been the stock market’s strongest period of the year, in part reflecting optimism about the new year to come, said Sam Stovall, investment strategist at Standard & Poor’s in New York.
So investors may have been trying to get on board in anticipation of more gains over the next three months, he said.
Some analysts, however, warned that Wall Street may have become too upbeat too soon, less than seven weeks after the global banking system had been racked with panic, and amid a still-sinking housing sector.
“You don’t have the multiyear credit boom that we had just wash itself out in a month,” said Peter Boockvar, equity strategist at New York brokerage Miller Tabak & Co.
Home builders’ stocks were among those rallying Monday, but they have rebounded periodically since February, only to quickly fall back to new lows as the extent of the housing industry’s slump has become more apparent.
Still, what’s different now is that the Federal Reserve has begun cutting interest rates. In the housing sector, that could make it easier for some struggling homeowners to refinance to loans with more affordable payments, and that in turn could help shore up falling home prices.
The Fed next meets Oct. 30 and 31, and a consensus has built on Wall Street that it will cut its benchmark short-term rate again.
Investors have become conditioned in recent decades to believe that the Fed has enormous power to keep the economy expanding by lowering the cost of money.
The Fed was compelled to act amid fear of a financial market calamity stemming from rising U.S. mortgage defaults. In early August, banks suddenly pulled back from extending credit even to some high-quality borrowers, and to each other, causing the banking system to seize up.
The Fed and other global central banks began to pump money into the financial system Aug. 17 to encourage banks to lend. The Fed followed that with an aggressive half-point cut in its key rate Sept. 18, to 4.75% -- the first drop in four years.
Wall Street hit its lows just before the Fed acted in mid-August. The Dow closed at 12,845 on Aug. 16, a drop of 8.2% from its mid-July peak.
Lower interest rates often are bullish for stocks, at least initially. The Fed’s cut has trumped other concerns that might have weighed on the stock market, including record oil prices.
“Don’t fight the Fed” is a time-honored strategy on Wall Street, S&P;’s Stovall noted.
Investors also have been waiting to see the extent of the earnings damage incurred by major banks and brokerages as they write off mortgage-related debt and other loans that borrowers are struggling to repay.
Besides Citigroup, the parent of Citibank, global banking giant UBS also warned Monday that third-quarter earnings would be hammered by charges related to credit troubles.
The write-offs probably will amount to worst-case scenarios to account for problems the banks already incurred and any that may be on the horizon, said Jefferies’ Hogan.
With that kind of “kitchen sink” approach to write-offs, banks try to wipe the slate clean and show investors they can quickly return to profitability.
Yet many experts say it isn’t clear that the banking system, or the economy, has felt the worst of the pain from the housing market’s troubles and the woes of other borrowers who built up heavy debt loads this decade.
“What’s been driving the economy in the last few years is a lot of borrowing,” said Tom Higgins, economist at investment firm Payden & Rygel in Los Angeles.
Higgins said interest rates were not likely to fall sharply enough to help many borrowers with adjustable-rate mortgages that will reset in the next year. And those with shaky credit won’t be able to get new loans, he added, because lenders have tightened their standards.
William Poole, president of the Federal Reserve Bank of St. Louis, warned Friday that “financial fragility is obviously still an issue,” given the losses faced by many banks and brokerages from bad loans.
Some market pros say the Fed may just have bought investors a little more time before they’re confronted by more fallout from the credit crunch and the housing debacle.
“I think you just kind of pushed off the critical decision point,” said Kevin Caron, market strategist at Ryan, Beck & Co. in Florham Park, N.J.
He worries that, just as in 2001, the Fed’s rate cuts will be too late to keep the economy from falling into recession -- which in turn could sharply depress corporate earnings.
Market optimists, however, point to economic strength outside the U.S. as a mitigating force that could help support the domestic economy. They note that U.S. exports are booming, thanks to the weak dollar.
Stocks’ rapid comeback from their summer swoon also may persuade many investors either to stay put in the market or to put more money to work there, figuring that it makes more sense to bet on stocks than against them -- at least until the broad economy begins to show serious signs of stress.
“Every time I get bearish the market makes me look more foolish,” said S&P;’s Stovall.
One key measure of the domestic economy is due Friday, when the government reports on September employment.
The August employment report, issued Sept. 7, was one of the factors that helped persuade the Fed to cut interest rates, economists say. That report showed the economy lost a net 4,000 jobs -- the first outright decline in four years.
If the September data also are dismal, the stock market could view it as good news on the assumption that the Fed will order more rate cuts, analysts say.
And in the often upside-down world of Wall Street, a strong employment report could trigger a market sell-off if investors believe the data would give the Fed a good reason to hold off on more rate cuts, said Miller Tabak’s Boockvar.
The rising stock market also could give the Fed pause, Boockvar said.
“I’d be really surprised if the Fed cut rates with the Dow at all-time record highs,” he said. “We rallied because the Fed is there to cut rates, and now we’ve rallied ourselves possibly out of rate cuts.”
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walter.hamilton@latimes.com
