The normally cheerleading Wall Street Journal, contrary to its usual form, voices considerable doubts about the near-200-point runup in the Dow yesterday:
Stocks soared to a new all-time high….suggesting that investors already are shrugging off the problems that rocked global financial markets only weeks ago….. The scamper to new highs comes despite surging mortgage defaults, the collapse of big buyout deals, a plunge in the dollar and growing fears of a recession.
Just yesterday….Citigroup Inc. announced a $5.9 billion hit….UBS AG said it was taking $3.41 billion in write-downs….
Rather than disrupting financial markets, the revisions seemed to bolster investor confidence that banks are taking their lumps and losses are mainly in the rearview mirror. Both banks saw their shares rise.
The optimists’ key assumption is that the Federal Reserve has the situation under control….
Yet housing, the source of the market’s late-summer woes, remains unstable. Over the next 12 months, Americans holding home mortgages with a total value of nearly $480 billion will face revised interest rates, typically as the low “teaser” rates that drew them in are reset at higher, market rates, according to data from Moody’s Economy.com. About 55% of these mortgages, or $260 billion, are loans given to subprime borrowers, generally people with poor credit, the data show.
Normally the stock market reflects expectations for the economy’s direction, which is why housing skeptics are scratching their heads over the Dow’s surge. One factor may be that, amid low interest rates and the freezing of credit markets, people with cash to invest feel little alternative but to put it in stocks.
It also may be that stocks are experiencing a false dawn. On several occasions during the collapse of the technology bubble early this decade, investors grasped at straws to argue the crisis had passed. Instead, the stock market’s down trend lasted for 2½ years, and the real resolution came after tech and telecommunications companies had completed several painful rounds of shedding debt and refocusing their businesses….
If more mortgages go bad, that could force banks and other financial firms to take repeated write-downs of the value of securities backed by mortgages. That could further roil debt markets and affect the stock market, given that financial institutions comprise 30% of the profits of the companies in the Standard & Poor’s 500 stock index.
“I think you’re going to get this constant flow of hits going forward, spread out over multiple quarters,” said Bill Laggner, a partner at hedge fund Bearing Fund LP, which has bet against financial institutions and other stocks involved in the housing market.
“A lot of people think that it doesn’t matter what happens, that the Fed will rush in and find some way to save some of these larger institutions and the various assets that they own,” Mr. Laggner said. “But I don’t see how there’s going to be a market for a lot of this paper for a long, long time.”
This much openly-stated skepticism in a front-page Journal story is a big near term bullish signal. Even if you don’t believe in this rally, I’d give it at least a couple of weeks based on this story alone.