U.S. stocks have rallied nearly 10% over the last month based on a handful of positive developments. First, the Federal Reserve-orchestrated buyout of Bear Stearns greatly reduced the probability of a financial system collapse. The President and Congress seemed committed to prevent a deep recession in this election year. In addition, many bank CEOs have expressed confidence that the worst of the credit market turmoil has passed. As a result, many investors expect that any recession will be short and shallow, with stronger economic growth just around the corner. Finally, first quarter corporate earnings, excluding GE’s surprising disappointment, have been better than expected from large companies such as Intel, IBM, Google, Caterpillar, JP Morgan, Honeywell, and Citigroup.
However, this may just be yet another bear market rally, and it is prudent to take a little off the table, based on the following:
- The credit markets continue to show signs of significant stress. This week’s big news was that banks may be under-reporting their true borrowing costs in the LIBOR markets, resulting in a substantial rise in borrowing costs over the past few days. If banks continue to hoard cash, then the borrowers most in need of credit have no access. This leads to slower economic growth, and a long de-leveraging process.
- Data released this week indicates the housing market continues to deteriorate. Housing starts have plunged to the lowest level since 1991, and declined by double the rate expected by economists in March. Housing weakness triggered the credit market turmoil, so it is difficult to see the light at the end of the tunnel without some signs of stability in the housing market.
- Commodity price inflation shows no signs of slowing as crude oil touched a record $117 a barrel today. There is a global shortage of key commodities, subjecting consumers and corporations to higher cost burdens at a difficult time.
- Major stock indices are now trading at the top of a range that has persisted for much of 2008.
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