The sentiment du jour is one of suspicion. There is still a crisis in trust and confidence. Few investors believe that earnings disappointments and asset write-offs in the financial sector are over, even though bank stocks have collapsed over 40% peak-to-trough and several bank CEOs have lost their jobs as a result of colossal losses. The Federal Reserve is working very hard to catch up on the deflation curve, but it remains to be seen whether the heightened effort will turn the stock market around. Even with the latest rate cuts, the damaged parts of the U.S. economy will not be turning on a dime.
In an effort to jumpstart a slowing economy, the Fed recently delivered rate cuts totaling 1.25%, the most concentrated dose of monetary easing on record. The rate cuts as well as the end of Fed references to inflation as a problem are important steps toward rebuilding investor and business confidence, especially since the domestic economy has dropped to the slowest pace since 2002 and the housing market slump continues to deepen.
A committed Fed will expedite the healing process in housing and house prices, the underlying cause of most credit market strains. In addition, it should ensure that corporate sector risk-taking does not completely dry up. Tack on fiscal help from Bush and Congress and the stimulus efforts should create positive support. Moreover, the U.S. non-financial corporate sector remains under-leveraged. It did not over-hire nor over-invest in the latest expansion. As a result, the self-reinforcing element of layoffs and wage troubles of past economic slowdowns should be averted. The recent sharp drop in interest rates may not immediately come to the rescue of housing and consumer spending, but benefits to the corporate sector should arrive soon in the form of a lower cost of capital.
Michael Ashley Schulman, CFA
Hollencrest Capital Management